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Would frontloading contracts make sense for the Blue Jays?

Signing bonuses in particular have some interesting advantages (and downsides)

MLB: Tampa Bay Rays at Toronto Blue Jays Eric Bolte-USA TODAY Sports

There has been a lot of discussion and suggestion this winter that the Blue Jays should have been looking to significantly frontload the payouts on a long term signing, a proposition running counter to widespread practice. The main reasoning for this is intuitively enticing: with a young nucleus that is very cheap for the next couple years before hitting arbitration eligibility when their salaries will rise significantly, frontloading can offset that and theoretically prevent a budget crunch down the road.

To a lesser extent, theoretically it also makes the backend of a contract more moveable if the Jays want to go in that direction. Essentially, given that expected production for prime aged players is heavily front loaded, it more closely matches how the costs of a contract match the benefits received.

This is a subject that was particularly on my mind a couple years ago, when the Jays were in the depths of the rebuild and not spending on current wins. If cash budget allocation in those years could be used to prepay future salaries and essentially buy more future space, it was an interesting opportunity to contemplate (among other tactics leveraging financial resources like taking flyers on players who could be flipped or taking on dead money contract for prospects).

But it was actually something else that really got me thinking about it. In February 2019, Auston Matthews signed an extension with the Maple Leafs, in which a whopping $54.5-million of the total of $58-million was in the form of signing bonuses. That followed their signing of John Tavares to a similarly structured deal (~71 of $77-million as signing bonus), and would be followed in turn by Mitch Marner later in the year.

I barely pay any attention to hockey, but the Matthews deal came to my attention because of the tax implications. It turns out the under the Canada-US tax treaty, unlike salary, signing bonuses paid to US residents are taxed in Canada at only 15% (and vice versa). Since US federal tax rates are well in excess of that, the player can fully claim the Canadian tax paid as a credit against his US tax liability, effectively eliminating any tax disadvantage from playing in Canada (unlike on salary, where combined Canadian rates are higher than most US jurisdictions).

One of the reasons often cited that the Blue Jays have trouble attracting free agents is due to higher Canadian taxes, and end up having to overpay/outbid for them. It occurred to me that the Blue Jays could use a similar mechanism to largely eliminate this disadvantage, at least in the case of Americans or established US residents US.

What I didn’t realize at the time is to some extent, this had occurred. In 1999, Carlos Delgado settled on a one year deal to avoid arbitration for just over $5-million. Highly unusually, $3.25-million was structured as a signing bonus, with taxes explicitly mentioned as the reason. His next two contracts also had significant amounts of the first year payout in the form of bonuses. When Roger Clemens signed what was then the biggest salaried contract in December 1996, almost $10-million of the $25-million of the total guarantee was in the form of signing bonuses.

There is a significant risk for a team in doing this though. Another reason those Leafs contracts were particularly attractive for the players was the risk of another lengthy labour stoppage when the collective agreement expired after 2021-22. Unlike salaries, which get paid only for services rendered, the consideration for a signing bonus is literally just signing the contract. That money is payable regardless, effectively insuring them against another lost seasons wiping out prime earning years of their career.

Though the recent history is not as bad in baseball, that would certainly be a risk with tensions about the economic stricture between MLB and its players ratcheting up. And of course, the past year has demonstrated further black swan risk that wasn’t even on the radar. Salaries were pro-rated to the shortened season and reduced revenues. Signing bonuses would not be. There’s the further case of a PED suspension; while a player forfeits their salary, a signing bonus would not be.

On balance then, it’s understandable that the Jays wouldn’t be heavily employing signing bonuses to offset tax disadvantages. There’s real advantages, but also real risks and costs that make it a more colourable decision.

While big signing bonuses effectively serve to frontload contracts, they’re not necessary to achieve that. Let’s turn more squarely to the merits of frontloading as a strategy in and of itself.

We have two examples of the Blue Jays frontloading money in long term deals. Randal Grichuk signed a five year, $52-million deal that was effectively a four year, $47-million extension covering 2020-23 as he was already under contract for 2019 at $5-million. $18-million of the new money came by the end of 2020, with just $29-million in the last three years.

And even that understates the frontloading, since 2020 would have otherwise been Grichuk’s last year of arbitration eligibility, in line for something like $7- or 8-million assuming his 2019 was in line with his career. Assuming $52-million represented fair value for 2019-23, it would have been something like 5/8/13/13/13 rather than 9/14/10/9/9.

The more recent instance is George Springer’s 150-million contract, of which $60-million is actually paid out in 2021-22 between signing bonus and salary, compared to $50-million straight average annual value and CBT hit. The 40% paid out in the first two years is still well short of the ~50% of WAR expected, so in terms of purely relating cost to benefit, effectively it’s backloaded (just less so than otherwise or normal).

Ultimately, these are both quite modest examples of frontloading at around $10-million each, though more significant in Grichuk’s case as a percentage of the contract. But it wasn’t on the grand scale variously proposed if the Jays were to have gone after Trevor Bauer (or even with Springer).

Against the reasons at the outset in favour of frontloading Blue Jays contracts, I can think of several against it. And on balance, I don’t think it really made sense for the team to pursue.

First and foremost, for a given 2021 budget, any frontloading effectively reduces budget room and the number of 2021 wins that can be acquired. Considering that the Jays are coming from the very fringes of the postseason and a season in which despite finishing above .500 they allowed more runs than they scores, every marginal 2021 win that can be added is critical.

There’s also a potential feedback mechanism to this consideration. Consider the difference in interest and revenues from 2014 and early 2015, when the Jays were good, and what happened after they became a playoff level team. If buying those wins now puts them in the playoffs and boosts revenues, that will lead to increased payroll in the future to deal with those increased salaries. It’s a not zero sum game where less today means more tomorrow—and quite possible the exact opposite.

Moreover, frontloading money has a real cost in terms of present value: a dollar today is worth more than a dollar tomorrow. Granted, that’s not totally prohibitive if the player is accounting for that time value of money and willing to take a smaller frontloaded amount. But the historical record shows the reverse: players and agents want to get the biggest (nominal) numbers possible, maximizing total dollars and average annual values even if it’s backloaded and the present value is much lower.

Consider the contract Max Scherzer signed after 2014, seven years with a headline total of $210-million to average $30-million per year. But with the money paid equally over 14 years, at a 5% discount rate, it’s about the same as getting $26-million for seven years (at 7%, more like $24-million). On top of that, it’s almost certainly the case that a public corporation with an explicit market-based cost of capital has a higher discount rate than the player does, especially on a risk-adjusted basis.

In this respect, frontloading makes a lot more sense in a sport with a salary cap that a team is constantly up the Leafs. If the total you can spend is fixed in nominal terms, paying out a given amount sooner adds value that raises your real salary cap. But unless and until the Jays are consistently around the CBT threshold, that’s not the case here.

All that considered, it didn’t and doesn’t make sense for the Blue Jays to be significantly frontloading contracts this winter, even given what is sure to bean escalating cost structure to just to maintain a core moving toward the middle part of this decade.