On Free Agent Draft Compensation and Making Trades

This time of year, trade ideas are thrown around like so many flying fish in Seattle. Most will never happen – indeed, most could never happen – but it’s still fun. Let’s send this overpriced, skill-declining guy to this team for these seven top 100 prospects. I could totally do this GM thing!

Increasingly, however, pundits and bloggers are tossing some poo in the proverbial punch-bowl: draft pick compensation.

As they explain it, when considering trading a soon-to-be free agent veteran, one must also consider the fact that, if the team simply kept the player, they would totally get draft pick compensation for him at the end of the year. That’s pretty much how those folks leave the discussion – as if mana from heaven, the draft picks just float down upon the lucky team. Grrr! Don’t trade soon-to-be free agents!!!!1!!!1!!!!

But here’s the thing about draft pick compensation. It ain’t that simple. Or exclamation point-y. And for the 2010 Chicago Cubs, knowing the finer points of draft pick compensation is critical to understand the moves the Cubs make – and the ones they don’t.

In order to receive compensation picks for a lost free agent, four things have to happen: (1) the player must be designated as a “Type A” or “Type B” free agent; (2) the player must be offered a one-year contract via salary arbitration; (3) the player must decline the offer of a one-year contract via salary arbitration; and (4) another team must sign the player, knowing that they may be giving up a draft pick to do so. Each step in the process presents significant hurdles.

First, the player must be in the top 20 percent of players at his position (as designated by the Elias Sports Bureau) to qualify as a Type A free agent, or in the top 40 percent, but not the top 20, to qualify as a Type B free agent. The former designation yields the team that loses the player a first round pick (unless the signing team has one of the top 15 picks, in which case it becomes a second round pick) and a sandwich pick between the first and second rounds. The latter designation yields a sandwich pick.

Second, the player’s team must be willing to offer him a contract for the following season without knowing exactly what his salary is going to be. Far more importantly – and far too often overlooked – is the fact that player’s salaries do not decline in arbitration. In fact, by the Collective Bargaining Agreement, a player’s salary in arbitration can be reduced by only as much as 20%. Veterans in particular are treated very well by the arbitration system. And the team offering arbitration must be cognizant of the fact that the player might very well accept the offer of arbitration knowing that, although he’ll get only a one-year contract out of the deal, it will be for a much higher rate than he could procure on the open market.

The correlate to the second step is the third step: the player must actually decline the offer of arbitration. As discussed above, a one-year contract with a salary likely to be higher than the year before is a very attractive option for an aging veteran, particularly in the current economic climate. Are you telling me that if you’re Derrek Lee, you would turn down a guaranteed one-year $13 million contract on the hope that you can land a multi-year deal for comparable money somewhere else? Of course you wouldn’t – and neither would he.

Finally, some team out there – with full knowledge of this whole losing-a-draft-pick business – must sign the player. For most free agents, this is not a huge hurdle. But just two years ago, free agents Orlando Hudson and Juan Cruz went unsigned deep into the offseason because they were Type A free agents. For less expensive guys like that, the prospect of going unsigned until the draft pick compensation hurdle goes away is very real.

If the player is a Type A free agent, a prospective signing team is going to think long and hard about offering him a contract, knowing that doing so will cost them a first or second round pick. Time was, this was never even a consideration – in fact, you rarely heard about draft pick compensation when it came time for your favorite team to pepper the free agent landscape with contracts. But as draft scouting becomes more precise, and cost-controlled younger players more valued, careless signings without regard for losing draft picks has gone by the wayside.

That’s why, for virtually every tradeable piece on the Chicago Cubs, the team should be looking to make move now, rather than hope for free agent compensation when guys like Ted Lilly or Derrek Lee walk. Of the impending Cubs free agents, none are likely to make it through the four step process outlined above, which would be necessary to yield the Cubs draft picks for their departure:

Ted Lilly – Obviously he’s the most likely of the Cubs to be traded in the coming days, but should the Cubs balk at a return of anything less than two first-round-pick-caliber prospects? First things first, yes, Lilly is highly likely to be a Type A free agent. At last estimation, he was a borderline Type A before back-to-back excellent outings. Assuming he doesn’t fall off a cliff this year, he’ll remain a Type A.

But Lilly carries a $12 million salary, so offering arbitration would result in a very expensive 2011 contract if he accepts. Then again, he might well decline, as he’d be able to get a multi-year deal – but is Lilly the kind of front-end ace that is worth giving up a first rounder for the privilege of signing to a multi-year, $12+ million per year contract? I’m not convinced, and there remains the chance – however unlikely – that Lilly would view a one-year $13-14 million contract to stay in Chicago as not a bad deal. Not trading Lilly in the hope of getting draft pick compensation would be defensible, but is a risk that the Cubs should avoid if they can get a decent return for him before the deadline.

Derrek Lee – The case for Derrek Lee is probably simpler. Lee carries a very high salary ($13 million), he’s aging, his skills are unfortunately declining, and it’s almost impossible to imagine him getting a big money multi-year deal. In other words, there’s almost no chance he declines arbitration, which would guarantee him a salary next year well over $10 million. If the Cubs can trade Lee for anything more than a career minor leaguer, they should do so. That is true even if they want Lee back next year – there’s nothing stopping them from signing him as a free agent this winter (and to a deal much cheaper than they would get in arbitration).

Xavier Nady – In Nady’s case, his 2010 salary ($3.3 million) is in the right range, and given that he will be healthier next year, he might well decline arbitration on the hope that he can get a multi-year deal. But that’s all academic, as he’s not going to be a Type A or B free agent, having been on the shelf last year, and unproductive this year.