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Front Loading vs. Back Loading
Posted 28 November 2011 - 05:02 PM
The question was asked why don't more teams front load a contract. Very good question. On the surface it may seem like a good idea for someone like Fielder or Pujols to get a heavily front loaded contract so that if you have to eat money in the twilight of the contract you have less to eat.
Well, this would be a false statement. Why, you ask? The time value of money. It is nearly always better to back load a contract (somewhere Jim Hendry is saying SEE I TOLD YOU SO)...that is in theory.
Every day you can delay spending a dollar is becomes more expensive to spend that dollar. Using a rough average of inflation from the past 70ish years (going off memory here from when it started) of 3% (I believe it is actually closer to 2.6% (and this is if you can trust governmental figures)) it costs you .008219178% of that dollar just by waiting one day. Small beans, sure, but when you are talking about a $130M payroll it adds up ($3.9M per year (or roughly Koyie Hill's intangible value to a team)).
So lets say that you sign Fielder to a 8 year $200M contract that pays him $1M for the first 7 and $193M for the final year. Just through inflation that $193M is would cost you $156M if you paid it today. Sounds like a bust, right? Well...
Now let us say you take that you have that $156M lying around to invest. Let us say you are Tom Ricketts and are in charge of a international investment company where you can earn 5% (definately not outside the realm of possibility even in this market with that much money) on your money. That $156M grows into $220M or a profit of $27M over the cost of inflation (or $15M after a 45% state, local and federal tax rate).
Obviously, doing this whole hog is nearly impossible, but if you could do it for 20% of your payroll? Extra $2M in free money coming in.
Why don't more teams do this? 1. Very few teams, if any, have that much money just lying around they could do this with, 2. Agents know about this as well so you would have to up the ante to where it might not be feasible to do this, 3. Owners, PBO's, GM's would be more likely to take that $156M and throw it into payroll some year to land a couple big names to try for immediate contention.
Front loading to this extreme would only make sense if you thought that there was going to be a period of stagnant investment returns coupled with hyper-inflation. If inflation was going to be at 10% for those 8 years but you still thought you could only get 5% investing then you would lose $29M by back loading.
Or, if your team has a giant cash infusion some year (say, possibly due to a new stadium) but you wanted to keep payroll flexibility in the future and aren't sure you can make more investing.
All in all, if you were to build a team from scratch or buy a team and have tons of cash sitting around for the payroll and you had access to a good investment firm not ran by a man named Bernie then you would want to back-load the deals as much as possible.
Posted 28 November 2011 - 08:17 PM
Posted 29 November 2011 - 06:55 AM
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