Evaluating pre-FA Contract Extensions

Every year a handful of players yet to reach free agency agree to contract extensions with their club, granting the club control of some of their free agent years in exchange for otherwise unattainable financial security. For the player, this usually means they've just made their first fortune. For the club, it means financial and personnel certainty. And everyone goes home feeling all warm and fuzzy because the possibility of the least desirable scenario (being for the player, suffering a sharp decline and never seeing a big pay day or, being for the club, the player darting for another team as soon as he is eligible free agency) is gone.

Long term extensions operate under the same set of assumptions any other contracts do. As a result, there are good ones (Evan Longoria) and bad ones (Vernon Wells). On the whole, they're a good thing for both teams and players, but there's always a non zero chance of a player leaving $50 million on the table or a team's MVP candidate turning into Richie Sexson.

I only mention this to make a point. Our perception of long term extensions seems to be skewed. When a player signs a long term deal, it's usually universally viewed as a positive thing for a team. If it were, everyone would sign one. The reason we see only a dozen or so a year is because it only makes sense for certain players and certain teams.

The bias in our perception isn't merely a coincidence, it's a systematic bias that stems from a few common pitfalls of evaluating a long term contract extension. The main pitfall involves comparing a player's salary to what the market would pay. Someone might point to a contract, note the player is paid less than the market would for his services, and conclude the contract is a club favorable one. The problem with evaluating a contract like this is, well, he was going to be paid less than market rate during his arbitration and pre-arb years, anyway. That's the way the system is set up, and salaries of long term extensions generally fall in line with what one would expect the player to earn in arbitration or free agency, given their otherwise eligibility.

Other factors like failing to consider aging or quality of team and opposition play a role in our skewed perception of these deals, but the flawed base line is the main thing. But, if we can not use market rate as our base line, how do we evaluate these contracts?

The best way I know of is to convert everything into surplus value (trade value, if you will) and consider three scenarios. Scenario one being what actually happened, the extension. Scenario two being what would happen if no extension ever happens. The player goes year-to-year until he hits free agency, at which point he packs his bags and heads elsewhere. Scenario three being the player is paid market rate (discounted for arbitration and pre-arbitration classification accordingly) for the life of the contract.

By subtracting the surplus value of scenario two (nothing) from that of scenario one (extension), we get a nifty number. That number tells us, quite simply, how much overall marginal surplus value the club has added by signing the player to the extension. This is obviously the most important number to consider when evaluating these deals. However, some of this surplus value comes from the way the market values players. For instance, if you're dealing with a type of player that the market generally under values, locking him up for many years at market rate is going to produce a lot of surplus value in itself, without the GM doing anything he couldn't have done on the free agent market. Therefore, to see how efficient an organization was with their spending, we subtract the surplus value of the contract at market rate from the surplus value of the actual contract. This tells us little useful information, only how efficiently the organization invested their dollars. Or, how much of a "home town discount" the player gave.

There's one final analytic metric I'll use to evaluate these deals. We'll call it bang for your buck factor (BFYBF), for lack of a better name. It's simply the first metric (surplus value of extension minus surplus value of the contract the day before the extension was signed) divided by total guaranteed dollars. The more surplus value an organization is able to extract per invested dollar, the better, which is basically the idea here.

In the 2010 pre season, ten teams guaranteed a combined $393.8 million to 15 players who have never been eligible for free agency over 51 years in extensions that granted the club control of at least one of their free agent years.  My original intention was to determine what the most club friendly extension is, which led me to ranking the fifteen contracts, the results I'll now present.

Here, I'm going to talk about the five best pre-FA contract extensions signed during the 2010 pre season. Next week, I'll discuss the other ten and present the raw data. For these rankings, I weighted each metric equally. This doesn't mirror reality, of course, but it does give us a nice balance, which is all I'm really looking to do. VORC = Value over replacement contract. The replacement being what he had before the extension was signed (year-to-year, presumably). VOMC = Value over market contract. The surplus value of the extension minus the surplus value of the hypothetical extension at market rate (adjusted). BFYBF = Bang for your buck factor.

1. Justin Upton. 6 years, $51.25 million. VORC: $26.1 million (1st). VOMC: $22.6 million (1st). BFYBF: 0.51 (5th).

Actual extension:

Year-to-year:

Market rate:

The Diamondbacks are paying significantly below market rate for an elite player two years into free agency. No other extension signed this off season accomplishes that.  Does Justin Upton strike you as any more risky than a typical long term extension candidate?  It doesn't seem like the case to me, but I'll listen to any argument.

t-2. Chris Iannetta. 3 years, $8.6 million. VORC: $6.8 million (5th). VOMC: $7.0 million (5th). BFYBF: 0.79 (1st).

Actual extension:

Year-to-year:

Market rate:

Am I being too kind when I give Iannetta credit for 7.5 wins over three years? CHONE projects 3.1 in 2010, the fans project 4.0, and I think Dan O'Dowd has very quietly signed one of the best extensions of the off season.  Maybe the market hasn't figured out just how bad catchers are at hitting baseballs.

t-2. Josh Johnson. 4 years, $39 million. VORC: $18.9 million (3rd). VOMC: $16.6 million (2nd). BFYBF:0.48 (6th).

Actual extension:

Year-to-year:

Market rate:

I used Tim Lincecum's arb 1 and arb 2 salaries as the base line for the arb 2 and arb 3 salaries of all three aces that signed long term deals this off season. This may not mirror reality, especially since the Marlins are rather shrewd with their money. Regardless, the Marlins locked up Josh Johnson at a very favorable rate. They basically got 75 per cent of the pitcher the Tigers got in Verlander for 50 per cent of the price.

t-4. Felix Hernandez. 5 years, $78 million. VORC: $19.5 million (2nd). VOMC: $14.7 million (3rd). BFYBF: 0.25 (7th).

Actual extension:

Year-to-year:

Market rate:

He's making a little bit less than the market would suggest he deserves during every year.  Truth is, he was an extremely valuable commodity before the extension, the extension just glorifies the notion a bit.  Then again, this is one that makes a whole lot of baseball sense.  The added benefit of locking the most talented pitcher in baseball up for his age 24, 25, 26, 27, and 28 seasons makes this deal a no-brainer.

t-4. Franklin Gutierrez. 4 years, $20.75 million. VORC: $11.0 million (4th). VOMC: $10.8 million (4th). BFYBF: 0.53 (4th).

Actual extension:

Year-to-year:

Market rate:

Even if his 2009 production isn't sustainable, I feel like I've been fairly conservative with his win totals. I think it's very likely he'll be worth 13 or more wins over the next four years. And I think this is one of the best contracts in baseball.

The explanation as to how I came up with these images and surplus value figures is here. Basically, it's Sky's TVC, adjusted for a few more variables and corrected for current economic conditions.

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As an aside, this is my first post here.  I hope it's enjoyed by everyone and I look forward to contributing in the future.  Thanks to the BtB staff for providing me with this opportunity.