The Baseball Analysts: Baseball Trading Economics 101

Baseball Trading Economics 101

By Doug Baumstein

As we enter the off-season with few marquee free agents on the market, the talk around baseball will start to revolve around potential trades. Fans, sportswriters and even real life GM's will start thinking about what they would be willing to offer other teams to get them to part with their stars. As George Costanza once mused, "I think I got it. How 'bout this? How 'bout this? We trade Jim Leyritz and Bernie Williams, for Barry Bonds, huh? Whadda ya think? That way you have Griffey and Bonds, in the same outfield! Now you got a team!" Unfortunately, a significant number of fans, sportswriters (and even the occasional GM) don't understand the basic rules that govern (or at least, should govern) trade value in baseball. So before the Mets go trading Jose Reyes and Mike Pelfrey for Johan Santana and Jason Bartlett, it is time to learn about the concept of lease equity.

Lease equity is, in a word (OK two), the easiest way to understand the trade market and assure that your team isn't selling its future for a short-term rental (yes, I am thinking of you, Houston Astros, for trading Jason Hirsh, Taylor Buchholz and Willy Taveras for Jason Jennings). The concept is simple, every player under contract has a certain value, in dollars, which is a function of the length they are under control and the amount of money they are owed. To figure out lease equity, you simply determine the difference between the relevant term of a player's contract and what that player would receive (or you, as the GM, would be willing to pay the player) as a free agent on the open market. So, if a player has a two-year contract for $10 million, but would likely get a two year contract for $15 million, that player has a lease equity value of $5 million. Significantly, lease equity value need not be positive. An albatross of a contract has negative value and, accordingly is only moveable as part of a salary dump. Indeed, a star can have negative lease equity value, as evidenced by the unwillingness of any team to pick up Manny Ramirez's contract a couple of years ago when he was left on waivers.

Under this scenario, it is clear that the most valuable commodity is a young star player locked up for multiple years. Indeed, a superstar at $15 million can have the same lease equity value as a replacement player at league minimum. Which brings me to an important concept, lease equity is not the same as quality. Having a team with lots of valuable commodities doesn't mean you will have success. Just ask the Florida Marlins, who have some great inexpensive players and not much success to show for it. Conversely, a team full of pricey veterans, think the Yankees, can be a powerhouse without a lot of contributions from its players with the most lease equity. A market priced Bobby Abreu or A-Rod added more to the Yankees success than guys like Joba, Hughes, Cabrera or Cano. What having a player with a positive lease equity value does is twofold: a GM can use that "saved" money elsewhere to improve his team within his budget or, alternatively, he can trade that value for other players who may have more value (as a player) or are a better fit for his team.

There are some other concepts that need to be understood, before we start figuring out how lease equity affects trade scenarios. The first concept is that control (i.e., the lease) is the key to value. Even if an arbitration eligible player does not have a contract for the next year, as long as his estimated value is higher than his probable salary (likely based on the arbitration rules), that player has positive lease equity value. The trick, of course, is estimating his salary and his likely free agent value.

The second issue to note is that lease equity value is market based. Unless a free agent takes a home town discount (which is rare because when a player signs an early extension, he is not really providing a discount but trading upside for security, just ask Chris Carpenter and the Cardinals), a free agent's lease equity is zero at the time he is signed. If the market determines that Gary Matthews or Juan Pierre is worth $50 million for 5 years, that is the market for a mediocre center fielder, irrespective if it is a "good" deal. The market is "right," because it constrains what a GM can do with his money or the lease equity value of the players he controls, the two primary assets that a GM has in building a team. Other signings also provide a good jumping off point for determining the values of players who are years from the market, like a Grady Sizemore (worth a lot more annually than Pierre or Matthews) or Lastings Milledge (probably fairly comparable).

The third issue to consider affects the way that "likely salary" is estimated. At this point, it's not unreasonable to assume that, if he hits the market a year from now, Johan Santana will command a six year $150 million contract. But $25 million a year is not the right number to plug in to determine his value in a trade right now. Santana is under contract for one year now at $13.25 million. If he went on the market and sought only a one year contract, he may well receive $30 million or higher. The reason for this is simple. As a one-year bet, the team takes a much smaller risk in terms of injury and future performance than with a long-term contract. Thus, a team would pay more, per year, for a shorter contract. After that, the player is still presumably available at market rate and the team can evaluate its needs then. Also, draft pick compensation if he leaves is also of some value. In other words, for evaluating trades, the shorter the remaining contract, the higher the assumption that needs to be made with respect to the per year annual salary.

The fourth issue to keep in mind is that, for prospects and young players, it may be hard to make a good estimate of future performance and reasonable minds may, and usually will, differ. That is how some players become busts and some trades for prospects go down as the worst in history. But just because it's hard, it doesn't mean it's impossible. The ability to project prospects is a cottage industry these days. Additionally, prospects are almost never likely to have negative lease equity value because if they fail, they will never cost much, and the option value of them being major league contributors can be estimated. Recognizing diamonds in the rough (think Terry Ryan getting Francisco Liriano as a throw-in for Pierzynski), is thus incredibly valuable to a team.

The fifth issue to note is that lease equity value in a contract may differ from team to team. When a player signs a free agent contract, the team that has the most need and willingness to meet that price makes the payment, thus establishing the value at the top. Based on market conditions, competitiveness and other factors, lease equity value in a trade can differ from one team to the next. The Mets might pay $35 million for one year of Santana, the Dodgers $30 million and the Royals $15 million. Those numbers factor into any offer that is made. Because lease value is subjective, each GM can determine it for his team separately.

The sixth issue to keep in mind is that lease equity value is a blunt instrument. Because we never know what a player will get on the open market (think of the collective reaction to Gil Meche's contract), the best we can do is estimate within a couple of million dollars. This may sound real rough, but when you factor in real numbers, you can see that it does not prevent appropriate consideration of trades. Also, because it is an art more than a science, there is no need to discount back the dollars in a salary or for determining equity value.

So What Is Santana Worth

Now comes the fun part, let's talk trade and value.

If the Twins decide they can't re-sign Santana this Winter, he will probably be the best player traded this Winter. As noted, he is set to make $13.25 million, at which point he will be a free agent and then may be acquired for "only" money at the market rate. For argument's sake, I am willing to say that if Santana was looking for only a one-year deal this offseason, he may fetch over $30 million. So let's assign a lease equity value to him, optimistically, at $20 million. Now, here in New York, no doubt based on his subpar September there are already beat writers and some fans talking about including Jose Reyes in a trade for Santana. Reyes is signed, including options, for the next four years (including an $11 million option in 2011) for $29.5 million. If Reyes were to be a free agent, for the four years covering his age 25-28 years, I think he likely would get $19-20 million per year, if not more, leaving him a lease equity value at around $45-50 million, far more valuable than a single year of Santana. (Note that I assume fairly high values for young players. This is because, unlike most free agents, if they were to sign today, a GM would be able to buy the peak years, whereas for most free agents, they are already at or past their peak.) It is also hard to see how the Yankees could give up the likes of Phil Hughes and Joba Chamberlain, or the Dodgers to part with Kershaw, Billingsley and Loney for one year of Santana. Of course, trades are made in a market, and if the Dodgers are offering multiple players with high lease values like Kershaw, Billingsley and Loney, then the Yankees better offer a more valuable group if they expect to complete the trade.

But Santana is not the most valuable pitcher likely to be the subject of off-season rumors. Dan Haren is under control for the next three years (including options) for $16.25 million. Considering Barry Zito's contract, three years of Haren is probably a safe bet to cost $60 million. That $45 million or so in value is, at minimum, a sign to any thinking GM that, before pulling the trigger on the winning bid for the Santana sweepstakes, he should see if Billy Beane will take that package for Haren. The other A's pitchers likely to be the subject of rumor, Harden (under control for 2 years at $11.5 million) or Joe Blanton (three years of ML service, so three years of control subject to arbitration eligibility) will be much better deals for the budget-minded trader. Indeed, Harden, with his injury history, probably wouldn't get much more than two years at $15 million total (although he could outperform that significantly), indicating that he is not nearly as valuable to most teams. If Beane gets offered Milledge or Clayton Kershaw for him, he should probably jump at it.

Concluding Thoughts

Long gone are the days when, because of the reserve clause, a GM would make a trade based on the pure baseball talent of the players at issue. Today, dollars are the primary mover of trades, whether it is in a salary dump or a trade of a bargain player that will soon become unaffordable as a free agent. Whether consciously or unconsciously, lease equity value appears to inform the thoughts of most GMs making trades. Even rich teams, like the Mets and Yankees, have recently refrained from doing whatever possible to bring in top talent, instead recognizing that young, under-control players are the coin of the realm in today's baseball market. Remarkably, most journalists and fans don't think this way, as is clear when they talk about what it will take to get Santana. But GMs know they have budgets and that they can't just give away young cheap talent in exchange for market rate stars and expect to succeed in the long run. As long as a GM is mindful of the value he controls and the market for players, he will be able to get the most out of his resources. And, next time you hear that it the Twins are "demanding" Grady Sizemore for Santana, calmly know that Mark Shapiro and the Indians, if they have any sense, are not going to bite.

Doug Baumstein is a New York City lawyer and Mets fan.

Comments

Wow, Boomer. You're finally published.

Posted by: Justin at November 14, 2007 7:50 AM

The concept is simple, every player under contract has a certain value, in dollars, which is a function of the length they are under control and the amount of money they are owed

I think it is not only simple, but simply wrong. It uses analysis that may be appropriate to "commodities" but is not appropriate to unique product like baseball players.

Because baseball players are unique, their value varies widely depending on the team they play for. Santana is a good example. Until you know the goals of the franchise, you can't really place a price on him. In baseball terms, what is he worth to a team which is in decline but still thinks it has a chance to win next year?

In most baseball trades, not only are the teams perceptions of a player's value different, but the actual value of the player to the two teams is different.

Using an analogy, if someone has five wheels for an auto and are dealing with someone who has only three, the value of the fifth wheel is much greater to the one who needs it than the one who has it. But the value of that fifth wheel may depend on where they intend to drive. In the empty spaces of the west, the 5th wheel may be very valuable but much less valuable to someone driving where they can quickly and easily get service for a flat. In fact, the person with the fifth wheel who is planning a long trip may not be willing to give up the extra wheel at all. On the other hand, the person with only three wheels may be willing to pay almost anything since they are going nowhere until they get a fourth wheel. In the real world of baseball, all the wheels that can get you to the world series are taken with the exception of a small number of free agents. For a team with three wheels, even one without much tread left is very valuable if they intend to take a trip to the world series this year.

Posted by: TT at November 14, 2007 8:21 AM

I think the concept picks up your concern.

"The fifth issue to note is that lease equity value in a contract may differ from team to team. When a player signs a free agent contract, the team that has the most need and willingness to meet that price makes the payment, thus establishing the value at the top. Based on market conditions, competitiveness and other factors, lease equity value in a trade can differ from one team to the next. The Mets might pay $35 million for one year of Santana, the Dodgers $30 million and the Royals $15 million. Those numbers factor into any offer that is made. Because lease value is subjective, each GM can determine it for his team separately"

In fact, the concept of lease equity comes directly from a field, real estate, that is the exact opposite of a commodity. Just as the spare tire you describe has different value if you are stranded out in the west or a block from the autoshop, so too can the right player be more valuable to a team, and each GM can determine that for himself. The point is, you can actually put a dollar value on it. If a GM is not looking at the net dollar effects of his trades, he is ultimately handicapping his team for the long run.

Posted by: Doug B. at November 14, 2007 8:55 AM

Sure, mortgaging the future is hardly a safe bet, but if it propels you to a ring...who cares?

If the Tribe somehow traded Adam Miller, Chuck Lofgren and a bunch of other prospects for a huge impact bat, say Miguel Cabrera since his name is on the market, then they win it all in 2008, are you telling me Tribe fans are going to complain because five years later, Lofgren and Miller are both solid #1/#2 pitchers?

I sure wouldn't.

Posted by: Steve at November 14, 2007 10:39 AM

I don't think it is appropriate to look at a trade retrospectively. If a trade leads directly to a WS win (which you can't know in advance, and maybe not after the fact), no doubt the lease equity value of the player was very valuable. Alternatively, if prospect becomes a star, 4 years later, that doesn't mean that his value was "wasted" by trading him before he blossomed.

More specifically, Cabrera for two years at an amount to be determined by arbitration (or settlement) has tremendous lease equity, probably between $20 and $30 million, which is probably more than the equity value of Miller and Lofgren combined, although I don't know enough about what a reasonable performance projection is for them over the next 6 years.

I am sure, however, that you wouldn't want to trade Carmona for Cabrera, because, although Cabrera may be better, the price and years for Carmona make him a more valuable property.

Posted by: Doug B. at November 14, 2007 1:27 PM

The problem with this is that you don't win by being financially smart. Sometimes you have to overpay to get someone. The idea isn't to allocate your resources the most efficiently but to win games. Joe Sheehan of Baseball Prospectus has a line in his column today about the same sort of thing:

"If you give me a choice between Andruw Jones or $70 million and Jeff DaVanon, I choose DaVanon and the cash."

At one level, this is correct, but if you don't spend your cash savings properly (or not at all), it defeats the purpose of signing a cheaper player.

Posted by: Tom at November 14, 2007 1:30 PM

Tom,

You hit on one of the key components. You don't win by having the highest lease equity value. The point of this concept is to properly value your resources, which are cash and players under control, so that you can create positive value from a trade and avoid being ripped off. But if your 'savings' are not put to use, you cannot expect to win. Indeed, at the trading deadline, a team in contention might be willing to vastly overpay for a rental because, at that point in the middle of the season, it is the only way to improve. My point is, even that can be monetized. The "do whatever it takes" mentality that tends to grip the media should not overtake good sense.

As noted:

"Having a team with lots of valuable commodities doesn't mean you will have success. . . . What having a player with a positive lease equity value does is twofold: a GM can use that "saved" money elsewhere to improve his team within his budget or, alternatively, he can trade that value for other players who may have more value (as a player) or are a better fit for his team."

Posted by: Doug B. at November 14, 2007 2:14 PM

An excellent explanation of the overwhelming majority of trades that happen in MLB. But in simple terms Doug you state the obvious, that MLB is about money. Go back to 1919 B-Sox Scandal. That happened because Comiskey wasn't paying his ballplayers enough. Everything is about money. The key in MLB and in all major sports is winning and trading for that key player at a certain cost to put us over the top and in the record books more valuable or are we better of being a medicore team and having our seats filled at 60-70% capacity. Very Very few teams in any sport are willing to trade players just to win. The Yankees and Steinbrenner is probably the best example of winning at all costs. His team is worth a billion dollars whether he wins or loses the world series.

Posted by: TrickyTroy at November 15, 2007 2:58 AM

The Yankees and Steinbrenner is probably the best example of winning at all costs. His team is worth a billion dollars whether he wins or loses the world series.

Is that true? Why are they building a new Yankee Stadium if money is no object? Steinbrenner wants to win, but he also knows winning is good business. A losing team doesn't generate the same revenue.

The Yankees also don't have an exclusive franchise in New York. If the Mets had performed like the Yankees the last 20 years and the Yankees like the Mets, Steinbrenner's franchise would be worth a lot less money.

Money is only one asset that teams have. Of course you can attach a monetary value to anything. That doesn't make it a useful exercise or clarify the real value of a player. The equivalent of one year of Johan Santana is not available in the market for any amount of money. No matter how much money a GM saves elsewhere, it won't get him Santana. And that is true of most baseball players.

As for using free agent salaries, they tell you virtually nothing about a player's real value. You are pretending an open market exists where there isn't one. The artificial scarcity created by the free agent system makes those salaries pretty much meaningless. Carlos Silva will likely get a huge payday this year, not because he is a great pitcher but, because he is one of the only reliable starters available under the age of 40.

Posted by: TT at November 15, 2007 6:31 AM

So What will Blanton cost should we decide to accept him in a trade even though he is going through arbitration?

Posted by: Bart H at November 15, 2007 11:07 AM

Based on most of the comments, it seems to me that some of you either didn't read the article in full or failed to comprehend it because Doug covered all of these subjects.

Lease equity is about quantifying the value of a player based on his actual cost vs. what he would be worth in the open market. It's easier to create positive lease equity through young players under the control of a team. These players are more likely to be undervalued because they generally are not subject to the free market forces like older, more established players.

Virtually every player is available for a price, including Johan Santana, who is rumored to be on the trading block because he only has one more year to go before he can become a free agent and the Twins recognize that they are unlikely to sign him to a market-based contract (let's say 6-8 years at $20-25M per year). If Minnesota deals him during the off-season or even as late as the trading deadline, it will most assuredly be based on the fact that he is about to become a free agent and his value will be determined based on the concept of lease equity (which Doug so artfully demonstrates in the first full paragraph under So What is Santana Worth).

As Warren Buffett says when talking about the concept of value investing (and I paraphrase), "Either you get it or you don't." The point is that it can't really be taught. It either resonates with you or it doesn't.

I believe the same thing is true here. Lease equity is nothing more than a Moneyball type concept in which a club tries to best use the resources available to it, whether it's a $200+ million payroll like the Yankees or a $50M payroll as in the case of several teams. A team with higher revenues can afford to make more mistakes than a team with lower revenues but money is important (perhaps to varying degrees) in all circumstances.

Posted by: Rich Lederer at November 15, 2007 11:03 PM

Virtually every player is available for a price,

Well, no they aren't in fact available for a price - if by price you mean for some dollar value. Johan Santana is not available at any dollar price.

as Warren Buffett says when talking about the concept of value investing

Warren Buffet is talking about money, not baseball.

is rumored to be on the trading block

Only in idle speculation. He has a no-trade agreement with the Twins and they have said they don't intend to trade him.

Lease equity is about quantifying the value of a player based on his actual cost vs. what he would be worth in the open market

What "open market"? There isn't one.

These players are more likely to be undervalued because they generally are not subject to the free market forces like older, more established players.

What free market forces? The system of allowing a small number of players to become free agents each year is not a free market.

you either didn't read the article in full or failed to comprehend it

No doubt. But it appears to me that the article fails to comprehend the actual complexity of valuing players in baseball and substitutes a "simple concept" for complex analysis.

The concept of lease-equity is based on a commodity - real estate - in which the question of what would it cost rent the same space on the open market has a tangible answer rooted in a real market for real estate, not a fanciful answer based on an illusory "free market".

Posted by: TT at November 16, 2007 1:46 PM

Well, no they aren't in fact available for a price - if by price you mean for some dollar value. Johan Santana is not available at any dollar price.

I think its pretty clear that price doesn't mean dollar value. Price means lease equity value, which is not the same as value. Manny Ramirez and A. Soriano are very good baseball players, but there is no way the Twins trade for one of them, they simply do not have the lease equity value to justify the trade, but may have more "player value" than any package offered.

What "open market"? There isn't one.

What free market forces? The system of allowing a small number of players to become free agents each year is not a free market.

There clearly are free market forces determining both trade value and free agent salary value. 30 teams can compete for a player in both circumstances. The artificial forces pumping up salary for free agents (i.e., the limited number of available players) are precisely the same artificial forces (i.e. limited availability of players) that affects the trade market. But GM's put dollar figures on the first, but some GM's don't appear to put dollar figures on the second (see the Jennings trade). I posit that a GM should try to put a dollar figure on the second factor, and that if they do so, they can properly evaluate trades.

Again, real estate is not a commodity and is the prototypical example of a unique good. There is also a tangible answer for what Santana or Miguel Cabrera would get if they could negotiate their salary with every team. You may not know the exact answer, but if a GM can't formulate a good estimate, he is in the wrong business.

Posted by: Doug B. at November 17, 2007 11:33 AM