THE BOOK--Playing The Percentages In Baseball

Wednesday, July 21, 2010

Salary Cap Hit

In the NHL, the value of a contract for salary cap purposes is simply the annual value of the contract… while he is active.  If he retires, then there is no contract, and therefore, the cap obligation disappears.

If, for example, you sign a 51MM$ deal for 6 years, where you are paid 10MM$ a year for the first 5 years and 1MM$ in the 6th year, the cap hit is 51/6=8.5MM$ per year, for each of the six years.  If in the 6th year, the player retires, well, that’s it.  Cap hit goes away.  So, the team will have earned a cap hit of 8.5MM x 5, while paying the player 10MM x 5.  That’s 7.5MM$ of relief by structuring the contract in such a way as to incentivize a player to retire.

This is common practice in the NHL, and the league has always told the teams to stop doing that, and this time, they meant it, voiding Kovalchuk’s contract with the Devils, for 102MM$ over 17 years, where the last 5 years was a total of 2.5MM$, while the player would be over 40 years old.

Now, in practice, this makes perfect sense.  Just for the sake of argument, let’s say Kovulchuk is a 4 win player that gets paid 2MM$ per win the first year, and inflation is 7.55%, while he loses 0.25 wins a year.  (Just making numbers up.) This is what it would look like:

Age Wins $perWin Salary
28 4.00 2.00 $8.00
29 3.75 2.15 $8.07
30 3.50 2.31 $8.10
31 3.25 2.49 $8.09
32 3.00 2.68 $8.03
33 2.75 2.88 $7.91
34 2.50 3.09 $7.74
35 2.25 3.33 $7.49
36 2.00 3.58 $7.16
37 1.75 3.85 $6.74
38 1.50 4.14 $6.21
39 1.25 4.45 $5.57
40 1.00 4.79 $4.79
41 0.75 5.15 $3.86
42 0.50 5.54 $2.77
43 0.25 5.96 $1.49
44 - 6.41 $-

That’s 102MM$ for 17 years. Clearly under this made up illustration, he should make less in the out years.  The problem is just the sudden drop that the Devils are setting it as.

In any case, the solution is easy: any difference between cap hit and salary paid will get applied to the first year he retires.  In Kovalchuk’s case, let’s say he retires after 12 years, where he will have earned 99.5MM$ of his 102MM$ in salary, but had taken a 102/17*12 = 72MM$ cap hit.  That’s 27.5MM$ in cap hit still unaccounted for.  Well, that gets applied his first year he retires.  Maybe it was a legitimate retirement, or whatever.  Fine, put the limit for any one year at 20% of the Payroll number (say about 18MM$ at that time).  So, they take a 18MM$ cap hit the first year and 9.5MM$ the second year.

The issue really is about making sure it all adds up, and the NHL and NHLPA accountants did not make sure it would add up.  Why?  I have no idea.

UPDATE: The frankness of the Devils GM:

Some have suggested it illustrates just what is wrong with the current collective bargaining agreement.

“I might agree,” Lamoriello said today. “But there is nothing we have done wrong. This is within the rules. This is the CBA. There are precedents that have been set, but I would agree that we shouldn’t have these.

“But I’m also saying that, because it’s legal and this is something ownership felt like doing for the right reasons, then it was done.”