Sunday, July 08, 2007

The Economics of Hometown Discounts

How much of a "hometown discount" is Mark Buehrle really giving if he agrees to a four-year, $56 million contract with some no-trade protection? How much should he be willing to give?

The answer to the second question is inexact, but it's greater than zero. Most people aren't taking some important factors into consideration when evaluating the potential deal. Let's set aside what Buehrle is really worth and focus on the discount. Why are the White Sox justified in asking Buehrle to take less money to extend his contract now?

Risk Management

This past offseason, the Cardinals gave Chris Carpenter--already signed through 2008 at a favorable price--another $49 million for his 2009-11 seasons, plus an option for 2012. Joe Sheehan and I both called the move more risky than good. I'm not letting results dictate the merits of the decision, but Carpenter's injury this year was an illustration of an important concept: to minimize risk, you ideally want to wait as long as you can to make a decision, especially with pitchers and long-term deals. There's no way Carpenter receives that extension or anything close to it if they negotiated today.

What does this mean for Buehrle? Sure, he probably won't get hurt in the second half, but the risk is still significant. He should be willing to take less money to account for this.

Cost Certainty

Teams are not the only ones trying to minimize risk. Every year, young stud players sign through their arbitration years for less money than they'd be expected to make with normal career paths. This is a move that makes perfect sense for both sides: the player is financially set for life with one contract regardless of how he performs, while the team is expected to save money in the long run. In a way, the team is acting like an insurance company, agreeing to "cover" the player in case of a catastrophic injury or strongly diminished skills.

Sometimes, this leads to players being ridiculously underpaid. Check out the salaries for guys like Grady Sizemore, Travis Hafner, Victor Martinez, and Jhonny Peralta. Of course, for every Sizemore there's an Eric Hinske who has worn out his welcome by the end of his contract. Still, all of these signings made sense for the players at the time. It's a lot easier to set up your life knowing you have $15 million coming your way, rather than wondering if you'll ever make more than the Major League minimum.

Anyway, back to a more relevant example. After the 2002 season, the Braves offered Greg Maddux arbitration in order to get draft pick compensation, "knowing" he would reject it and sign elsewhere. Maddux ended up accepting the offer, winding up with one year and $14.75 million when he probably could have gotten something like 4 years/$48 million on the open market. A year later, Maddux signed for two years and $15 million guaranteed, leaving a fortune on the table.

Buehrle is unlikely to be this stupid at the end of the year, but like Maddux he might misjudge the direction of the market and expect to find a pot of gold at the end of the rainbow. Crazy market or no, there are no guarantees that an $80 million contract will still be waiting for his signature in November.

Draft Pick Compensation

Let's say Mark Buehrle has a twin brother who will also be a free agent this winter and is his equal as a pitcher. If the Sox let Mark go and sign Romulus Buehrle, what happens?

Aside from an interesting Thanksgiving in the Buehrle household--can you imagine how awkward things must have been for the Weavers after Jered cost Jeff his job with the Angels?--
the Sox would give up their second-round draft pick (because they will certainly pick in the top 15) and receive two picks, one in the supplemental round and the other probably in the late first round since Buehrle will likely sign with a contender.

That's a hell of a trade, one draft pick for two higher ones. What are the better picks worth? Given the price of mediocre veterans in today's environment and how underpaid draft picks are, I think the value of this trade-up is in the neighborhood of $4-5 million. The White Sox front office probably has a better handle on this number than I do.

If the Sox can replace Mark Buehrle with an identical pitcher and gain a $4-5 million profit by doing so, this necessarily means that they should be willing to pay that much less to sign Buehrle.

Other Factors

Buehrle's familiarity with U.S. Celluar Field, his American league opponents, etc. may help his stats, although it is hard to determine if this is really the case. He does have a lower career ERA at home than on the road despite pitching in a bandbox. If pitching for the White Sox will give him more wins and a lower ERA over the next four years--and remember that we're not sure this is true--then that will positively impact his next contract and should be factored into his current deal.

I don't buy too much into the media's depiction of how hard it is to play well in New York, but it is certainly true that if you don't perform after signing a big money deal to pitch for a team like the Yankees, the fans will make things less pleasant for you. Ask Carl Pavano how his quality of life has been since he came to the Bronx. Meanwhile, fans tend to stand by their aging former stars; Craig Biggio still gets a big pop at home games. This is a negative externality cost of signing elsewhere, making Chicago more attractive.


The $56 million offer is not nearly as bad for Buehrle as you might believe. He shouldn't necessarily take it, but it's a fair deal.

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