Draft Pick Compensation

The MLB offseason is a little slower to develop than some of the other major sports, but there is plenty to follow from the start. One of the first steps in the offseason journey is the extension and acceptance or decline of the Qualifying Offer (QO). The qualifying offer is a pretty simple concept that comes along with some relatively important consequences.

It works like this. Teams who are losing free agents are able to offer those free agents a one-year contract which the players can choose to accept or reject. If the player rejects the contract and signs with another team, the team who lost the player gets an extra (between the first and second rounds) draft pick the following June and the team signing the player loses their first round pick the following year. Because this is baseball, there are a number of nuances to that description.

How It Works:

First, teams can only make the qualifying offer to free agents who spent the entire previous season with the team. If you got traded this year, you are immune from the qualifying offer. Additionally, teams only have until 5pm the day before the start of free agency (i.e. last Friday at 5pm this year) to make the offer. Once it’s on the table, players have seven days to accept or reject the offer. The qualifying offer is uniform, as it is a one-year deal equal to the average of the highest 125 salaries in MLB the previous year. For the 2015-16 offseason, the qualifying offer is $15.8 million. It was $13.3 million after 2012, $14.1 million after 2013, and $15.3 million after 2014. To date, no player has ever accepted the qualifying offer.

If a player accepts, they remain with that team for another season at the set price. If they reject the offer, they are free to sign with any team, including the one that made the offer. If they end up signing with another team, their previous team is awarded a draft pick between the first and second round of the Rule 4 Draft the following June. The team who signs the player loses their first round draft pick, unless they are slated to have a pick in top ten. If that is the case, that pick is “protected” and the team forfeits their next pick. If a team signs multiple free agents who had been extended qualifying offers, the signing team loses subsequent picks. So if you had the 15th pick in the draft and sign two qualifying offer free agents, you would lose your first round pick and your second round pick the following year.

The signing team does not lose a draft pick if the player waits until after the June draft to sign with a new team. This happened with Kendrys Morales in 2014. The Marines made him a qualifying offer after 2013, he rejected it, but did not sign with a new team (the Twins) until after the draft. As a result, the Twins did not lose a pick and the Mariners did not gain one. Stephen Drew was in a similar spot that year, but the Red Sox re-signed him making the issue moot given that they were the team who had made the offer.

To summarize: Free agents who played with only one team the previous year are eligible for the qualifying offer. The qualifying offer is a one-year deal worth the average of the top 125 salaries in MLB. If a team makes the offer and the player does not accept it, the offering team is eligible to receive a compensation draft pick if the player signs elsewhere. The new team also loses a pick, but it is not the same pick as the one gained by the old team.

Purpose:

So what is the purpose of the qualifying offer? The stated purpose of the system is to compensate teams who are losing a significant free agent. It is essentially a competitive balance concept in that teams who are willing to offer a nice salary get to walk away with something if they are outbid by a big market team.

In reality, the qualifying offer does provide some protection for small market teams, but the main result is negative pressure on free agent salaries. In other words, the qualifying offer creates a cost for signing free agents. A draft pick has value to a team, so if they value a player at $100 million over 6 years, they will factor in the cost of losing that pick into the offer they are willing to make to the player on the open market. So a free agent who might be worth $100 million in a no-qualifying offer bidding war might wind up getting $90 million to $95 million because the teams are factoring in the loss of the draft pick.

It’s not a big deal when you are thinking about elite free agents. If you are going to invest $100 million into a player, five or eight million one way or the other doesn’t move the needle much for either side. However, it could be a huge factor for a player whose fair market value is around $25 million or so. Team value draft picks in different ways, but first round picks 11-30 probably fall in the $5 million to $15 million range in terms of expected value. Those are estimates, but you can see how free agents without huge paydays coming might find their earnings significantly impacted by the qualifying offer.

In other words, imagine two players. They are both corner outfielders in their early thirties who are probably 2.0 WAR players next year. They can probably expect to get 3-year, $36 million contracts, let’s say, this winter. If one is offered a qualifying offer and one isn’t, the one who doesn’t have a draft pick penalty attached will get a bigger contract because it will cost less, in absolute terms, to sign him. In this way, the qualifying offer depresses free agent salaries. Overall, the offers don’t impact the total free agent salaries of the league in a big way, but for a handful of players, it is a very big deal.

To Offer, To Accept?

So now that we know the purpose of the qualifying offer and how it works, we can turn to the decision to offer it and how players react to it.

For teams, the calculation is pretty simple. They want to make a qualifying offer to any player who will reject it, or any player who they would be happy to have for one-year at about $16 million. From a team perspective, the player rejecting the offer is great. They get a free draft pick. If the player accepts, it only hurts the team if they aren’t worth $16 million for one year. Roughly speaking, if they think the player will be worth 2 WAR or more, that is a fine bet.

For players, the calculation is a bit more complicated. They have to consider the contract they expect to get with a draft pick penalty attached to them and then compare it to what they might get a year from now (plus $16 million). Keep in mind that while teams can make a straightforward decision about a player, the player has to 1) consider for whom they want to play and 2) how much they value security and certainty in their lives.

Rejecting the qualifying offer will hurt the size of their upcoming deal, but it may simply mean they make 4/$50M instead of 4/$56M, and that’s an acceptable trade-off for the player given their desire to put down roots and commit to a franchise. But if a player is only going to get a 1/$8M offer because of the draft pick, they may prefer to take the $16 million and try again in a year.

Essentially, teams have been conservative with qualifying offers in the past. The first three rounds in 2012-2014 saw universal rejection of the offer. This year, twenty players got a qualifying offer and many of them were lined up for smaller deals. Clearly, teams have seen how likely players are to reject the offer and have increased the number of them that they have handed out, because as you remember, you want to make the offer and have a player reject it.

The qualifying offer system is likely going to get some type of makeover in the next CBA (which needs to be in place for the 2016-17 offseason). While it doesn’t negatively affect very good or very bad players, there is a group of players in between who have made less money in free agency because of it. While it’s sold as a measure to promote competitive balance, it is generally clear to everyone that it is simply a tool to slightly restrict free agency salaries and salary inflation in general. The next CBA negotiation will have to deal with many issues in which the players and owners are at odds, and the qualifying offer may be a place of contention.

So while this may be the last time you need to truly understand it, the decisions players make this week will impact teams and players this winter and into next June.

Links for Further Reading

CBA Details – MLB.com