Revisiting the cost of draft pick compensation

Another offseason is almost done and several more free agents have felt the sting of the qualifying offer. Ervin Santana, Stephen Drew and Kendrys Morales are still unsigned. Ubaldo Jimenez had to wait until February 17 to sign a slightly disappointing four-year, $50 million deal. Nelson Cruz even had to settle for a one-year, $8 million deal, after walking away from the $14 million qualifying offer, though his connection to the Biogenesis clinic was also a factor in his underwhelming market. These free agents all have their flaws but the key factor slowing down their market appears to be the cost of a draft pick that comes attached with signing them.

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As Michael Clair noted on these pages recently, teams are probably more invested in the draft now than ever before, thanks to the hard-slotting system and the trend towards signing players to extensions prior to free agency. As a result, the less-than-premium free agents appear to be looking at a severely reduced market and being forced to accept lower offers than they would have likely received without the cost of draft picks attached to them. Faced with this tepid market, these free agents are waiting longer and longer to sign and even considering holding out until after the draft to cut a deal.

For many fans, this might be infuriating. The draft doesn't produce instant results the way a free agent addition can and watching teams turn down potentially productive additions because they aren't willing to sacrifice a pick that will have little impact on the 2014 can be hard to take. For teams, however, the additional cost of draft-pick compensation should be primarily a financial concern. A draft pick is an investment and it has an expected rate of return. If they lose that pick, they need to save the value of that expected return somewhere and the obvious solution is to discount the rate they are willing to pay for the player that will cost them that pick.

Last offseason, as Michael Bourn, Kyle Lohse and Rafael Soriano battled with this effect, I attempted to calculate the value of the draft picks in question using the model for draft-pick valuation developed by Victor Wang of the Hardball Times. I found that draft picks in the 10-30 pick range had a net value of just under $8 million and the second round picks of teams with protected first round picks were worth approximately $3 million dollars. Inflation bumps that up slightly for this season, but with two years of data on the books, these estimates don't seem at all unreasonable. There is a sliding scale of value for these picks depending on the exact spot of each pick and there also might be some additional opportunity cost to missing the ability to pick to consider, but the numbers appear to have some reasonable predictive power when it comes to contracts for free agent players who are extended the qualifying offer.

With that in mind, I want to try to look at the value assigned to draft picks from the other side. Rather than trying to determine the value produced by the draft pick in question, let's try to take a look a the impact the qualifying offer has had on those players who have had draft compensation attached to them. I am employing the same basic process I used to look at pitcher risks, but using Zips projections this time around instead of Steamer projections.

First, the 2013 qualifying offer players, excluding those players who resigned with the same team:

The first thing to note is that the average dollar per WAR ($/WAR) is well above the norm for 2103 free agents, which was around $5.5 million, but that total is completely deceptive. Remove the lone reliever, Rafael Soriano, from the group and the $/WAR rate drops to $4.71 million. Excluding Soriano, this group had an average projected WAR of 3.1, so there certainly appears to be a sizable hit from the offer across the full sample. For these players, the average number of years on their deals is 3.83, so the discount here totals an average of $9.38 million, well above the $7.73 million estimate I put on an unprotected first-round pick. However, including Adam LaRoche, who resigned with the Nationals after failing to find a deal outside of Washington, in this sample drops the price down to $7.83 million, practically the same number I reached using Wang's model.

Now, here are this year's qualifying-offer players, excluding those how have not signed and those who remained with the same team:

There are no relievers in this group to throw off the dollar per WAR rate and with inflation pushing that rate up to approximately $6 million this season, the overall discount is slightly smaller than it was for the previous group. This group features three deals longer than any of the qualifying offer players from 2013 received as well, however. All told, qualifying offer players as a group are being hit with what looks like a discount of $8.4 million this offseason, slightly above the $8.1 million inflation-adjusted cost of a 2014 draft pick from my previous estimations.

The numbers for draft pick compensation created from Wang's model certainly seem to be in line with the values teams are assigning to draft picks as judged by the difference between the average free agent's $/WAR rate and the one being paid to those free agents who are costing teams draft picks by this method. These are small samples and it would be going too far to say that these numbers are anything like precise calculations of the cost of draft compensation. However, they do match up with my previous estimates of that cost well enough to give us some confidence that team's value draft picks much the same way we have guessed.

If anything, teams appear to be valuing draft picks slightly more, especially since so many of these players had trouble finding a deal and several signed with teams that had already lost a pick by signing a player with draft compensation attached. They may not be subtracting the cost of signing the draft from the pick's surplus value since the opportunity to sign the player is inherently more valuable than the savings that losing the pick brings. They may also have a more nuanced model to build upon than what experts like Nate Silver and Victor Wang have used thanks to their ability to join their scouting information to the statistical results, helping them to adjust their models to account for the talent level of the specific draft and their place in it.

Even so, the estimated costs of draft compensation from my original look at the issue are still persuasive when looking at the results from the first years of this system. Though the popular viewpoint seems to be that top free agents aren't impacted by the cost of draft picks, this simple analysis seems to suggest otherwise. It may be that we have a harder time recognizing the discount applied to the top free agents because that deduction is a much smaller percentage of their overall contract. It could also be that the cost of draft compensation is still applied to their deals, but it is not keeping anyone from bidding on them as it certainly seems to be doing for the lesser free agents who receive the offer.

Though the numbers here are close enough to what I expected to see, we can't simply say that each of these players signed a deal that was discounted by $8 million to compensate for the lost picks. Teams are buying in bulk on long-term deals like Cano's and Ellsbury's and they should be under the $/WAR as a result even before compensation. The end of these deals will occur in a market that has a much higher $/WAR average and these players will decline as well. We are only looking at 14 players here and each player has their own risks which could affect their $/WAR separately from the qualifying offer. We can't isolate the cost of the qualifying offer from those factors here and the small sample size means the differences in other factors are not necessarily balanced out.

The numbers this method gives us are not proof of anything by themselves, but rather evidence towards an estimation on how teams are valuing draft compensation. As such, they appear to support the idea that teams are currently discounting players who cost them a draft pick by approximately $8 million dollars on average. Specific cases will vary greatly from this guideline, but it seems to be a helpful starting point. Incorporating that number (adjusted for inflation) into projections of salaries for future qualifying-offer players should allow us to be more accurate in predicting free agent salaries.