### Introducing Expected Contract Value – Part 4

Introducing Expected Contract Value

Part 4:  Salary Cap Budgeting

Part 1:  Justification, Theory, & “Contract Analytics”

Part 2:  Inputs & Outputs

Part 3:  Contract Comparison

In addition to enabling the valuation of a contract from the perspective of the amount of money that the player can expect to earn, Expected Contract Value also enables teams to budget for the contract from the perspective of the amount of salary cap space that the player can be expected to account for. This objective can be accomplished by applying the expected outcome to the scheduled cap number in the relevant contract season, rather than to the amount of money that could potentially be earned by the player.

There are two conceptual ways to approach this exercise. The simpler way, what I will refer to as “Either/Or Cap Budgeting,” involves looking at the expected outcome, rounding up or down, and then selecting either the player’s cap number or his dead money number, whichever is applicable. For example, let’s take a look at Trent Cole’s contract from the perspective of Either/Or Cap Budgeting.

 Trent Cole Year Cap Number Expected Outcome Dead Money Inverse Either/Or 2012 \$5,850,000 99.8% \$15,500,000 2.9% \$5,850,000 2013 \$5,350,000 98.7% \$9,900,000 8.0% \$5,350,000 2014 \$6,600,000 84.1% \$4,800,000 23.3% \$6,600,000 2015 \$11,625,000 47.9% \$3,200,000 58.5% \$3,200,000 2016 \$12,600,000 29.9% \$1,600,000 80.3% \$0 2017 \$14,000,000 9.1% \$0 90.9% \$0

The likelihood that Cole would have remained under contract for the 2012, 2013, and 2014 was very likely. As a result, Either/Or would dictate that the Eagles plan to include Cole’s cap number in their cap budget for those seasons. On the other hand, Expected Contract Value forecasts that there is less than a 50% chance that Cole will remain under contract for 2015. As a result, Either/Or would dictate that the Eagles include Cole’s dead money number in their cap budget for 2015. Unless such a 2015 release were executed as a post-June-1st cut, then all of the dead money would be absorbed in 2015. As a result, Either/Or would dictate that the Eagles not budget any cap room for Cole their budgets for the 2016 and 2017 seasons.

The other way to approach the exercise, what I will refer to as “Weighted Average Cap Budgeting,” involves calculating an expected cap budget based on an average of the player’s cap number and dead money number, weighted by the relative likelihood of each being applicable. This method is less intuitive, but it is more true to the theory of Expected Contract Value, and it more properly accounts for the prospective uncertainty regarding factors such as performance, health, and team needs. As in the case of Schrodinger’s cat, all that exists before we “open the box” is a probability. At the time the contract is signed, we assume, for each contract season, the player will be simultaneously both under contract and released.[1]

###### [1] We are willing to bet that this is the only quantum physics reference you will read in an NFL related article today.
 Trent Cole Year Cap Number Expected Outcome Dead Money Inverse wAverage 2012 \$5,850,000 99.8% \$15,500,000 0.2% \$5,869,300 2013 \$5,350,000 98.7% \$9,900,000 1.3% \$5,409,150 2014 \$6,600,000 84.1% \$4,800,000 15.9% \$6,313,800 2015 \$11,625,000 47.9% \$3,200,000 52.1% \$7,235,575 2016 \$12,600,000 29.9% \$1,600,000 70.1% \$4,889,000 2017 \$14,000,000 11.9% \$0 82.1% \$1,274,000

As you can see, Weighted Average would prefer that the Eagles budget a little more salary cap room during 2012 and 2013 than Either/Or would. This budgeting hedge factors in the relatively remote possibility that the Eagles would release Cole in either of those years, such as could have been the case if Cole suffered a career-ending injury in offseason workouts. The recommended cap budget of Weighted Average is a little lower for 2014 than Either/Or, which accounts for the opportunity that the Eagles had that year to save a little bit of cap room.

The most noticeable differences in recommended cap budgeting between the two methods come in 2015, 2016, and 2017. Whereas Either/Or definitively assumes that Cole will be released in 2015, and therefore recommends that the Eagles disregard any other possibilities, Weighted Average takes into consideration the reasonably likely possibility that the Eagles would keep Cole under contract for 2015. With the benefit of hindsight regarding Cole’s 2014 performance, it doesn’t seem likely that the Eagles will keep him under contract, but at the time that the contract was signed, there was certainly a possibility that Cole would play at an extremely high level in 2014 and justify the \$8.425M delta between his (potential) cap number and his dead money number. The same holds true for 2016 and 2017, albeit at correspondingly smaller likelihoods.

At this point the reader may be thinking, “Ok fine, but there are more possible outcomes than just ‘Cole remains signed under this contract as currently constructed’ or ‘Cole is released.’ What if Cole takes a pay cut to remain under contract for 2015 making less money than he is currently scheduled to make?” Well, let’s imagine how that would play out:

Eagles: “Trent, we don’t think you are worth your scheduled cap number.”

Cole: “I think that I am worth my scheduled cap number.”

Eagles: “We want you to take a pay cut.”

Cole: “I don’t want to take a pay cut.”

Eagles: “If you don’t take a pay cut, we will release you. You are then free to negotiate a new contract with any team.   Please let us know what your best offer is, and we will exceed it by \$1.”

Cole: “…how much of a pay cut would you like me to take?”

Eagles: “X dollars.”

At this point, if Cole accepts the Eagles pay cut offer of X dollars, he has implicitly conceded that the offer is better than any offer he expects that he would receive as a free agent.[2] Accepting an offer for a pay cut that you expect is better than any offer you would receive as a free agent, in the face of being threatened with a release, sounds indistinguishable from in fact being released and then signing a completely new contract with the original team. Therefore, with respect to Expected Contract Value, a pay cut is treated the same as a release. The newly “restructured” contract is then reevaluated, based on its new characteristics, by Expected Contract Value.[3]

###### [3] Contract restructurings that do not involve a pay cut are treated differently and will be addressed in a subsequent post.

Another possible outcome is that the Eagles release Cole as a post-June-1st release, thereby pushing \$1.6 million of the 2015 dead money into 2016. However, this is a strategic decision regarding timing; the same total amount of cap room will be allocated toward Cole whether he is released before June 1st or after June 1st. Expected Contract Value can forecast the decision that an average team would make with respect to an anonymous contract, and the option to delay dead money via the June 1st rule is incorporated as a metric input. Having said that, Expected Contract Value can’t forecast the strategic dead money timing decisions that a particular team will make with respect to a particular contract. As a result, implicit in an Expected Contract Value generated salary cap budget is the acknowledgment that a team could delay some of the budgeted salary cap allocation into the subsequent year.