Using M&A Collar Provisions to Solve the Underpaid Star Problem (Part 2 of 2)

In this two-part series, I will propose a unique contract structure that can potentially help teams and star players agree to terms by addressing some of the risks faced by each. In Part 1, I will identify the unique concerns of star players and describe a method by which corporate attorneys address similar concerns in an analogous context. In Part 2, I will use the concepts described in Part 1 to design similar provisions applicable to the NFL context.    

As I explained in Part 1, star players face a large degree of uncertainty as to the future market price for their services, and they desire to minimize the opportunity cost associated with being locked into a contract. The longer the potential contract, the more uncertainty and opportunity cost faced by the player. In M&A transactions, a similar risk exists during the period between the signing and closing of a deal due to the fluctuation of share prices on public stock exchanges. M&A practitioners sometimes combat this problem by using “collar” provisions that cap and shift uncertainty-related risk at predetermined levels of market fluctuation. Today, I will explain how this concept can be used within the context of the NFL.

The basic NFL contract is a fixed-value deal, as the contract must state a specific amount of money as its Paragraph 5 salary (the “base salary”). The base salary can, however, be subject to adjustments referred to as “escalators” or “de-escalators” that are based on criteria and calculations established at the time the contract is signed. My proposed NFL contract collar provision will utilize escalators (and potentially de-escalators) to convert the star player’s contract from a fixed-value deal to a fixed-exchange deal upon the occurrence of certain triggers.

In the M&A context, movement in target (or acquirer) stock price typically triggers the collar provision. The parties sign the deal with the expectation that the target stock price will be worth X, but they provide for automatic risk shifting if the target stock price unexpectedly becomes X + Y or X – Y. The “Y” allows for some movement in target stock price before the collar is triggered. In the NFL context, the parties almost certainly expect that there will be some upward movement in market price between the beginning and end of the deal. This expected upward movement should be factored into the original price at which the player is willing to sign. Therefore, the important thing is to include protection that will apply in the event of unexpectedly significant upward movement.

The trigger itself could be based on any number of criteria indicative of the current market price for star players at the applicable position. The specific criteria do not particularly matter, but for the sake of this article I will use franchise tag values as an example. I think that it is more appropriate to base the trigger on criteria related to the amount of money paid to individual players, rather than on something such as a certain percentage of the league wide team salary cap. League trends may cause front offices to gradually alter the value they place on certain positions as compared to others, but individual players will always be paid relative to their peers.

Therefore, I will use changes in the applicable franchise tag value as the trigger for the escalator component of the collar provision, but I will set the trigger so as to allow for some upward movement before escalating the base salary. For example, let’s imagine that the franchise tag value applicable to the player in question is $10 million at the time a hypothetical contract is signed. Let’s imagine we expect such franchise tag value will increase by $1 million per year over the duration of the hypothetical deal, as this is a proxy for the expected upward movement in the market price for star players at this position.[1] However, now let’s imagine that the actual increase in the applicable franchise tag value turns out to be $2 million per year. This additional increase of $1 million per year was not expected, and represents a significant opportunity cost to the star player.

The collar provision will provide that in the event the franchise tag value is greater than $11 million in Year 2, then the player’s base salary will escalate upwards by an amount corresponding to X% of such difference between the actual franchise tag value and the $11 million expected value. The same adjustment would apply in each year of the contract (using $12 million for Year 3, $13 million for Year 4, etc.). The specific percentage used to determine the escalator amount does not matter; it will be dictated by the amount of leverage held by the player in the negotiation and his willingness to concede on other points. For the sake of easy calculations, let’s use 100%.

Because the expected franchise tag value for Year 2 was $11 million, the actual franchise tag value turned out to be $12 million, and the escalator component of the collar provision provides for 100% recapture, the player’s base salary will escalate by $1 million in Year 2. In Year 3 the expected franchise tag value was $12 million and the actual franchise tag value turned out to be $14 million, so the player’s base salary will escalate by $2 million. The escalator will be $3 million in Year 4 and $4 million in Year 5. In total, the player will earn an extra $10 million as compared to the original deal due to the unexpectedly rapid upward movement in the franchise tag value. If the recapture percentage equaled 80%, then the escalators would have totaled $8 million (50% and $5 million, etc.). The collar would likely also provide for reciprocal de-escalators in the event of a decline in franchise tag values beyond some specified amount.[2]

However, as with the M&A collar, there would also likely also be a secondary trigger that would shift the risk back onto the player if the degree of adjustment were to become too extreme, with the player also having the option to terminate the deal if such trigger were reached. For example, the 100% recapture could be set up to apply only to increases between $1 million and $3 million per year. If so, the player’s base salary in Year 3 of the contract would escalate by 100% of the amount by which the franchise tag value exceeds $12 million, but only by a maximum of $4 million (the difference between $16 million and $12 million). If the franchise tag value in Year 3 is $18 million, the player must either accept [base salary + $4 million escalator] or choose to terminate. The basic idea is to avoid contract disputes and renegotiations within a reasonable range of unexpected market movement, but at a certain point it makes sense to give the player the option to walk away. The team would likely resist such a provision, but perhaps the player would be willing to concede on other points in exchange.

It is worth highlighting the benefits that would accrue to the team by agreeing to a provision like this. First, it is beneficial to the team to avoid the conflict associated with contract disputes whenever possible, even though the consequences of such conflict are difficult to quantify and probably easy to overstate. More importantly, if a contract dispute does result in a new contract, the team will almost certainly assume a large amount of new risk in the form of new guarantees. Additionally, the player’s cap number increases from one year to the next will be much less smooth if an existing contract is superseded halfway through with a new, much larger contract. The collar concept serves to promote smoother cap increases over the course of the contract, as the existing contract is adjusted a little bit at a time, rather than supplanted with wholesale changes.  Furthermore, from a precedent-setting perspective, teams display a strong aversion to renegotiating contracts until a significant amount of time has passed since signing. A contract that incorporates built-in adjustment mechanisms at the outset avoids this issue and allows the team to refuse to renegotiate other contracts with a straight face. Lastly, even though a provision like this may not be team friendly, it may be worth accepting if it is the difference between getting a deal done and seeing a valuable player walk away.

In summary, my goal here is not to design a specific contract for a specific star player, but rather to propose a creative contract framework that can reduce risk related to uncertainty by incorporating provisions that preemptively address unexpected outcomes. The collar mechanism that I have suggested can be manipulated in any number of ways, but I think in its basic form it would consist of establishing criteria that would trigger base salary escalators that would transform the contract from a fixed-price deal to a fixed-exchange deal. In any form, it should help the star player to get comfortable with the risk of future underpayment associated with the opportunity cost of being locked into a long-term contract, and it will help teams to avoid the disadvantageous effects of contract renegotiations by providing for a sort of automatic mini-renegotiation that can keep the player reasonably happy.

[1] The specific numbers do not really matter; the example can work with any numbers plugged in.

[2] The historically unsmooth change in franchise tag values from year to year may be one reason to use some other type of trigger. The trigger could even be based on a pages-long formula that captures whatever the parties think is important.

  • McGeorge

    I don’t agree with your conclusion.

    >>It is worth highlighting the benefits that would accrue to the team by agreeing to a provision like this. First, it is beneficial to the team to avoid the conflict associated with contract disputes whenever possible, even though the consequences of such conflict are difficult to quantify and probably easy to overstate.

    I don’t agree. A player may feel like they can demand a new contract at any time. They may see a team make a bad signing (Ndamukong Suh), and believe they are underpaid and demand a new contract. Look at M Bennett moping. It’s not in a teams interest to cater to players like this. What if a team over pays? They have no recourse, they have to honor the contract. They can cut the player but still have to pay the guaranteed money.

    >>More importantly, if a contract dispute does result in a new contract, the team will almost certainly assume a large amount of new risk in the form of new guarantees. Additionally, the player’s cap number increases from one year to the next will be much less smooth if an existing contract is superseded halfway through with a new, much larger contract. The collar concept serves to promote smoother cap increases over the course of the contract, as the existing contract is adjusted a little bit at a time, rather than supplanted with wholesale changes.

    I don’t agree. I’d rather lock in a player at (roughly) X, X, X, X (plus bonuses) rather than:
    X, X + C%, (X + C%) +C1%, ((X + C%) +C1%)+C2%. I’m fine with a jump in 4 years.

    >>Furthermore, from a precedent-setting perspective, teams display a strong aversion to renegotiating contracts until a significant amount of time has passed since signing.

    Correct, it’s the leverage the team has. If a player outperforms the contract, the team benefits. If the player under performs, the team has to eat the contract until they can cut the player.

    >>A contract that incorporates built-in adjustment mechanisms at the outset avoids this issue and allows the team to refuse to renegotiate other contracts with a straight face. Lastly, even though a provision like this may not be team friendly, it may be worth accepting if it is the difference between getting a deal done and seeing a valuable player walk away.

    A team that uses this strategy may end up paying more for players than other teams. It’s “fair” and won’t lead to play off success.

    The only players with anywhere near enough leverage to ask for this type of contract are good QBs. For everyone else as a team I’d say No, as I don’t want to set a bad precedent.

    The collar idea only makes sense for a team if they can pay a lower initial base rate.
    If the Seahawks can pay Russel Wilson 22MM, then as the cap rises, he gets more and more, so that he averages out to 25MM, then fine.
    Its almost the same as a straight 25MM contract.

    If instead he wants 25MM plus escalators, then I’m not interested.

    It’s an interesting concept, but from a teams point of view (I am going to be forced to pay more and more over time), I don’t like it. If that becomes the standard contract, I think players starting base salaries would have to come down a little , due to uncertainty.

    This would also push up the franchise tag and the cap escalators as those highly paid players would all cause each others contracts to shoot up.

    QB 1 – QB5 make 21, 22, 23, 24, 25 MM this year.
    QB1 (21MM) has his contract up and now gets 26 + cap increases.
    His salary increase just bumped up everyones salary by 600K,
    Next year he gets a raise because the cap went up, soley due to his contract forcing up the franchise tag. The same thing happens every year. His contract goes up and up because it forces up the other contracts.
    This I don’t like. I would want a mechanism that at least doesn’t allow the player to self raise the cap, and get raises because he forced up the cap for everyone.

    Good QBs are in demand so may be able to ask for this, but the other players aren’t.

    • Ghoston

      The 1 Bennett(Chicago)and Antonio Brown have no guarantees left on their contracts right now, McGeorge. Most non rookie contracts are not guaranteed after yr one. And not many have guarantees in year 3. so after year 2 players are screwed. It’s only a 5 yr contract to help the team spread out the signing bonus over 5 years. Year 3 is a dummy year depending on team. Ravens the yr 3 of a contract will be a hinderance cause the dead money cost more than the cap even though there are no guarantees left.
      More teams are going with a roster bonus yr one or no signing bonus to prevent this stupid structure of low base salaries and high signing bonus which screw the player, if they outperform the contract.
      as for the bennet on seattle he can complain next yr, too bad he will be 30.

      • McGeorge

        Why would a team care if a player is screwed if they out perform their contract?
        As a player I’d rather have a big signing bonus and lower salary, than a low bonus and a higher salary. In the later case I’d be more likely to be cut, while in the former, my base salary is lower and the team is more likely to keep me.

        A roster bonus protects the team, and if it must be exercised early in the of season, it gives the player more time to find a new team. But I view a roster bonus as part of the yearly salary, unless it’s structured to be high, in which case the player is cut in a few years, just like now.

        If a player outperforms, he’ll stay on. It doesn’t seem like that wonderful a situation.

        (High Roster Bonus) works out for over performers, everyone else is cut
        (High Signing Bonus) Works out for all players, unless they outperform, which is hard to judge and doesn’t happen that often as a percentage of contracts.

        • Ghoston

          Wrong these contracts are 2 years. The signing bonuses are prorated for 5 years. The last 3 years are dummy years. Look. At the contracts more cash, guaranteed, dead money. Each yr in the 4-6 year deal. This is not hard they can tear it up easy after 2 years now the are executions like Suh

          • McGeorge

            Not all contracts are for 2 years. Frequently it makes sense to keep players for 3 years. You need to look at the contracts individually.
            You could just as well say “wrong these contracts are for 1 year” since a team could cut the player (of course the’yd take a big cap hit and still owe guaranteed money.

          • Ghoston

            But 90% of the guarantees are the first year. That’s why you are wrong .

            Tell me a deal where a player is tied in for 4 years other than Suh right now

          • McGeorge

            It depends on the contract, you need to look at them on a case by case basis and not generalize. In most contracts the team can get out after 2-3 years. I don’t feel like investing the time looking into this. It’s not really pertinent to the original conversation.