Salary negotiation constraints – Management
- Discount rate: 8.5% (same for both sides)
Due to existing salary cap constraints, the team cannot offer nominal values of more than…
- $2m in year 2
- $4.5m in year 8
- The maximum present value of the entire contract cannot be more than $28.5m.
- The team knows that the player is open to the idea of deferred compensation. However, they know that he will want to limit the nominal value of deferred compensation. They don’t know what his limit is, but it’s probably somewhere less than 10m in present value.
- The team knows that, given the market for this player, the player would be unlikely to accept any contract whose present value is less than $22 million. However, the team does not actually know for certain that this is the minimum the player would accept.
The league sets rules on player compensation. The following are known to both sides:
- The total nominal value of a contract of this length cannot exceed $60m; i.e., a $60m deal would be the “league maximum.”
- Signing bonuses are allowed, but not required. They are paid when the contract is signed. That is, they are paid today (T=0).
- Salaries for each of the 10 years are paid at the end of the year. I.e., salary for year 1 is paid at T=1, salary for year 2 is paid at T=2, …, salary for year 10 is paid at T=10.
- The player must receive a salary during each of the 10 playing years of at least $0.5 million per year.
- The salary amounts can change during each year of the playing contract (i.e., years 1-10).
- Contracts can include deferred money, but it is not required.
- Deferred money must start in the first year after the playing contract ends (i.e., it must start at T=11).
- Deferred money must be in the form of a constant annuity. That is, the player must receive the same amount in each year of the annuity.
- The deferred annuity must have a minimum of 5 payments and a maximum of 10 payments. That means that if deferred compensation is offered, it will start in T=11 and end at T=15, T=16, T=17, T=18, T=19, or T=20.
- No more than 30% of the contract’s nominal value can be in the form of deferred compensation. For example, if the overall nominal value of the deal were $50m, and the contract included 5 years of deferred money, those annuity payments could not exceed $3m each ($3m per year * 5 years = $15m, which is 30% of $50m).
The purpose of the exercise is to simulate a salary negotiation between management and a free agent’s player rep. Your goals are 1) To successfully negotiate a 10-year contract with the other party 2) Within that agreement, to get the best possible financial terms for your side