Today's LA Times has an interesting article on the subject of contracts gone bad in baseball. As used in the baseball world, the term "dead money," is analogous to the economic concept of sunk cost. The article has a number of quotes from baseball people that illustrate the sunk cost principle.
Dead money is a product of the era of mega-revenues, free agency, and long term contracts. In a competitive market, bidding for players will generate contracts in which salaries are essentially estimates of the expected value of future productivity. But all expectations are subject to forecast errors, and the production of some players will be less than expected. The payment of big sums to players in decline -- particularly those who have been traded or fallen out of the league -- is the weight of dead money on a baseball club. The article begins with the ironical situation of Vernon Wells, traded by the Blue Jays to the Angels over the winter, batting against his former team while still on their payroll! This situation may be more common than you might think. Roy Oswalt, the ex-Houston pitcher traded to Philadelphia, has faced Houston several times in the past two years. The story notes that Houston is paying $11m of Oswalt's post-trade compensation, along with other examples.
The article concludes with a series of quotes illustrating the sunk cost principle, beginning with the somewhat bizarre contract between the Mets and Bobby Bonilla, who renegotiated the $5.9m owed him in 2000 into a deferred 25 year annuity. The quotes which best illustrate the principle are underlined:
When the Mets released him in 2000, they were still on the hook for $5.9 million remaining on his contract. Needing cash to sign free agents, they asked to defer those payments for more than a decade, with interest.
As a result, the franchise now pays Bonilla — who is retired and working for the players' union — more than $1 million annually for 25 years. That number might seem outlandish, but [economist John Charles] Bradbury tells fans to take a closer look at the economics of the game.
"You don't want to see general managers make decisions based on dead money," he said. "You don't want them playing a guy just because they're paying him a lot of money."
Colletti says teams cannot be afraid to admit their errors and move on.
"My first boss, Dallas Green, used to say that all the time," Colletti recalled. "The worst mistake sometimes isn't the first one, it's the second one."
And if fans criticize the front office for absorbing sunk costs, at least general managers can try to balance the ledgers with homegrown talent that works for less than market value.
Bradbury points to the San Francisco Giants' young catcher, Buster Posey, who will make $575,000 this season, still waiting for a bigger payday when he qualifies for arbitration and free agency down the road.
"Fans are upset that you paid Edgar Renteria too much," Bradbury said of the Giants' shortstop last season, "but you don't get credit for the shrewd move."
Ultimately, dead money might represent the market correcting itself. When an overpriced player gets traded, his new team ends up paying a more realistic price.
"The new market is looking at the player, thinking they want this to be a great deal," Boras said. "They're getting what was a higher value player for a lower cost."
Wells, who had a run-scoring single against his old team but has struggled at the plate through the first month of the season, is hoping that means a fresh start.
"The money side of it can't play a factor in anything you do on the field," he said. "All that matters are the guys in the clubhouse and how they feel about you as a player and what you can do to make the team better."