Wednesday, September 17, 2014

Ryan Johansen and the Economics of NHL Offer Sheets

Cam (aptly, @offersheet on twitter) raises a good question here. Why aren't offer sheets more common in the NHL?

Botchford's response - 'they always get matched, so what's the point?' is a big factor. It may be that teams don't have the stomachs to go big enough - in effect, you need to offer the player the same money he'd get as a UFA to make it happen.

Another answer that is commonly given is that the draft-pick compensation is a hindrance to offer sheets. I'll tell you right now: it's not. The inclusion of draft picks in the equation is a zero-sum game that may alter the ideal contract price, but not the incentive for a team to put out an offer sheet in the first place.

Let's use Ryan Johansen as an example. No, no one's signed him to an offer sheet yet, though for all we know, teams have called his agent and asked.

Johansen's Market Value

Blue Jackets president John Davidson revealed the team's most recent offers to Johansen, and most of the hockey media agreed that the numbers were pretty darn fair. The offers were:

- $6m over 2 years;
- $32m over 6 years; or
- $46m over 8 years.

Let's do a little reverse-engineering to guess a contract value. Reportedly, Johansen has 4 more years as an RFA; so the last 4 years of the 8-year deal are UFA years. If years 7 and 8 are worth $14m (the difference between the $46m of the 8-year deal and the $32m of the 6-year deal), the Jackets are working off a UFA valuation of $7m. For comparison, Paul Stastny, Alex Semin, Daniel Sedin and Henrik Sedin are all players currently on UFA contracts with $7m annual averages.

Let's put aside, for a second, whether or not those players are comparably valuable to Ryan Johansen. Maybe they're not far off. But the point is, the offer is such that if Johansen is worth $7m/year on the open market, he'd be worth $56m on an 8 year contract, or $49m on a 7-year deal (which is the longest you can go on an offer sheet).

Back to RFA-land for a second. If the UFA years are worth $7m each, based on the $46m/8 offer, that leaves $18m for the first 4 years. If years 1-2 are worth $3m each (based on the bridge contract), years 3-4 (arbitration years) are worth $6m each. If the Jackets offered Johansen a 7-year deal, they'd be offering him $39m/7 ($46/8 minus $7/1)

Adjusting for Draft Pick value

So if Johansen would get $49m/7 as a UFA (again, let's assume), we have to deduct a bit from that price for the draft pick compensation. The draft pick compensation depends on the AAV of the offer sheet; in 2013-14, a $7m AAV would call for compensation of two 1st-rounders, a second and a third. However, because we're going to deduct a little from the price to reflect the cost to the buying team, we're going to slip down one bracket to compensation of a 1st, a 2nd and a 3rd.

We don't know the dollar value of those draft picks; there are a lot of variables, including where in the round they are, who the team might get, and so on. But for sake of argument, I'm going to pull a number out of the air and say that the three picks are worth $5m total. Again, let's assume. Play along with me.

So now we're looking at a $44m/7 market price for Johansen, after the value of the picks is removed. Mind you, the total cost to the signing team is $49m when you include the lost draft picks. Note that this valuation is considerably higher than the $39m/7 valuation represented by CBJ's offers. The decision the signing team faces is:

Door #1: Give Johansen an offer sheet, and if it's accepted, he's worth $49m over 7 years. Pay $44m and lose $5m worth of draft pick assets. Net gain: zero.

Door #2: Don't make an offer. Net gain: zero.

If Johansen signs the $44m offer sheet, Columbus has a decision to make:

Door #1: Let Johansen go. Pick up draft picks worth $5m. Net gain: $5m.
Door #2: Match the offer sheet at $44m/7. Keep Johansen, who is worth $49m over the contract. Net gain: $5m.

As you can see, in both situations, Columbus would just as happily let Johansen go as they would keep him. The net value to them is the same either way.

Now let's mix it up a little. As we saw above, the signing team isn't realizing any profit by signing Johansen at $44m/7. What if they offer, say $42m/7 instead? This offer would still be above Columbus' $39/7 valuation. Let's say Johansen signs the offer sheet. Now, the signing team has a potential $2m profit.

The math now changes for Columbus, though. Here's what happens:

Door #1: Let Johansen go. Pick up draft picks worth $5m. Net gain: $5m.
Door #2: Match the offer sheet at $42m/7. Keep Johansen, who is worth $49m over the contract. Net gain: $7m.

Clearly, Columbus should match the contract because it's below open-market value. Thus, if all other factors are equal, it is impossible for a signing team to come up with an offer sheet that won't be matched unless they are willing to pay full market cost for the player (after accounting for the value of the draft picks).

Now, obviously, 'all factors' will rarely be equal. A smaller-market team like Columbus may not have the financial flexibility to pay Johansen. If he were with a larger-market team, they may have overspent their cap space and couldn't afford to allocate as much salary room for him. Teams might place different valuations on a player's abilities, may feel he's a better/worse fit for their system or their locker room, et cetera.

In short, an offer sheet can succeed where the player is worth more to the offering team than the current team. That being said, unless the valuations are far apart, the offer sheet will have to be close to the UFA market price, which will reduce the incentive for offering teams to make the offer in the first place.

I would suggest, also, that the 'factors' described above will tend to actually increase the current team's valuation of the player. The player may be integral to the team's system, its locker room, its fanbase, and the community. The team is more likely to have made roster decisions on the assumption that the player will be there, and losing the player would create a hole that would be nearly impossible to fill. It appears that most of these factors apply in the case of the Blue Jackets, and that's why I would suggest they're not vulnerable to an offer sheet in this case. I'd argue that the Shea Weber situation had a lot of similarities.

How can the league create more incentive for offer sheets (though it's not clear they want to)? as one example, I imagine that if the compensation picks came from the league rather than the signing team (the same way sandwich picks are awarded in baseball), that would reduce the cost to the signing team and improve their incentive to make an offer.

That being said, I don't think the league wants this. In CBA bargaining, it has consistently tried to protect the ability of poorer clubs to keep RFAs as long as possible. I don't think we'll see a change to offer sheets anytime soon. For now, they are merely an occasion and extraordinary remedy for teams that are clearly undervaluing their RFAs.

Follow Rory Johnston (@rnfjohnston) on twitter:

No comments: