The Captain's Blog

The Yankees’ austerity plan, which seeks to trim the team’s payroll below the $189 million luxury tax threshold by 2014, has placed the franchise in an unfamiliar position this off season. Instead of pursuing the best free agents, including re-signing several of their own, the team has eschewed long-term contracts in favor of value-laden one-year deals. These are not your father’s Yankees any more… at least not Hal Steinbrenner’s father.

Why have the Yankees decided to cut payroll? Before discussing the merits of the team’s new cost conscious approach, this question must be answered first.  In particular, it is important to examine whether or not the Yankees need to reign in costs in order to maintain economic viability as well as determine the exact benefit derived from lowering payroll beneath the luxury tax limit.

According to Forbes’ snapshot of the team’s financial condition in 2011, the Yankees continue to enjoy industry leading revenue, a skyrocketing franchise valuation, and EBITDA in the black. At the end of July, S&P also painted a rosy picture of the Yankees’ financial strength, upgrading the debt rating of the team’s holding company and adjusting its outlook from stable to positive. These two assessments came before the Yankees agreed to a multi-billion dollar contract extension with YES that will see the value of the team’s television rights rise from $85 million presently to approximately $350 million by the end of the contract in 2042. Business has been good for the Yankees, so it doesn’t appear as if the team’s emphasis on cost control is being driven by financial distress.

Yankees’ Financials Snapshot: 1997-2011

Note: All figures are in $ millions. Revenue is net of stadium-related payments.
Source: Forbes annual baseball valuations

Just because the Yankees don’t need to cut payroll, doesn’t necessarily mean they shouldn’t. If the financial incentive to dip below the luxury tax threshold is strong enough, why shouldn’t the Yankees consider taking advantage? That question would be easier to answer with a better understanding of what exactly the team stands to gain from reducing its payroll.

By falling below the new $189 million luxury tax threshold in 2014, the Yankees would avoid paying the associated 50% fine on payroll above that limit. Using a $210 million payroll as a guide, that would equate to a savings of $10.5 million. Although that seems like a substantial sum, it’s worth noting that if the Yankees were assessed such a penalty in 2014, it would represent the lowest tax bill the team has ever paid. In other words, by virtue of the limit rising from $178 million to $189 million, the Yankees would save $5.5 million off the bat, putting the team in a better financial position without cutting a dime from the payroll.

If the luxury tax savings was the only benefit, the Yankees might not be considering life on a budget. However, in addition to a stick, the new CBA also added a carrot to encourage compliance.  Called the Market Disqualification Refund (MDR), the new agreement prohibits certain teams from receiving revenue sharing. This money is collected in a fund and then returned to the teams who paid it. However, there is a catch. In order to receive a refund, a revenue sharing payor must be under the luxury tax threshold. By exceeding the tax limit, a club can forfeit all, or part, of its refund for that year. It’s hard to determine the exact amount the Yankees would receive as a refund, but considering the team’s annual revenue sharing bill was approximately $130 million in 2011, the kickback could be substantial.

When you add up all the potential savings (payroll, luxury tax, and revenue sharing refund), it’s easy to understand why the Yankees want to get below the luxury tax threshold. However, that doesn’t explain the why now. The same savings available in 2014 would still be around in 2015, so if it meant a less bumpy transition, wouldn’t it make sense to delay the budget by at least one year?

The Yankees’ 2014 budget plan is designed to take advantage of the increased luxury tax threshold, which is essentially rising to meet the team’s falling payroll in the middle. However, there are other reasons for the Yankees to get below the cap sooner than later. The first one deals with the luxury tax rate, which resets to 17.5% once a team falls under the threshold (and then rises to 30% and 40% in subsequent consecutive seasons spent above it). Of course, this benefit implies the Yankees willingness to immediately resume spending after 2014, but such a short-term gain doesn’t seem worth the interruption.

A second benefit to getting below the luxury cap by 2014 is derived by the structure of the MDR program. Beginning in 2013, only 25% of eligible money will be returned to compliant revenue sharing payors, but that increases to 50% by 2014 and finally to 75% and 100% in 2015 and 2016, respectively.  So, as long as the Yankees remained under the cap, it would be eligible for an increasing revenue sharing refund. But, what if the team should go over again?

As a chronic violator of the luxury tax, the Yankees are classified as a Tier 5 team, meaning it will forfeit 100% of its revenue sharing refund the next time it exceeds the luxury tax limit. Such will be the case in 2013. However, if the Yankees achieve their objective in 2014, the team would qualify for Tier 3 status. As a result, if the Bronx Bombers went back over the luxury tax limit in 2015, it would get to keep half of its MDR. Alternatively, if the team remained under the threshold for a second consecutive year in 2015, its status would drop all the way to Tier 1, which would effectively reset the clock. By qualifying as a Tier 1 team, the Yankees would be eligible to receive a full MDR in 2016, regardless of their luxury tax status. Because the current CBA ends after 2016, and the Yankees need to be below the threshold for two consecutive seasons in order to reach Tier 1, the team would have to begin its austerity program in 2014 in order to reap the full benefits of the revenue sharing refund in a non-compliant year. That’s why getting started on the program as soon as possible is so important.

Yankees Potential Savings Under the New CBA

Note: Payroll and luxury tax savings based on comparison of a $210 million payroll to a $189 million payroll. MDR is assumed to be 10% of Yankees’ 2011 revenue sharing contribution of $130 million, pro-rated based on the applicable percentage eligible to the program in each year.

Note: Payroll and luxury tax savings based on comparison of a $210 million payroll to a $189 million payroll. MDR is assumed to be 20% of Yankees’ 2011 revenue sharing contribution of $130 million, pro-rated based on the applicable percentage eligible to the program in each year.

Note: Payroll and luxury tax savings based on comparison of a $210 million payroll to a $189 million payroll (in 2016, payroll of $210 million is assumed). MDR is assumed to be 10% of Yankees’ 2011 revenue sharing contribution of $130 million, pro-rated based on the applicable percentage eligible to the program in each year.

Note Payroll and luxury tax savings based on comparison of a $210 million payroll to a $189 million payroll (in 2016, payroll of $210 million is assumed). MDR is assumed to be 20% of Yankees’ 2011 revenue sharing contribution of $130 million, pro-rated based on the applicable percentage eligible to the program in each year.

The scenarios above illustrate the significant savings available to the Yankees if they can spend at least 2014 and 2015 below the luxury tax threshold. Although these calculations rely on speculative assumptions, the underlying premise is clear. With the potential for over $100 million in savings over the next three years, it’s easy to see why Hal Steinbrenner, a self-proclaimed finance geek, would be intrigued. However, that only brings us back to the question that is on the mind of most Yankee fans. Should the Yankees be cutting payroll in order to reap a financial benefit when the team’s fiscal health does not require it?

Considering the team’s financial strength, it’s hard to justify the Yankees’ frugality. So far, the team has not explained why it is placing a greater emphasis on improving the balance sheet at the expense of the roster. And, if Brian Cashman can continue to field a winner, they won’t have to. However, if the team’s play starts to suffer, Hal Steinbrenner will need to communicate a vision to the fan base that goes beyond simply putting more money in his pocket. Perhaps he is underestimating the challenge of building a perennial championship contender, or overestimating the loyalty of his fan base, but if the Yankees have the money and don’t spend it, fans will not indulge a decline in team performance.

If the Yankees are headed for a fiscal cliff, they’d better be prepared to go over it alone because there’s no guarantee their fans (and their money) will follow. After all, the franchise’s mandate every year is to win the World Series at all cost, not simply compete. This lofty goal is not a fan creation, but an expectation fermented by the team. If Steinbrenner wants to maintain this standard of excellence, he can’t shy away from the financial obligation it entails. Having your cake and eating it too sounds good in theory, but if the team’s money grab impacts the quality of the team, humble pie could be the dish served next.