Take the Money and Run

Let's do a thought experiment, like Einstein used to do, but without the Greek letters. Suppose you knew that over the next seven years your unique ability would likely be worth $33 million to your employer. That's life's lottery ticket, wouldn't you say?

If things go right, you could be worth even more -- like $68 million. But if something goes awry, your career will fizzle after the first $900,000 earned.

In other words, it's pretty likely that you'll be able to guarantee that your grandchildren will be rich even if you never work another day in your life. But you're one ACL away from missing out on all of that.

Now suppose your employer comes to you in the middle of your second year, at which point you've earned less than a million dollars, and offers you $25 million over the next five years. There's a very good chance you'd be leaving millions on the table -- up to $43 million.

Would you take the deal?

If you're like me, or Evan Longoria, you sure would. The reason is diminishing marginal utility.

Diminishing marginal utility means the value of a million dollars is immense for the average college professor, plumbing supplies salesman or nurse. It would change most of our lives. But the marginal utility of a million dollars to someone with 20 million already in the bank is significantly smaller.

That $25 million offer catapults you into the "set for life" category just as $33 million or $68 million does. It relieves you of the financial risk of flaming out.

Think about it this way: you probably pay homeowner's insurance knowing in advance that you're unlikely to recoup your premiums over your lifetime. Still, you'd rather pay $100 a month-- an amount you can afford -- rather than risk losing a quarter of a million dollars when a freak hurricane flattens your Ann Arbor home.

Four years ago, the Tampa Bay Rays inked rookie third baseman Evan Longoria to a six-year deal for $17.5 million. (Subsequent team options could make the contract worth $44 million over nine years.) Longoria was ecstatic about the deal then, two weeks into his Major League career.

"Knowing now that I'm pretty much set for life, that's just very assuring to me," he said.

Today, it's the Rays who are thrilled. Even with the dampening effect of arbitration, Longoria would probably have made his $17.5 million by now with a bigger payday ahead for year six. Those three years of options that kick in when Longoria would have qualified for free agency will pay him $26.5 million over three years, a fire sale price for a player worth 24 wins in his first four seasons. In all, the opportunity cost of that contract was somewhere in the vicinity of $32 million for the slugging third baseman.

But suppose Evan, who after all had 50 at bats when all the hands got shaken, hit instead like Eva during his big league career. He'd be back in SoCal today, but he'd be surfing with the dudes on the best dang board in town, thanks to $17.5 million guaranteed. He'd live in a big house and drive whatever car he wants. He'd have done all right.

So what we have, in effect, is a baseball team selling an insurance policy to a young potential star.

We've seen this before, most recently two weeks ago when the Brewers signed Matthew Lucroy to a similar deal. Expect this to become the norm as teams recognize the potential savings and players cash in on the guaranteed riches. And everyone can thank diminishing marginal utility for this latest development.
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