How Free Agent Compensation Works

There have been a lot of questions in the past few days about free agent compensation and offering arbitration to pending free agents.  The process isn’t one we’ve had to cover in Pittsburgh for quite some time.  That’s mostly because the Pirates haven’t seen many ranked free agents in recent years.  Most of the candidates have been traded away prior to reaching free agency.  The last time the Pirates saw a compensation pick for a departing free agent was in 1993, when they had two compensation picks, taking Jermaine Allensworth and Charles Rice with the selections.

The common assumption is that when a player elects free agency, the team must try to bid on him against every other team.  That’s true to an extent, although the team reserves the right to offer arbitration.  The arbitration process is no different than the process used in years 4-6 of a player’s professional career.  The team offers arbitration, and if the player accepts, the two sides exchange salary figures, and head to arbitration.  The two sides can still work out a deal prior to the arbitration hearing, although once the offer is accepted, the player forfeits the rights to negotiate with other teams.  The only difference with free agents is that the player can turn down arbitration and choose free agency.

In most cases, arbitration is offered to “ranked free agents”.  Ranked free agents are the free agents that ranked in the top of their positions over the previous two seasons, according to an Elias formula.  MLB Trade Rumors has reverse engineered the rankings to provide an estimate of the upcoming ranked free agents, although the official list isn’t out yet.  Arbitration is usually offered to ranked free agents to allow the team to get insurance if a player signs elsewhere.

There are two types of ranked free agents.  There’s a Type A free agent, and a Type B free agent.  Here is a rundown of each group.

Type A Free Agents

Type A free agents are the top of the class at their positions.  If they are offered arbitration, and if they turn that down and sign with another team, Type A free agents net their former team two draft picks.  The first draft pick is provided by Major League Baseball, and falls in between the first and second rounds of the following draft.  The second pick comes from the signing team, as compensation for losing a player that is considered one of the best at his position.  The signing team forfeits their first round pick to the former team for signing a Type A free agent.  There are exceptions to this rule:

1. The top 15 picks in the draft are protected.  If a team with a top 15 pick signs a Type A free agent, they lose their second round pick in the draft, rather than their first round pick.  So if the team with the first overall pick signs a Type A free agent, they still keep the first overall pick, but lose the first overall pick in the second round.  Note that compensation picks from previous drafts don’t count towards the top 15 picks.  If there is one compensation pick in the top 15, then the number of protected picks is extended to 16.  If there are two compensation picks, the extension goes to 17, and so on.

2. If a team signs more than one Type A free agent, the first round pick goes to the team that lost the best free agent, according to the Elias rankings.  As an example, if a team with the 18th pick signed Albert Pujols and Ramon Hernandez, the St. Louis Cardinals would get the 18th pick as compensation for Pujols, while the Cincinnati Reds would get the 18th pick in the second round as compensation for Hernandez.  Teams are limited as to how many Type A free agents they can sign.  The limit is two more Type A free agents than you lost that year.

An arbitration offer isn’t always guaranteed, and there are instances where Type A free agents don’t receive offers, even with the chance for two compensation picks.  This usually happens with relievers, as their Type A status can serve as a penalty.  Take Matt Capps, as an example.  Capps is projected to be a Type A free agent this off-season.  Any team signing him will have to give up a draft pick.  Because the team is already paying a draft pick, they might offer less to Capps.  Since the draft pick compensation could hurt his free agent value, Capps might feel it makes more sense to accept the arbitration, rather than go on the open market with the Type A status dragging down his potential earnings.  Again, this is a hypothetical situation with Capps, but this kind of situation happens every year, and prevents teams from risking the arbitration offer, since arbitration guarantees a salary that is greater than the previous year’s compensation package.

Type B Free Agents

Type B free agents only land their former team one compensation pick.  This pick is awarded by Major League Baseball, falling in between the first and second rounds of the upcoming draft.  While a team that signs a Type A pick must give up one draft pick, there is no penalty to the signing team for signing Type B picks.  Since there is no penalty, the Type B status doesn’t impact the potential earnings on the open market.

The only reason teams refuse to offer arbitration to Type B free agents is the risk that arbitration will net a bigger return than the open market.  The Pirates have a player with that risk this year.  Ryan Ludwick is projected to be a Type B free agent, but had a $6.775 M salary in 2011.  If the Pirates offered him arbitration, and he accepted, he would be due a raise over that 2011 salary.  It’s unlikely that Ludwick would receive anything near $6.775 M on the free agent market, which means that he’d be a risk to accept arbitration.

In some cases, teams work out handshake agreements, where the player will agree to refuse arbitration when offered, allowing the team to get a draft pick, all without the risk of being stuck with an unwanted contract.  There’s nothing to stop teams and players from doing this, although it’s not an extremely common practice, and shouldn’t be expected in every situation.

Option Years

The Pirates made it clear this week that they won’t be picking up the options for Paul Maholm or Ryan Doumit this off-season.  Doumit is a Type B free agent, which brought up the question: can he be offered arbitration?  The answer is yes.  Once the Pirates officially decline his option, Doumit becomes a pending free agent.  That gives the Pirates all of the normal rights that they would have with any other free agent, including an exclusive window to negotiate with the player, and the ability to offer arbitration.

In this case, it makes more sense for the Pirates to offer arbitration, rather than pick up the option.  Doumit’s option is two years and $15.5 M.  If he accepts arbitration, the Pirates only pay a raise over his $5.2 M salary in 2011, which probably won’t be much more than $6 M.  The total cost would be his arbitration price, plus the $500 K buyout, which is considerably less than the option price.  If Doumit declines, and signs elsewhere, the Pirates would receive a pick between the first and second rounds of the 2012 draft.

Unranked Free Agents

Another question has been brought up lately about unranked free agents.  Paul Maholm projects to be an unranked free agent, and the question was raised as to whether he can be offered arbitration.  Again, the answer is yes.  The only difference between ranked and unranked free agents is that Maholm wouldn’t land the Pirates compensation if he signed elsewhere.  He would still be eligible for arbitration, which would be a raise over his $5.75 M salary in 2011.  He’d also get the $750 K buyout, which means the cost to the Pirates would be at least $6.5 M.  If the Pirates wanted to keep him around at a lower price, they could go this route and hope he accepts, although it seems more likely that he will test the open market.  If he does test the open market, there is no rule that prevents the Pirates from continuing to pursue him.

Pirates Off-Season Projections

The following Pittsburgh Pirates are projected as ranked free agents, according to the MLBTR rankings:

Ryan Doumit – Type B ($5.2 M in 2011)

Chris Snyder – Type B ($5.75 M in 2011)

Derrek Lee – Type B ($8.5 M in 2011)

Ryan Ludwick – Type B ($6.775 M in 2011)

The only one that would surprise me if he got an offer would be Ryan Ludwick.  The Pirates have no need for him with Andrew McCutchen, Jose Tabata, and Alex Presley.  He would make a nice fourth outfielder, but definitely not at $7 M or more.  That risk isn’t worth the potential draft pick.  The only way I see him getting arbitration is with a handshake agreement, or if he just really didn’t want to play in Pittsburgh.  Like I mentioned earlier, the handshake agreement shouldn’t be counted on in any situation.

It would make sense to offer arbitration to Lee.  The Pirates need a first baseman, they want to keep Lee, and a raise over his $8.5 M salary would be fair, based on his value in the upcoming free agent market.  The Pirates could either keep Lee, or get a compensation pick if he leaves.

As for the catchers, it might be a risk to offer both arbitration, as you risk bringing both back for at least $12 M combined.  Doumit might be less of a risk because of the American League DH factor.  As a catcher, his defense isn’t very desirable, and he’s too injury prone.  It’s possible that he could be tempted by what the market could offer, and turn down arbitration in the process.

Snyder is more of a risk, mostly because of his back injury.  He might get more through arbitration, rather than on the open market, due to questions about his health.  The Pirates would also be spending more on Snyder if he accepted arbitration, as they’d be giving him a raise over his $5.75 M salary, plus the $750 K for the buyout to his $6.75 M option.  Unless he received $6 M in arbitration, it would be cheaper to pick up his option.  The Pirates do seem to like Snyder more than Doumit, so there’s the chance that they could just bring him back.  Personally, I feel that if you’re going to spend close to $7 M on Snyder, you’d be better off giving that money to a Ramon Hernandez or a Rod Barajas.  Both are better options than Snyder at this point, and $7 M would provide more than enough to land either one.

I wouldn’t be surprised to see the Pirates tender offers to both catchers, but I think it’s a risk, as you could potentially see $12 M given to the catching position in 2012.  Overall I could see the Pirates getting anywhere from one to three compensation picks for the 2012 draft, although there are way too many variables involved that could alter that outcome.

Tim Williams

Author: Tim Williams

Tim is the owner and editor in chief of Pirates Prospects. He started the site in January 2009, and turned it into his full time job during the 2011 season. Prior to starting Pirates Prospects, Tim worked with AccuScore.com, providing MLB, NHL, and NFL coverage to various national media outlets, including ESPN Insider, USA Today, Yahoo Sports, and the Wall Street Journal. He also writes the annual Prospect Guide, which is sold through the site. Tim lives in Bradenton, where he provides live coverage all year of Spring Training, mini camp, instructs, the Bradenton Marauders, and the GCL Pirates.

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