contract negotiations

SM 630: Contract negotiations

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Introduction

The purpose of the exercise is to simulate a salary negotiation between management and a free agent's player rep.

Your goals are

1) To successfully negotiate a 10-year contract with the other party

2) Within that agreement, to get the best possible financial terms for your side

While, in reality, there may be many aspects to a negotiation, this exercise focuses solely on the financial aspect.

This exercise requires that you evaluate the financial terms of what is being offered by the other party, and,

correspondingly, the financial terms that you are offering the other party. This is a 10-year contract, and thus you

will primarily be calculating present values of various contract offers using the time value of money techniques.

Throughout this document you'll notice that I'm saying "negotiate with" and not "negotiate against." I loathe the

phrase "negotiate against." The language frames negotiations as adversarial and zero-sum, yet in any negotiation,

both sides want to come to an agreement (otherwise they wouldn't be at the table in the first place).

General rules and assumptions

You're motivated to make a deal…

Each side wants to reach an agreement with the other side. That is, the player does want to sign with the team,

and the team does want to sign the player. The challenge for each side is to find the common financial ground that

will allow an agreement to be reached.

…with certain restrictions…

Each side will have a set of constraints within which their negotiations take place. Management will have limits as

to the maximum they can pay in any given year and/or limits as to the total maximum (present) value of the

contract. Similarly, the player rep will have limits as to the minimum they will accept in any given year and/or limits

as to the minimum total (present) value of the contract. These restrictions will not be known until shortly before

the negotiation begins.

Each side will use the same discount rate for calculating the present value of the offers.

…that are unknown to the other side.

The management team will know its own constraints, and the player representative team will know its own

constraints, but neither side will know the other party's constraints.

Specific assumptions

League rules state that the total nominal value of a contract of this length cannot exceed $60m; i.e., a $60m deal

would be the "league maximum." In addition, there are specific rules around other aspects of the contract:

Signing bonuses

• Signing bonuses are allowed, but not required. They are paid when the contract is signed. That is, they are

paid today (T=0).

Annual salary

• Salaries for each of the 10 years are paid at the end of the year. I.e., salary for year 1 is paid at T=1, salary

for year 2 is paid at T=2, …, salary for year 10 is paid at T=10.

SM 630: Contract negotiations

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• The player must receive a salary during each of the 10 playing years of at least $0.5 million per year.

That's the league minimum as negotiated in the Collective Bargaining Agreement with the Players Union.

• The salary amounts can change during each year of the playing contract.

Deferred compensation

• Contracts can include deferred money, but it is not required.

• Deferred money must start in the first year after the playing contract ends (T=11).

• Deferred money must be in the form of a constant annuity. That is, the player must receive the same

amount in each year of the annuity.

• The deferred annuity must have a minimum of 5 payments and a maximum of 10 payments. That means

that if deferred compensation is offered, it will start in T=11 and end at T=15, T=16, T=17, T=18, T=19, or

T=20.

• No more than 30% of the contract's nominal value can be in the form of deferred compensation. For

example, if the overall nominal value of the deal were $100m, and the contract included 5 years of

deferred money, those annuity payments could not exceed $6m each ($6m per year * 5 years = $30m,

which is 30% of $100m).

Overall contract

In summary, an agreement will look this way:

Example using a three-year contract

Using a simplified 3-year contract situation, the example here shows the kind of information that might be given to

both sides.

Information given to management

• Signing bonus (i.e., at T=0): $4m maximum

• Nominal salary in year 1 (i.e., at T=1): $6m maximum

• Present value of entire contract: $25m

• Discount rate is 9%, which is the same rate for both sides.

You also have knowledge that, given the market for this player, the player would be unlikely to accept any contract

whose present value is less than $20 million. However, you do not actually know for certain that this is the

minimum they would accept.

Information given to player rep

• Signing bonus (i.e., at T=0): $2m minimum

• Nominal salary in year 3 (i.e., at T=3): $11m minimum

• No more than $4m (in today's dollars) in deferred compensation

• Present value of entire contract: $19m minimum

• Discount rate is 9%, which is the same rate for both sides.

You also have knowledge that, given the market for this player, the team would be unlikely to accept any contract

whose present value is greater than $28 million. However, you do not know for certain that this is the maximum

they would accept.

SM 630: Contract negotiations

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Some hints

Pre-preparation (before negotiations begin)

Set up your Excel spreadsheet so you can quickly calculate the present value of various contract offers. That is, set

up the spreadsheet so you just have to plug in the salary numbers for each year, and the present value is then

automatically calculated. At a minimum, the Excel sheet should show you…

• The PV of each year's payment

• The PV of the deferred compensation portion (if applicable)

• The PV of the overall contract

• The nominal value of the overall contract

• The nominal value of the deferred compensation portion (if applicable)

During negotiations

Once you receive your constraints, you must develop an initial offer to be presented simultaneously to the other

party. The initial (and subsequent) offers only need to include the nominal values of payments within each year.

This will serve as the starting point for negotiations.

This is a collaborative process in that you do want to reach an agreement with the other party. However, it is also a

competitive process – you want to negotiate the best possible contract for your side. Therefore, while you want to

explore areas of mutual agreement, you never want to disclose your constraints (i.e., your "bottom line" figures) to

the other party. Doing so would cause you to lose all your negotiating power and will ensure that the other party

gets the best possible contract.

At the end of negotiations (what to submit)

Each side will submit the following deliverables via Blackboard:

1. Its initial offer

2. The final version of the Excel file used during negotiations.

3. The salary terms of the final agreement. Or, if you fail to reach an agreement, each side will input its final

offer and a summary (no more than 1 page) of why the negotiations failed.

Evaluation

I will be looking for (in order of importance):

• The ability to reach an agreement that satisfies all constraints.

• The present value of the final agreement. For management, lower present value is better. For the player

rep, a higher present value is better.

o In addition to your team grades, I will combine the results for the two teams within each group.

The group with the best results overall (across both of its teams' negotiations) will earn bonus

points. However, remember that teams cannot communicate with other group members once

the negotiation period begins.

• The quality of your Excel tool used in negotiations. It should…

o Be accurate

o Clearly show all pertinent contract information & calculations

o Be flexible enough (i.e., use cell references) to calculate contract offers quickly

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Mechanics (How will this work within Sport Finance?)

Dividing our course groups into teams

In order to ensure that everyone is involved, each course group will divide itself into two teams (e.g., Group 3 will

turn into Team 3-1 and Team 3-2). That will put 2 people on each team. Since groups 5 & 6 already have only 3

people each, they will stay whole and negotiate with each other. I will let you all determine the most effective way

to divide your groups. For example, perhaps you want to divide such that each team has someone with strong

Excel skills and someone with strong communication skills.

Groups 1, 2, and 5 will represent Management, and Groups 3, 4, and 6 will represent Players.

Groups can work together before negotiations start. That is, the two teams (e.g., 1-1 and 2-1) can discuss strategy

with their groupmates, work together to develop your Excel workbook, etc. However, once negotiations start (i.e.,

once the constraints are distributed to each team), there can be no communication with any other group members

or teams other than the team with whom you are negotiating.

Negotiation Management Players

A Team 1-1 with Team 3-1

B Team 1-2 with Team 3-2

C Team 2-1 with Team 4-1

D Team 2-2 with Team 4-2

E Team 5 With Team 6

Conducting the negotiations

There will be dedicated groups for each negotiation, accessible via the link titled "Group pages for conducting

salary negotiations." In there you will see the board for your particular negotiation; for example,

"SalaryNeg_1-1with3-1" is the board for Team 1-1 with Team 3-1, the first row in the table above.

These discussion boards are where the negotiation will take place between the two sides. Any communication with

the other side should go through this board, including your official offers.

Note that communication with your teammate(s) should not occur on this board since you don't want the other

side seeing your planning. Likewise, teammate discussion cannot occur on your Group's board since you cannot

discuss the negotiation with other group members (e.g., Team 1-1 cannot talk with Team 1-2). Therefore,

communication with your team member(s) will occur outside of the Blackboard environment.

Schedule

Now (-ish)

You can begin to construct your Excel files as soon as you're ready. Anything you need to do so is covered in the

Excel lessons, and of course, I am very happy to review your files and give you feedback (but only before the

negotiations start – i.e., before the salary constraints are released).

Before Wednesday, September 27, 2017, 11:59 AM – Decide on team members

There is a discussion board forum titled "Team members for salary negotiations." Post a thread in there with the

members of each team for your group.

Thursday, September 28, 2017, 8:00 AM – The negotiation period begins

The salary negotiation constraints will be made available on Blackboard. Your group will only be able to see the

constraints for your side – e.g., if you are representing the team, you'll only see Management's constraints.

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Saturday, September 30, 2017, 11:59 AM – Initial offers due

Post your initial offer to the other side on the discussion board sometime before noon on the negotiation start

date. Even though you hit submit, the post will not appear right away. The setting on the discussion board requires

moderation of posts, which means they will not appear until I release them. Thus, I will get on the board and

release the initial offers precisely at noon. At that point, I switch off the post moderation so you can go back and

forth with the other side as normal.

Before Wednesday, October 4, 2017, 11:59 PM – submit final materials

Your salary negotiation deliverables (initial offers, final agreement, and Excel tool) must be submitted via

Blackboard. You can submit these earlier, if you like, depending on when you finish your negotiations.