Setting the Salary Cap: The Zero-Sum Game and How to Fix it

Updated: February 5, 2015 at 10:35 am by Thomas Drance

What follows is an article from Nation Network senior collective bargaining agreement correspondent and corporate lawyer @BeantownCanuck. You may remember him from his stellar work on rule 13.23, or his piece on the penalties for cap floor violations

Today Beantown sets his eyes on the NHL’s confusing escrow system, which pits players against players, and results in uncertainty for NHL executives. He has some ideas to improve the system. 

Every July we hardcore NHL fans get all excited and giddy about free agent frenzy.

We anxiously refresh our Twitter feeds because we can’t wait to see where each player will land. And we especially can’t wait to hear what crazy amounts of money those players gonna’ get paid. Well I’m here to tell you it’s all a pack of lies.

Because of the intricacies of the NHL salary cap system, actual player salaries are never known until the end of the season. And, depending on how clairvoyant the league and NHLPA were in setting the salary cap for that season, are quite likely to be less than the amount Nick Kypreos skillfully tweeted to his followers 12 seconds before Darren Dreger did the same. In some years a lot less. 

According to the NY Post’s Larry Brooks, last season, every single player’s actual salary was roughly 12% less than the amount agreed in their contract. In the case of the Shea Weber, he who earned the league’s highest salary, the Predators paid him roughly $12.3M in the end, not the $14M listed here at NHLNumbers.

The Source of the Problem

The NHL-NHLPA Collective Bargaining Agreement is the culprit here.

The salary cap that governs the maximum and minimum amount teams can spend in any given season is set by estimating the amount of money that will be required to be paid to players under the CBA that season. The model is based off of only one real number: how much revenue the NHL makes that season. Everything else flows from that. And that number will only be known when the season is over.

The CBA provides that exactly 50% of hockey related revenue must be paid to players. If the total amount of salary slated to be paid to players in any season ends up being more than 50% of revenue earned that year, then players are required to forfeit an appropriate portion of their salary so that the 50% mark is hit.

This forfeiture is standard practice when the salary cap is set “too high” such that, when the numbers are crunched at the end of the season, the accountants conclude that teams had “overspent”. And this is what has happened almost every season since the salary cap started a decade ago.

To avoid the possibility of sending full-salary cheques to players only to then require players to return some of that money after the season, the CBA includes an escrow concept, whereby a portion of all player salary is retained in an escrow fund. After the season, the accountants determine how much of the escrow fund should be paid to the players and how much should be returned to the owners. Players do not like this (just ask Dan Ellis).

It’s perfectly understandable why the players hate it–if you signed a contract saying you’ll earn $10M next year, shouldn’t you reasonably expect that you’ll actually earn $10M next year?

At the beginning of the current NHL season, the escrow amount was set at 14%. Halfway through the season–presumably as a result of the ever-slipping Canadian dollar–the league and the PA agreed to the unusual step of increasing the escrow to 16%, which suggests to me that there was concern that 14% was likely not going to be enough of a clawback at season’s end.

That means that this year the Shea’s of the world’s (pre-agent, pre-tax) take-home pay from his $14M contract might really be below $12M. Players will surely not be happy. The good news for Dan Ellis is that the NHL salary cap does not govern the AHL.

Player against Player, and Team vs. Team

The logical solution, then, from the perspective of an angry player earning less than it says in his contract, is to be super-duper conservative when setting the salary cap.

Any player under contract should, from a self-interest point of view, always want the salary cap to be as low as possible. Conversely, any free agent should want the salary cap to be as high as possible because that maximizes the amount of cap space available for teams to sign them. 

Without huge cap space, there can’t be huge contracts. The uncomfortable and unavoidable reality for the NHLPA under the current model is this: every time a player signs a contract, he’s taking money that would otherwise have gone into the pockets of players already under contract. The pool of money to be paid out to the players is set at 50% of revenues no matter what; how that money is split between free agents and those already signed is thus a zero-sum game. 

Understandably, this creates an ugly tension before each season. In his most recent edition of 30 Thoughts, Sportsnet’s Elliotte Friedman highlights a manifestation of this tension:

There is a legendary story about two players who got into an argument during one team’s escrow vote several years ago. As the tale goes, one star, who had already signed a long-term contract, said his teammates should vote against raising the ceiling this time. Another star, heading into free agency, exploded at him, saying, “Oh, so the maximum should be available when it benefits you but not me?”

Meanwhile, from a team perspective, there’s also the reality that high-spending teams, who typically drive league revenues, can find themselves in big trouble if the cap is set too low, and may need to jettison good players eating cap space.

The Islanders took advantage of that last off-season when, sitting nice and close to the cap floor, they happily picked off Johnny Boychuk from the Bruins and Nick Leddy from the Blackhawks, two quality players from quality teams that gambled on the salary cap rising higher than it did.

Whether that is a problem, mind you, depends if you like or dislike the notion that shrewd (or lucky) accounting management should be a factor in team success. Me and my buddy Laurence Gilman love it, but you may not.

An Alternative Approach

To solve some of these issues I would suggest that the NHLPA and the league seek to reformulate the cap structure to remove both the zero-sum tension of free agents vs. signed players, and the understandable frustration of getting paid less money than the number plainly written in your contract.

How would this work? Well, instead of delicately determining the salary cap before each season, create a salary cap mechanism free of fixed dollar values but instead focused on relative salary share. Intuitively, in a system where aggregate player salaries is not a fixed amount but rather a fixed portion of an amount to be determined (i.e. league revenue), shouldn’t individual player salaries also not be a fixed amount but rather a fixed portion of an amount to be determined (i.e. aggregate player salaries)?

Let’s get specific. Each team must spend between 700 (cap floor) and 1000 (cap ceiling) “salary units” each season. Subject to a minimum salary (say, 8 units), individual players can be signed for any number of units so long as each team in total spends somewhere in the 700-1000 range. League-wide, a total of between 21000-30000 units will be divvied out each season. If teams make similar economic decisions under this system as they do under the current system, top players will likely be signed for around 150 units, or about 15% of the salary cap.

At the end of each season, the value of each unit is determined by dividing 50% of league revenues by the total number of units allocated that season. For example, let’s suppose league revenue is $3.7B (as it was last year), and most teams spend close to the cap such that 28000 units have been allocated to players. Then each unit would be worth: $1.85B (being 50% of revenue) divided by 28000 units, which amounts to $66,071.43 per unit.

For an elite player signed for 150 units, that would mean an annual salary of $9.9M. Compare that to, for example, Sidney Crosby, who last year had a cap hit of $8.7M, a listed salary of $12M, and actual earnings (after escrow forfeiture) of $10.6M. For a replacement-level player earning league minimum of 8 units, their annual salary would be $529,000, which is similar to current league minimum.

Most of the other rules that govern the current CBA cap structure could be incorporated on analogous terms into this structure. Perhaps teams can transfer unit allocations as part of trades. Or players under long-term contracts could be allocated different amounts of units for each season, and the amount of units can be averaged out over the length of the contract. Or perhaps it would be more interesting if they weren’t averaged out, because cap hits that appear large today will no longer be relatively less massive in the future if the concept of a rising cap is rendered moot. That would change contracting strategies.

Allocated cap space are, for the most part, known quantities going into each season. There is no longer any yearly salary cap determination and the zero-sum game among players is no more. Teams have certainty about where their future plans stand with respect to the cap, and players have certainty as to what proportion of league revenue they will earn (aka “what is my salary relative to other players”).

While salaries will still need to be paid out based on estimated revenue throughout the season to be reconciled with actual revenue upon season end, the distasteful notion for players that they are forfeiting salary earned is no more. It makes a whole lot of sense to me.

And don’t worry, free agent frenzy can remain as exciting as ever. Listed salaries under the current regime are really just estimates disguised as fixed sums, and there’s nothing to stop reporters from doing a teeny bit of math before tweeting out estimated mega dollar amounts under my proposed salary unit system. Or they can hire bloggers to do the math for them!

Beantown Canuck is a lawyer in real life specializing in corporate transactions and commercial contracting, which is probably why he nerds out on CBA mechanics. Because he’s a lawyer, he wants to be clear that nothing in this piece should be construed as legal advice, although he’d like to see how you would attempt to construe it as such because, well, it’s not very legal advice-y in any way. You can follow him on Twitter at @BeantownCanuck