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January 31, 2005

The Arbitration Process

The Basics

by Thomas Gorman

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With all of the player movement and flying paychecks, the offseason can sometimes be as exciting as the regular season. As we enter the final phase of the offseason of 2004-2005, salary arbitration hearings, it seems timely to examine what for many is the most confounding part of any baseball winter.

Salary arbitration had humble beginnings. The owners were exhausted by holdouts who refused to show up for spring training. The players were sick of having that refusal to play as their sole leverage in contract negotiations. With Flood v. Baseball failing to force a change in the reserve clause, arbitration seemed a reasonable solution.

Ed Fitzgerald, the Milwaukee Brewers Chairman and head of the owners' Player Relations Committee (PRC) in the early 1970s, embraced the idea as a way to neutralize the MLBPA's push for free agency. The Association's arguments against the owners would be weakened if the Lords showed a willingness to submit to binding and independent salary arbitration. Other owners, in particular the A's Charlie Finley and the Cardinals' Dick Meyer (who had experience with binding arbitration when he was labor chief of Anheuser-Busch), were suspicious, claiming that arbitration would drive salaries up. Which it would, compared to the status quo.

Thirty years on, the process endures. The onset of full free agency, in 1976, for veteran players would create three classes: those with no leverage, those with some leverage, and those with full leverage. Arbitration exists today largely to handle the second class.

How does salary arbitration work?

The process is what is known as "Final Offer Arbitration" (though in the world of alternative dispute resolution it is now becoming known simply as "Baseball Arbitration"). In mid-January, each side to the dispute submits a salary figure to a panel of independent arbitrators. After a few hours of hearings, held in early February, the arbitrators pick one figure or the other. The arbitrator cannot "split the baby" and settle on a salary in the middle of the spread between the club's figure and the player's. One side leaves the arbitration a winner and the other a loser, heightening risk and encouraging negotiation and settlement.

This is the critical element of baseball arbitration: it is designed to produce a settlement, not a verdict.

Are free agents eligible for salary arbitration?

There are two main groups of players who are eligible for salary arbitration. The first are free agents: players who are no longer under control of a club. Free agency is granted upon completion of six or more years of service time.

Baseball's calendar can sometimes push free agents and their clubs into arbitration hearings that neither side really wants. Consider the '04-'05 offseason. As soon as the World Series concluded, each club had an exclusive negotiating window with its free agents. Following this was a short period in which players could negotiate with other teams as well. On December 7, clubs had to decide whether to offer salary arbitration to their free agents. If a club did not offer salary arbitration by this date it was forbidden from signing a contract with that player until May 1. Since this date is well after the season has started, the decision to not offer salary arbitration essentially ends the possibility of the player rejoining the club.

Clubs make arbitration offers for two main reasons. Sometimes the team genuinely wants to continue negotiating with the player on a contract. One recent trend is that teams make arbitration offers to their free agents for the purposes of extending negotiations, with an understanding that the player will not accept this offer. The negotiation window is extended, but there is no risk to the club that the player will win a large arbitration award.

Other times the club is betting that the player will sign a deal with another team, and they will be awarded compensatory picks in the June amateur draft. You must offer arbitration to be eligible for compensation if the free agent signs elsewhere. Sometimes this calculation by the club is made incorrectly. The Braves offered Greg Maddux arbitration in 2003; when he didn't find a multi-year deal with another club, he accepted, eventually dinging them for $14.75 million.

It is extraordinarily rare for a team to actually plan on going to arbitration with one of its free agents, as the risk involved there for a team is tremendous. Teams don't want to go to arbitration with free agents because the arbitration hearing tends to award higher salaries than the free market for players who were looking at pay cuts in the market. This has been the case since 2002, as players who signed contracts under the old Collective Bargaining Agreement had those contracts expire and reached the market under the new one. As a practical matter, pay cuts are virtually unheard of in arbitration, so a player's expectation could actually be higher in an arbitration case.

Nevertheless, free agents usually don't want to go to arbitration because the one-year deal they receive offers far less security and total money than a negotiated multi-year deal. Sometimes the calculated strategies of the two sides don't pan out though, and the player returns via arbitration.

Free agents have to make their decision on whether or not to accept the arbitration offer in late December.

What about non-free agents?

The other players eligible for arbitration are the ones who have not yet accumulated the six years of service time necessary for free agency, but have been on the active roster of a major league club long enough to be eligible for salary arbitration. Under the current CBA these are players with less than six years of service time but at least three, and a handful of players with close to three years' service time.

What the heck is a "Super Two?"

The original 1974 agreement called for players with two years of service time to be included in salary arbitration. The MLBPA traded back a year of eligibility for other gains in the 1985 CBA. Not happy with that giveback, the MLBPA fought for extended salary arbitration privileges in 1990 and negotiated what has become known as the "Super Two" category. Players with at least two years of service time, but less than three years, who also accumulated at least 86 days of service in the previous year, and were in the top 17% of all two-year players in service time, would also be eligible for salary arbitration. Essentially this means that players who almost have three years of service time in the bank are also eligible for salary arbitration.

There are 172 days in a championship season (service time is accumulated according to how many days a player is on the active roster, not according to games played), and from 1990-2003 the cutoff for Super Two players has been somewhere between two years, 128 days and two years, 153 days. In eight of those 14 years the cutoff was somewhere between 2.130 and 2.140. Careful management of young players so as to prevent them from being in a future Super Two class is an important tactic for front office personnel as that extra year of arbitration can make millions of dollars of difference to a payroll.

No matter how the player gets to salary arbitration (Super Two, 3+, 4+, 5+, or free agent) the process is the same.

Who are the arbitrators?

The MLBPA and the Labor Relations Department of MLB jointly agree upon a slate of 16 or so arbitrators to hear all cases in panels of three (one of the three is designated the "Chair" of the panel). If the two sides are unable to agree on a slate the CBA directs them to request a list of qualified arbitrators from the American Arbitration Association (AAA) and each side alternately strikes names off the list until they are left with enough arbitrators to hear all cases.

The arbitrators are lawyers and judges with extensive arbitration experience and arbitration certification from a professional guild like the AAA. Essentially they serve as judges in a quasi-judicial hearing.

The hearings take place during the first three weeks of February. Once the 16 arbitrators have been selected, the next important task is for the Players Association and the Labor Relations Department of MLB, Inc. to schedule arbitrators for specific hearings on specific days. Ninety percent of this scheduling is done according to logistical concerns, but occasionally there is a bit of gamesmanship involved. Neither the Players Association nor the Labor Relations Department want market-setting cases to be scheduled early in the three-week hearing period. For example, if a young pitcher receives a huge victory early in February, the award could impact the hearings of other young pitchers later in the month. For this reason, MLB and the Players Association are careful to plan out the hearing schedule so that the other side has no potential advantage. Often this means that very similar players have their hearings scheduled for the same day.

How does the hearing proceed?

The club and player submit their "last best offer" for a salary ahead of time to the Labor Relations Department and the Players Association respectively. On "exchange day," representatives from both sides meet in New York and exchange figures one by one.

Hearings are arranged in neutral cities by mutual assent (the CBA directs Los Angeles, Phoenix and Tampa/Orlando to be preferred sites). Typically the hearing takes place in a hotel conference room.

The technical procedure is simple. The player and club supply the arbitrator with a Uniform Player Contract (in duplicate) that has been properly completed except for the salary figure. Each side gets one hour to present its case. There is a short recess and then each side gets 30 minutes to rebut the other side's case and 30 minutes to present their summation. By tradition, the order of presentations is Player-Club-Player-Club-Player-Club, which gives the club the last word in each phase. Occasionally the player's representative will successfully move to have the order reversed. Some agents feel that even if this motion is unsuccessful it may stand as a helpful symbol to the arbitrators that the club has a unfair advantage in the hearing.

Within 24 hours of the end of the hearing the panel chief informs the Players Association and the Labor Relations Department of MLB of the final decision, providing additional time for a settlement. The panel does not submit an opinion explaining their decision; it does not explain why they chose one salary figure over the other. The panel chair is also directed not to inform either party of the actual vote of panel members (3-0, 2-1, who voted for whom?). That information is communicated to the Players Association and the Labor Relations Department on March 15th following the hearings and is used by the two sides to help them craft arbitrator slates for the next year. Baseball arbitration is considered a pretty good gig for professional arbitrators. Some observers cynically note that to keep the job you can't side consistently with one side or the other, lest the other group nix you from the job in future seasons.

Who argues the cases?

At the beginning, salary arbitration cases were traditionally argued by an agent representing the player and by front-office personnel representing the club (perhaps the GM, Assistant GM, or someone further down the organization chart). Old-time baseball men were no match for law school-trained agents in a semi-judicial setting. Agents began employing statistical specialists, most notably Bill James, to help them develop sophisticated arguments and counter-arguments and the result was usually domination by the player's side.

Soon enough the teams caught on and began employing their own specialists and hiring their own lawyers. Currently the cases are almost always argued by professional labor lawyers (guys like Mark Rosenthal and Eric Joss) and neither side presently has a talent advantage. The teams that do still use their front-office personnel for presentation always use individuals who are noted for their arbitration abilities (Paul DePodesta was Oakland's representative for Chad Bradford's case before it settled, while Thad Levine argued the Shawn Chacon case for the Rockies).

Cases are prepared rigorously by personnel on both sides. Agents are known to hire full-time arbitration staff, and also to bring on short-term consultants and advisors during the off-season. Teams often do the same, bringing on interns or advisors and often designating senior Baseball Operations personnel to organize case preparation throughout the off-season.

What criteria are admissible? What is inadmissible?

The Collective Bargaining specifically outlines what can and what cannot be brought up by either side's representatives. If evidence is brought up that is not specifically listed in the CBA it is not to be considered by the arbitrators.

The following evidence is admissable:

  1. The quality of the player's contribution to his club during the past season (including but not limited to his overall performance, special qualities of leadership and public appeal).
  2. The length and consistency of his career contribution.
  3. The record of the player's past compensation.
  4. Comparative baseball salaries (the arbitration panel is provided with a table of confidential baseball salaries for all players broken down by years of service).
  5. The existence of any physical or mental defects on the part of the player.
  6. The recent performance of the club, including but not limited to his league standing and attendance.

The following evidence is inadmissible:

  1. The financial position of the player and the club (though player representatives often try to get this information in the back door by presenting attendance information that implies the health of a club's revenue streams).
  2. Press comments, testimonials or similar material bearing on the performance of either the player or the club, except for recognized annual player awards for playing excellence.
  3. Offers made by either the player or the club prior to arbitration.
  4. Cost to the parties of their representatives.
  5. Salaries in other sports or occupations.

What's this about "comparative baseball salaries?"

For years, the Players Association executed a brilliant strategy. As free agency created market competition and poor payroll management, GMs would bid each other up and ink players to ridiculous contracts. In arbitration hearings, player-agents would make clear and convincing comparisons between their young stud and the mediocre talent with a ridiculously bloated contract.

The result was devastating for management. Each bad contract sent ripples through the market and forced salaries up for everyone, all the way down to two-year veterans in their first salary arbitration hearing. As John Helyar writes in The Lords of the Realm, "They couldn't be free agents, but they could compare themselves to free agents. The rising tide of salaries in the open market would lift all boats."

In the 1985 labor agreement, the owners were able to address that in part. The current CBA contains this clause: "The arbitration panel shall, except for a Player with five or more years of Major League service, give particular attention, for comparative salary purposes, to the contracts of Players with Major League service not exceeding one annual service group above the Player's annual service group."

In other words, Super Twos can be compared to Super Twos and three-year players, but not four-year players. Threes can be compared to other threes and fours, but not fives. The exception is that fives can compare themselves to anyone, just like free agents. Aramis Ramirez says, "hi."

The Players Association did secure a loophole, though. "This shall not limit the ability of a Player or his representative, because of special accomplishment to argue the equal relevance of salaries of Players without regard to service, and the arbitration panel shall give whatever weight to such argument as is deemed appropriate" (emphasis added). Essentially the player's representative can argue that the player's accomplishments are so unique as to demand comparison to players outside the designated group of comparable players.

How special do you have to be to call your accomplishments "special?" It is unclear. Each panel is directed to give as much weight to the argument as they choose to. If the argument is strong, maybe they'll go for it. If not, the case is probably lost right there, since any representative arguing "special accomplishment" is also probably arguing for a salary totally out of line with comparable salaries in the player's true service-time class.

What about salary cuts? Isn't there a rule about this?

Yes, there is, and this is one of the more confusing rules in baseball contracts. No club may submit a salary figure that is less than 80% of the player's previous year's salary (or 70% of his salary two years' previous).

The CBA is incredibly unclear on this point, but it seems that for the purposes of this rule the term "salary" is a combination of guaranteed money and earned performance bonuses. This is critically different from the rule regarding maximum salary reduction for players who have not yet reached salary arbitration eligibility. For pre-arbitration players the term "salary" is a combination of guaranteed money, earned performance bonuses and unearned performance bonuses. In any case, it is incredibly rare for this rule to come into play. The nature of the arbitration system almost never propogates salary reductions.

The maximum-cut rule does not apply for free agents in arbitration. The Collective Bargaining Agreement specifically states that the maximum salary reduction rule is inapplicable in free-agent arbitration cases. To clarify, when Joe Sheehan wrote that that Toronto wouldn't risk going to arbitration with Carlos Delgado because of the 80% salary rule, he had his facts wrong. The rule didn't apply to Delgado because of his free-agent status.

The last case where someone walked out of an arbitration hearing with less money than they made the previous year was Randy Milligan in 1994. Occasionally players settle prior to their hearing and settle at a salary that is less than they made the year before, but even that is extremely rare.

How do the arbitrators decide which figure to choose? Is there a rule on that?

No, there isn't. Arbitrators can use whatever logic they want to reach their decision. Labor arbitration tradition usually calls for the arbitrator to come up with what they consider to be the correct market salary for the player, and then to compare that figure with the two figures submitted as "final offers." Whichever figure is closest should be selected. Essentially this is the same as an arbitrator looking at the midpoint between the two submitted salary figures and trying to decide whether the player is worth one dollar more or one dollar less than that midpoint.

For example, Clemens submits at $22 million, The team submits at $13.5 million. The midpoint is $17.75 million, so the arbitrator would theoretically have to ask whether Clemens should be paid more or less than that mid-point figure. If he finds the correct price to be higher than the mid-point, he must pick the $22 million. If he finds the correct salary to be lower, he goes with the club's offer.

To be clear, though, this is how "Final Offer Arbitration" typically proceeds in a labor salary setting. There is no directive in the rules of baseball's salary arbitration that force the arbitrators to use this type of logic in reaching their decision. There is some suspicion that even if mid-point analysis should lead the arbitrators to go with the player's figure, the panel might be hesitant to "set a record" with their award.

Why are the owners always trying to take salary arbitration away in labor negotiations?

Because they view arbitration as an inflationary process. It is, in that salaries are higher through arbitration than they would be if players had no recourse other than a holdout. However, arbitration is a better system for management than full-fledged free agency; whatever Johan Santana is guaranteed in his arbitration-realized contract will be a fraction of what he would be guaranteed in open bidding for his services.

Various changes have been proposed to the system over the years, most notably first-refusal free agency for players in the arbitration class, or a rigid salary structure based on performance and service time for this class. These would be better for management than arbitration, but have little chance of being negotiated into a CBA, because the MLBPA correctly sees them as tools for lowering salaries.

Arbitration is an effective compromise that eliminates holdouts and forces the two sides to come forward with reasonable figures that, more often than not, lead to a negotiated solution.

--

Tom Gorman writes Fogball and can be reached here.

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