A recent trend has emerged where NBA superstars are opting to sign short-term, one-to-two year contracts in lieu of longer, four-to-five year agreements. For many fans, this move seems counterintuitive. Why would an NBA player turn down a longer contract that fully guarantees payment? Wouldn’t this option better mitigate risks associated with the increasing likelihood of getting career-diminishing injuries? For those unfamiliar with how athlete contracts work, the following will serve as a crash course in how and why NBA players enter their selected agreements.
For starters, let’s discuss maximum contracts, or contracts that pay the player the maximum amount allowed over the total course of a contractual period. Maximum contracts are primarily dependent upon the league salary cap for the upcoming season. Depending on the amount of time a player has been in the league, the player’s first-year max contract salary will be 25%, 30% or 35% of the upcoming year’s salary cap. So, for NBA superstars who have been playing for many years, the higher the league salary cap, the better. Additionally, the salary for years two-through-five can only increase by a set percentage — either 5% or 7.5%. For example, if a player signs a 4yr max deal where the first year pays $20 million and has 5% annual increases, then the second year would be $21 million, the third year would be $22 million, and the fourth year would be $23 million. That’s right! It is not compounding interest.
Now, how is the annual salary cap determined, you ask? The cap is based on the Basketball Related Income estimate (or the BRI), which is the anticipated amount of revenue the league will earn in the upcoming year. The BRI includes numerous types of revenue, such as: ticket sales, team sponsorships, and a portion of naming right, among other things. However, the main driver of BRI is typically TV licensing rights. This is relevant considering the NBA recently extended its TV deal with ABC and TNT for nine more seasons starting in 2016 for a reported $2.66 billion. This move drastically expanded the salary cap.
(Source: USA Today, Basketball-reference.com)
As you can see from the above graph, the TV deal had a dramatic effect on the salary cap, growing from $59 million in 2013 to a projected $102 million in 2016. With annual percentage increases in the salary cap that exceed the maximum in-contract increases, renewing a contract as often as possible – for many top players – will provide greater opportunity to capture more money. Thus, shorter-term contracts are preferred.
Let’s take Lebron James for example, when he returned to Cleveland he could have signed a 4yr, $102 million guaranteed contract with 7.5% annual increases in the summer of 2014 when the estimated salary cap was $65.5 million (scenario 1 below). Instead, he signed two one-plus-one contracts (1yr with a player option for a second) followed by a two-plus-one contract (2yrs with a player option for a third). This gave Lebron over $133 million in the same four-year period, $31 million more than if he signed a standard max contract. Each year he re-signs he can capture a greater sum of league revenues if the salary cap continues to jump.
Moving forward, however, it is unlikely that players will continue to take the risk of signing short-term contracts since there will not be an abnormal increase in the salary cap until the TV contract is up for renewal. So, look for both Lebron James and Kevin Durant to sign long-term contracts in the near-future.