The value of serial deferred payments: a deconstruction of Bobby Bonilla Day

Do you prefer $1.00 today or tomorrow? What is the value of deferred payments? Let's deconstruct a famous deferred payment story: Bobby Bonilla, the New York Mets, and Bernie Madoff.

Most people want their money now. Some, however, are smart enough to defer their payments and end up earning far more. Let’s deconstruct one of the most famous deferred payment structures in the history of US sports: the case of Bobby Bonilla, the New York Mets, and a huge curveball named Bernie Madoff.

Background

Bobby Bonilla played his last season with the New York Mets in 1999. He was injury-prone and the Mets wanted to use his remaining salary to invest in new players. He was owed $5.9 million in CY 2000. Rather than pay him that amount, the Mets wanted to use the money to

1. make outside investments and

2. invest in new players

The Deal: Deferral #1

The Mets and Bonilla agreed to the following terms

1. defer payment of the remaining salary until the year 2011 (11 years later)

2. accrue interest at 8% for the lifetime of the balance (i.e., an 8% interest rate until the liability to Bonilla has reached $0.00).

Why this deal looked good in CY 2000

For the Mets, this was a good deal. By growing the $5.9 million at a rate (12% annually) greater than their liability to Bonilla (8% annually), they would have made approximately $6.7 million ($20.5 million - $13.8 million) at the start of CY 2011. That return would have allowed them to invest further into players or continue with their high-returning, 12% per annum investment endeavor.

For Bonilla, he would stand to gain $13.8 million at the start of CY 2011 — if he agreed to have it all paid at once.

He didn’t.

Bobby Bonilla from 2011 to 2035

With regularly scheduled payments of $1.19 million every year on a liability of $13.8 million and at 8% interest per annum, Bonilla would collect a total of $29.8 million over the lifetime of the payment period (25 years from 2011 to 2035).

The power of two deferrals

Bonilla made two financial decisions that resulted in a ballooning of his salary from $5.9 million (t = CY 2000) to $29.8 million (t = CY 2035)

1. he deferred payment for 11 years at 8% interest

2. he declined a lump-sum payout in CY 2011 and chose to spread payments over 25 years

Choice #1 allowed him to grow the balance of his salary from $5.9 million (t = CY 2000) to $13.8 million (t = CY 2011).

Choice #2 allowed him to grow the balance of his salary from $13.8 million (t = CY 2011) to $29.8 million (t = CY 2035).

The Mets from 2008 to 2035

The Mets made a fiscally-sound decision by agreeing to deferral #1. Remember, Bobby Bonilla wanted an annual 8% rate of return on his $5.9 million, while the Mets were participating in an investment that returned 12% annually. On paper, this was a sound decision.

Unfortunately, the “mystery investment” that the Mets used to earn 12% annually was with Bernie Madoff, the perpetrator of the largest Ponzi scheme in the history of the United States. The Mets never had 12% returns per annum - they had 0% returns. So in CY 2008, when the Madoff Ponzi scheme began to unravel, the Mets had a phony investment worth $14.6 million. By the time CY 2011 rolled around (the first year that Bonilla would receive payments), the Mets had a confirmed investment value of $0.00.

The value of serial deferrals

The case of Bobby Bonilla, the Mets, and Bernie Madoff illustrate the power of deferrals. It’s okay to defer payments as long as you’ve attached a cost to that deferral. In this case, Bonilla attached the average market return of 8% per year.

It’s also okay to defer a one-time lump-sum payment for scheduled payments, provided that you attach a cost to that schedule. In this case, Bonilla declined taking the $13.8 million in CY 2011 and spread the payments over the next 25 years at the same annual average market return of 8%.

There you have it. The value of payment deferrals and spreads. Leave a comment below and tell us how you celebrate Bobby Bonilla Day (1 July every year until 2035).