Offering arbitration is about the smallest gesture you can make to say “Yes, we’d like this player back.” So without the requirement to offer arbitration, you’re compensating teams (like the Brewers) for losing a player they weren’t even considering bringing back in the first place (like Gagne).

Now that the Brewers have declined arbitration, they’re still free to negotiate with Gagne on a cheaper deal. The old rule that you couldn’t negotiate until May after declining arbitration is gone. But the biggest pay cut Gagne could have taken in arbitration was 20% (I’m pretty sure), so the least he could have made in arbitration is $8 million, well above his likely market value.

The compensation rule is in place to protect smaller market teams. Essentially, it’s allowing a team to say “We’re willing to pay you fair market value for next season.” Then, if the Yankees exceed fair market value to sign a player or sign him for multiple seasons, his previous team gets something to help restock from within.

OK – but in this case – we are getting screwed. I am sure the DM would bring Gagne back – for fair market value – (a lot less than he made last year) – but because of the arbitration process he couldn’t risk it so we lose the pick. I guess that is just part of the game

It’s what the 1981 strike was about. In 1976, when free agency first started, owners were afraid salaries would shoot way up and wealthier teams would have too much of an advantage. So they sought to put limits on free agency. Well, most of them did: Charlie O. Finley wanted to make all players free agents every year to keep prices down. Since Finley was a radical, the rest of the owners ignored him and negotiated with the MLBPA to place some restrictions on free agency. Players with six years’ service time could file for free agency and such players could only file for free agency once every five years. Also, only twelve teams would be allowed to negotiate with each free agent. These teams were determined at a post-season draft of negotiating rights. Compensation for losing a free agent was the signing team’s highest draft pick (unless the team was selecting in the top half of the first round, in which case their highest pick was considered their second round pick).

Even with some checks on free agency, the owners spent so profligately the average salary nearly tripled in four years. So when it came time to work on the 1980 CBA, both sides agreed to put a committee together to recommend a compensation scheme in 1981. If it failed to produce one, the owners could implement their own proposal but the players would have a right to strike. Nothing was solved, the owners put their own proposal in place, and the players struck in the middle of the season. After 712 games were canceled, a new form of compensation was agreed upon.

Type A and B free agents were introduced for the first time with similar definitions although the top whatever percentages were different. Each team was allowed to protect 24 players in its organization. Teams that didn’t sign any Type A free agents could protect 26 players. Up to five clubs could protect all of their players by pledging not to go after any Type A free agents in the negotiating draft for three years. If a team lost a Type A free agent, it could select an unprotected player from any team in the league as compensation. In addition, they got an amateur draft pick. Type B free agents netted two draft picks. All other free agents netted one draft pick.

It didn’t work. Players could be taken from teams that weren’t involved with a free agent signing. The Mets’ Tom Seaver went to the White Sox as compensation for Dennis Lamp heading to Toronto. The Athletics were allowed to draft Yankees’ top prospect Tim Belcher even though Belcher signed with New York after the deadline for protecting players had passed. Fans couldn’t figure out why any of this made sense. Heck, some teams couldn’t figure it out.

So by 1985 owners were sick of the compensation draft idea. After contentious negotiations over a number of other issues (made worse by owners claiming the last year baseball made a profit was 1978 when all 26 teams combined to make a whopping $4,568), the compensation draft was dropped. The annual draft of negotiating rights was dropped. This meant that for the first time all free agents could talk with every team. The one catch installed, however, was that for a player’s original team to retain its negotiating rights with the player they had to offer him salary arbitration. That’s where the offering arbitration to free agents thing got started.

It all comes down to this: as said above, offering arbitration is a sort of last resort way of saying to the player that the team wants him back. The idea of linking draft picks to arbitration again comes from the idea of compensation. By offering their free agents arbitration, the team is expressing interest having them back. Thus if the player accepts presumably everyone’s happy. If the player doesn’t accept and signs elsewhere, the team’s interest in keeping their now lost player is rewarded by draft picks. If the team doesn’t offer arbitration, it’s saying the team doesn’t want a player back even for fair market value set by an impartial arbitrator. Thus if/when that guy goes elsewhere, the former team gets no reward for not wanting the player back.