Taleb on compensation in banks
Another article that caught my eye while skiing and reading my iphone on the chairlifts. Taleb penned a scathing critique in the FT of the "free option" bankers have.
There are several themes in the article (that I remember, sorry no link it was last week :)). First, the existence of a free option. That is good old "privatize gains, socialize losses" culture. Then Taleb rehashes his notion of a black swan by pointing out that yearly incentive schemes create perverse incentive. You load up on back risk as a money manager, say you know you blow up every 10 years but make 10% every year and charge 2/20% of profit or 4% a year. That means that in 10 years your investor blows up but you walk away with 40% accumulated over time. Get it? I have blogged about this theme in the context of private equity. In PE, the payout is AT EXIT.
Taleb then calls for nationalization. Saying that there is no way to solve these problems. Regarding 2/ I do believe that being paid at exit solves the incentive problem it could also include a clause whereby the Hedge fund can close the fund after a period of time. Regarding 1/ I don't think there is anything to do, by definition of OPM (Other People's Money), the payoff for manager/investor are win/win if the portfolio goes up and zero/lose if the portfolio goes down.
There are several themes in the article (that I remember, sorry no link it was last week :)). First, the existence of a free option. That is good old "privatize gains, socialize losses" culture. Then Taleb rehashes his notion of a black swan by pointing out that yearly incentive schemes create perverse incentive. You load up on back risk as a money manager, say you know you blow up every 10 years but make 10% every year and charge 2/20% of profit or 4% a year. That means that in 10 years your investor blows up but you walk away with 40% accumulated over time. Get it? I have blogged about this theme in the context of private equity. In PE, the payout is AT EXIT.
Taleb then calls for nationalization. Saying that there is no way to solve these problems. Regarding 2/ I do believe that being paid at exit solves the incentive problem it could also include a clause whereby the Hedge fund can close the fund after a period of time. Regarding 1/ I don't think there is anything to do, by definition of OPM (Other People's Money), the payoff for manager/investor are win/win if the portfolio goes up and zero/lose if the portfolio goes down.
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http://www.ft.com/cms/s/0/fa89be08-02aa-11de-b58b-000077b07658.html