The Robert Rubin Free Option
Taleb’s Robert Rubin example illustrates asymmetric executive compensation: personal gains can remain intact while the costs of later institutional losses fall elsewhere. He argues that delayed bonuses alone may leave much of that asymmetry in place.
THE IDEA
The Robert Rubin Free Option
Robert Rubin, former treasury secretary, earned $120 million from Citibank in bonuses over about a decade. The risks taken by the institution were hidden but the numbers looked good … until they didn’t look good. Citibank collapsed, but he kept his money—we taxpayers had to compensate him retrospectively since the government took over the banks’ losses and helped them stand on their feet. This type of payoff is very common, thousands of other executives had it.
The analogy is an architect who hides a risk of delayed collapse while collecting fees protected by legal complexity.
Some people suggest enforcing a “clawback provision” as a remedy, which consists of making people repay past bonuses in cases of subsequent failure. It would be done as follows: managers cannot cash their bonuses immediately, they can only do so three or five years later if there are no losses. But this does not solve the problem: the managers still have a net upside, and no net downside. At no point is their own net worth endangered. So the system still contains a high degree of optionality and transfer of fragility.
The same applies to the fund manager involved in managing a pension fund—he, too, has no downside.
But bankers used to be subjected to Hammurabi’s rule. The tradition in Catalonia was to behead bankers in front of their own banks (bankers tended to skip town before failure was apparent, but that was the fate of at least one banker, Francesco Castello, in 1360). In modern times, only the mafia executes these types of strategies to remove the free option. In 1980, the “Vatican banker” Roberto Calvi, the chief executive of Banco Ambrosiano that went bust, ran to take refuge in London. There, he supposedly committed suicide—as if Italy was no longer a good place for acts of drama such as taking one’s own life. It was recently discovered that it was not quite suicide; the mafia killed him for losing their money. The same fate befell the Las Vegas pioneer Bugsy Siegel, who ran an unprofitable casino in which the mafia had investments.
Taleb reports that, at the time of his account, some countries such as Brazil made top bankers liable to the extent of their own assets.
When to use it
Evaluating and designing executive compensation packages in publicly traded companies to align incentives with long-term stability.
Analyzing risk-taking behavior in financial institutions and proposing regulatory safeguards such as personal liability for executives.
Understanding the moral hazard created by government bailouts and the need for reforms that make bank executives personally accountable.
Assessing pension fund management to ensure that fund managers are not incentivized to take excessive risks without personal consequences.
FROM THEORY TO EVERYDAY LIFE
In practice
Robert Rubin at Citibank
Taleb reports that Robert Rubin earned $120 million in Citibank bonuses over a decade and retained those gains after the institution required public support. He uses the contrast to criticize compensation that does not share the later losses.
Catalonian Banker Beheading
In Catalonia, failed bankers were beheaded in front of their own banks to eliminate the free option, as occurred with Francesco Castello in 1360.
Mafia Enforcement
Taleb cites the deaths of Roberto Calvi and Bugsy Siegel as extreme illustrations of investors imposing personal consequences on people who lost their money. The analogy concerns exposure to losses, rather than a proposed compensation system.
A MOMENT TO REFLECT
Put it to work.
How can executive compensation be restructured to ensure that risk-takers have genuine downside, not just upside?
What historical practices, like Hammurabi's rule, could inspire modern regulatory reforms to reduce systemic risk?
In what other industries or contexts does the 'free option' appear, and how might it be detected and mitigated?
CONTINUE THE CONVERSATION
Source texts
- Antifragile (Nassim Nicholas Taleb)