74. Optionality and skin in the game

Jaap Vergote
Feb 13, 2019 · 2 min read

Readers of Nassim Taleb’s Incerto will be familiar with these terms.

Any strategy with optionality is like a highway with multiple exits — Nassim Taleb

What is Skin in the Game (SITG)? The phrase is often mistaken for one-sided incentives: the promise of a bonus will make someone work harder for you. For the central attribute is symmetry: the balancing of incentives and disincentives, people should also penalized if something for which they are responsible goes wrong and hurts others: he or she who wants a share of the benefits needs to also share some of the risks. — Nassim Taleb

A recent tweet by Avichal Garg made me connect the two in a way I hadn’t done before.

There’s this adage in Silicon Valley that early employees take on as much risk as the founders. The company might shut down, run out of money and the employee could spend two years working on something that fails. Telling your next potential employer you joined a failed startup could be seen as poor judgment.

The tweet made me see founders and early employees in the light of Taleb’s optionality and SITG:

Founders have a lot of SITG and no optionality. They have to build their company, there’s no way out unless it succeeds. If they succeed they can win big and get ultimate optionality(money). If they fail they hurt their reputation, their finances and their employees. Early employees have almost no SITG and have all the optionality. They can leave and join another company. They are free.

Along this dimension we could agree that SITG and optionality are negatively correlated. The more SITG, the less optionality. If you’d have unlimited optionality, you wouldn’t have real SITG, because you could leave and not lose everything.

Hence the bankers in 2008. They had no SITG. There was only upside, and minimal downside, so they had optionality. As they were at the helm of the financial ecosystem, this resulted in a moral backlash, but monetary gains.

I highly recommend reading Taleb’s Incerto.

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