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Why convexity is a helpful career guidepost

Updated: Oct 6, 2022

As a career guidepost, one should opportunistically consider industries and companies providing significant compensation upside with a manageable downside. That is, one should view their career through a convex lens.

In our article Scale and Resilience, we introduce the reader to scale and creating resilience in our lives. We also introduce the reader to the antifragile concept (also known as convexity) in a broad context. In this article, we show how we may apply antifragile thinking to the career decisions we make. We will start by defining antifragile. Then we will provide examples, starting with fragile (or concave) based careers, followed by antifragile (or convex) based careers.


According to N.N. Taleb and in his book Antifragile:

"Some things benefit from shocks; they thrive and grow when exposed to volatility, randomness, disorder, and stressors and love adventure, risk, and uncertainty. Yet, in spite of the ubiquity of the phenomenon, there is no word for the exact opposite of fragile. Let us call it antifragile. Antifragility is beyond resilience or robustness. The resilient resists shocks and stays the same; the antifragile gets better"

In my finance experience, the classic way of thinking about antifragility is in the context of bond convexity. Convexity is a measure of the curvature, or the degree of the curve, in the relationship between bond prices and bond yields. Investment professionals know the value of a convex bond – it gains more from falling rates than it loses from rising ones. According to N. N. Taleb, people and institutions can and should position themselves to be convex. Indeed, they should be antifragile – ready to gain from disorder or uncertainty.


I like this way of thinking about convexity and the application of antifragile principles. So what does this have to do with our career? How can higher volatility create more career value? We will start with a concave or fragile example.


Professional Services and concavity - In my experience, the functional relationship between professional services compensation and performance is mostly concave. (See the lower panel in the following graphic.) As an example, many professional services firms (legal, accounting, tax, advisory, etc) are concave in their relationship with volatility and compensation. Using an accounting firm example, many firms manage performance and pay differently in terms of upside and downside. Performance may be measured and managed in different ways, but 2 core revenue-based metrics are:

  1. Utilization - the % of client work billed to the number of hours available to work (In the U.S., the denominator generally assumes a 40-hour work week.)

  2. Sales and managed revenue - this is the amount of client work sold and/or managed, this measure is generally applied to more senior professional services resources (like partners)

The concavity occurs because of how volatility impacts core metrics and related compensation. Generally, professional services firms have significantly punitive outcomes for volatility on the low end of the performance measure scale. Many firms have standard percentages of low-performing employees that will be fired every year. The low-end measure volatility may be caused for many reasons, but the low-performing outcome standards are pretty consistent across professional services firms. However, the upside outcome for high-end measure volatility is relatively small. Most firms work off a percentage of salary basis for performance-based bonuses. So in a "knock the ball out of the park" year, someone may get a 15% salary bonus instead of the average 5% salary bonus. As such, the bonus compensation difference between an average and a stellar year is relatively small. To connect the dots to antifragility - high-end measure volatility equates to a small upside, and low-end measure volatility equates to a very large "job existential" downside.


In fact, upon speaking to a new partner at a Big 4 Accounting firm, on the condition of anonymity, he said that the advice received from seasoned partners is to not put much energy into exceeding current year performance targets. In this model, it is most important to "hit your numbers" and maintain a consulting practice resilient to the downside.


Portfolio investing and convexity - In the context of convexity, think of portfolio investing as a way to manage your downside but participate in the significant upside. (See the upper panel in the previous graphic.) This can be applied to financial assets, real assets, or many other portfolio-type businesses. In our article Wayne Gretzky and creative-divergent thinking, we discuss related portfolio examples of large upside while managing downside. Here is a quote:

Venture Capitalists play a similar game. They know, even with the most rigorous selection process, that many investments will underperform, but a single high-flying investment may more than makeup for the laggards. The challenge is knowing which investment will fly and quickly adapting as new information is learned.

The idea of portfolio investing is to:

  1. Maintain a portfolio investment process with a relatively high number of individual investments. (to dilute the risk when some of those investments underperform)

  2. Have a process that limits the downside. For most, this means either quick divestment or the knowledge the downside is bounded by zero.

  3. Invest in projects with unlimited upside. This will more than makeup for the laggards.

"Never test the depth of a river with both feet." - Warren Buffett

For many people, this could mean 1) developing your own portfolio-based investing business, or 2) becoming employed by portfolio investing companies. As an employee, the idea would be to advance through the company to someday become a senior leader. In many portfolio companies, senior leader compensation is in part from stock options or other forms of ownership. Often, on the path to becoming senior leaders, many portfolio-based companies find ways to share the upside with their employees. As such, this would be a way to participate in a significantly larger upside. [i]


To be clear, portfolio companies may be many different kinds of companies, not just investment firms. Also, the word "investment" should be considered broadly. For example, a portfolio company could be a technology company with a number of different technology solutions and/or related use cases (i.e., the portfolio). The point is, for any company, to evaluate the 3 "ideas of portfolio investing" previously mentioned. Then, to understand your potential upside/downside tradeoff and answer the questions, "Do I have an opportunity to participate in the significant upside?" and "What is my downside risk, relative to the upside?"

As a rule of thumb, bonus compensation structures tied to salary are more likely to be concave, bonus compensation structures tied to value creation are more likely to be convex.

Aligning compensation with portfolio company upside: Another reason to align your compensation with overall portfolio company value creation is related to labor cost incentives. Lagging or even reducing salaries is more likely in firms with professional business managers from MBA schools. MIT economist Daron Acemoglu shows in a recent paper that companies with professional business managers are more likely to decrease firm salaries. Even though, over the period of study, total firm value creation does not increase. [ii] The point is, while firm incentives may lead to reduced employee salaries, being aligned with company value creation will be more likely for you to participate in company upside. Generally, you want at least a portion of your pay to be aligned with how firm leadership gets paid. In other words, the tradeoff of more conservative cash compensation could be worth more ownership upside. Finally, as a caution, be careful about holding too much of a single company's stock. You are better off diversifying your wealth. [iii]


Concluding thoughts


As a point of emphasis, Professional Services companies can be great places to work. One can learn quite a bit about a variety of industries and solutions. Retired partners are often wealthy. The challenge remains, the path to a "wealthy retired partner" is through a concave compensation structure. These concave compensation structures may limit the upside and with a significant downside. For every 1 retired partner, there are 100s of people that started in professional services but do not become a partner. Alternatively, portfolio-based companies are not a panacea. Just because there is a convex compensation structure does not guarantee success. Like anything else, one must work at it and have a bit of luck. Certainly, underperforming employees may be shown the door.


The point is, as one is evaluating their career, especially in the context of our articles They kept asking about what I wanted to do with my life, but what if I don't know?, one should consider industries and companies with convex qualities. In this linked article, we described multiple career personalities. The "High Growth" industry segment could provide a convex upside, especially for those with a "Climber" career risk personality, like Liam.


Thinking about your career and the industries and companies in terms of antifragile qualities may provide the opportunity for significant upside with a manageable downside.

Notes:

[i] See our article Know when to hold 'em, know when to fold 'em: Understanding Ergodicity We provide a framework for why portfolio investing, including employment portfolios, is critical for managing career risk and optimizing career upside. We explore how most individual company investments (whether career or financial) may lead to ruin. This is also known as a “non-ergodic” system. Thus, employment or investment with portfolio-seeking (aka: ergodicity-seeking) companies is a smart arbitrage trade.


[ii] Hulett, They kept asking about what I wanted to do with my life, but what if I don't know?, The Curiosity Vine, 2021 - See footnote [vi] for a more robust explanation.


[iii] Hulett, Managing risk and avoiding ruin: The Ergodicity View, The Curiosity Vine, 2021 - See the "Ergodicity as related to investing" example for more information.


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