How Manager Leverage Works

A manager's value is in the amount of equity, or over-performance they can generate from their team

The manager creates leverage through the use of their time. However, it is difficult to appreciate how levered a manager truly can be. Using principles from portfolio management, we can build intuition on how a manager should construct their team to maximize the amount of return they are getting on their time equity.

A manager's value is in the amount of equity, or over-performance they can generate from their team. They should not be awarded for simply increasing the size of the team to generate more output.

Specifically, because you are running a leveraged portfolio, you want to maximize your total expected value as much as possible, subject to two constraints:

1. Each marginal addition to your team is accretive

2. The variance around the expected impact of your team will not blow up (e.g. create layoffs for) you and your team

That is, the larger the impact of your mandate, and the lower variance of the impact of your team, the more levered you can be.

A simple way to see this is thinking about a team as an asset and liability table. The assets you have are the total net hours your team can output, and your liabilities are your management time and the expectation of what your team can produce (i.e. the expectations from senior management or peers). Your team’s performance is the difference between these values, like equity on the team. When the equity is positive you are running an over-performing team, and when it is negative you are running an underperforming team.

Additionally, this equity accumulates over time - quarter on quarter of over-performance nets increasing equity that can be used to take on more leverage.

Adding an additional person to the team will (hopefully) increase the total net hours, but also increase the expected output since more is expected from your team. This is what increases the leverage of your team, since your total hours increase, but your equity did not.

The issue with increasing your team’s leverage is that you are more sensitive to the performance volatility of your team.

For example, in a team that nets 100 hours, if you have a bad quarter and your impact (as measured by total net hours) decreases by 20%, you go from being an over-performing team to a team that is performing at expectations (see below). This is not great, but still manageable.

However, in a team that is more levered, the same 20% decrease in team output will now turn your over-performing team into a significantly underperforming one (see below). This puts your team at risk of a smaller mandate, which will further increase leverage, and eventually layoffs.

In order to structure your team in an optimally levered way, the most important thing to understand is whether your team looks like a stock portfolio or an options portfolio. That is, does the team derive impact in a linear or non-linear way. At a high level:

• Options-like teams need to run at low leverage, since the payoffs are sporadic but significant. You want to make sure that you don’t create enough negative equity that your team gets “stopped out” - i.e. people get laid off or you face a reorg.

• Stock-like teams can run at much higher leverage, since the returns are more predictable on a per project and per person basis. The manager of these teams need to “bend the curve”, i.e. ensure the marginal hours of impact decay slowly and the marginal hours of cost do not explode too fast.

By understanding which type of portfolio you are managing, you are able to determine what factors affect the output of your team and thus structure things in a way that will maximize the long-term equity of the group.

Options-like Teams