Free In an Uncertain World by Robert Rubin, Jacob Weisberg Page A

officers at both companies, much as a securities analyst does. I almost never had all the information I would have liked. Seldom did I have enough time to think everything through.
    But even with as much information and time as I might have hoped for, risk arbitrage would have fallen far short of science. Many of the notes I put down on my legal pad weren’t quantitative or measurable points of data. They were judgments. And once I finished all my analysis and reached a point of relative clarity, a correct answer wouldn’t simply present itself. The final decision was another judgment, involving my sense of a situation. We might pass up a transaction where the numbers looked promising simply because of a feeling that two companies didn’t make a good match or because we didn’t trust some of the people involved.
    But recognizing the essential component of experienced feel in this kind of judgment is different from not having a framework and making decisions in a nonsystematic way or on the basis of instinct. Some arbitrageurs at other firms operated on a far more ad hoc and subjective basis, their decisions driven by bits of information, trading activity, and gossip. At Goldman, our decisions were driven much more by analysis. We always tried to think of everything that could possibly go wrong with a deal and then tried to evaluate how much weight to accord to such risks in our analysis. Despite the all-too-human tendency to lose sight of one’s own disciplined framework, we tried our best to be cool and hardheaded. Emotion, like instinct not moored in analysis, could be misleading. If you became frightened easily—or were greedy—you couldn’t function effectively as an arbitrageur.
    In merger transactions such as Becton-Univis, our projected loss would typically be much larger if the deal fell apart than our projected gain if it went through. That meant that the odds had to be substantially in our favor for us to choose to participate. But how greatly did they have to be in our favor? Someone who had been to business school would have recognized the charts I made on my yellow pad as expected-value tables, used to calculate the anticipated outcome of a transaction. After a while, organizing my analysis according to these tables became second nature and I’d do them in my head. But I still constantly scribbled notes and numbers on a legal pad—a lifelong habit with me.
    The basic inputs in an arbitrage expected-value table are the price you have to pay for a stock; what you will get for the stock if a deal goes through (the potential upside); what you will have to sell it for if the deal doesn’t go through (the potential downside); and finally—the most difficult factor to assess and the heart of risk arbitrage—the odds that the transaction will be completed. With the help of some papers from Goldman’s archives, I’ve re-created an expected-value table for Becton-Univis. After the merger was announced, Univis stock traded at $30½ (up from $24½ before the announcement). That meant the upside potential from an arbitrage trade was $3, because a Univis share would be worth $33½—.6075 of a share of Becton Dickinson—if the deal went through. If the deal didn’t go through, Univis would be likely to fall back to around $24½, giving our investment a downside potential of around $6. Let’s say we rated the odds of the merger being completed as slightly better than six to one (about 85 percent success to 15 percent failure). On an expected-value basis, the potential upside would be $3 multiplied by 85 percent. The downside risk would be $6 multiplied by 15 percent.
    $3 x 85 percent = $2.55 upside potential
– $6 x 15 percent = – $0.90 downside risk
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Expected value = $1.65
    The $1.65 was what one could expect to earn by