Skin in the Game

Inspiration for this month’s topic comes from the book, Skin in the Game. Hidden Asymmetries in Daily Life, by Nassim Nicholas Taleb. If you have the time, I highly recommend the read. The concept of “skin in the game” is nothing new. Taleb argues its origins trace back to the days of King Hammurabi in ancient Babylon where we get a form of retaliatory punishment vis-à-vis an eye for an eye and a tooth for a tooth.¹ In other words, there was personal risk for those who broke the laws of Babylon and they endured a harsh punishment. If you committed a crime you had skin in the game because the consequences were real and visceral. 

Fast forward 3,800 years and the situation has drastically changed. The use of corporeal punishment has been significantly reduced, a good thing in my opinion, as theft was punishable by death.² Unfortunately, the spirit of this law has changed as well. Centers of influence: from governments-to- captains of industry, have acted without the fear of consequences. The reason is simple: there is no skin in the game, so the consequences do not matter. This is in part why there was such a public outcry during the Great Recession of 2008-2009. Occupy Wall Street was a protest against the excesses of American capitalism at the expense of the population. The “risk” of bad decision making by corporations was effectively transferred to the people, but the executives and policy makers got to keep the spoils. This is definitely an asymmetrical arrangement! 

As an extension of this concept, I suggest that you never accept the opinion or advice from someone who you know has no skin in the game. For example, economists are notorious for their outlandish predictions because there is little-to-no-risk to them personally if they are wrong. You could argue for reputational damage, but the same folks are still at it after all these years. Wall Street has numerous gurus who utter proclamations about what to buy and when, but can we really be sure of their authenticity?  I would suggest no. So where does this leave us? I have a couple of practical solutions:

• Ask the giver of advice if he/she actually has skin in the game. For example, as a portfolio manager, I believe I must hold the same portfolios as my clients to ensure I share the risk at an investment level. I invest in the growth model right along all other growth model investors. This is also the case for many hedge fund managers who start funds with their own seed-capital. They literally put their money where their mouths are! Unfortunately, many of these products are not investor-friendly and tend to make money for the manager in spite on the investor. 
• Use this question as an effective lie detector. Next time someone offers you advice try to determine if he/she has a downside for being wrong? I once engaged a business consultant to help me organize and enhance my practice. He had a lot of interesting ideas, but when I pressed him on the details for his own use, he became evasive and confrontational. I fired him immediately, as he had no skin in the game, only theories disconnected from personal risk-taking.         

I hope you found this an interesting read.  We encourage you to share your thoughts.

[1] See pages 16-18. 

[2] https://en.wikipedia.org/wiki/Code_of_Hammurabi

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