Have too much skin in the game?

Hey friend, have you heard the phrase "skin in the game" before? It‘s all about having something personal at stake – your "skin" – in an endeavor. Especially financially!

Skin in the game is super popular in business and investing thanks to Warren Buffett. But is more skin always better for performance and smart risks? Let‘s dive into the meaning and merits of having skin in the game across business, politics, and life.

What Does "Skin in the Game" Mean and Where Does it Come From?

The core idea behind "skin in the game" is having personal resources or money invested in something so you really care about the outcome. It provides conviction and aligns incentives.

But where did this metaphor come from?

The phrase appears to originate from old gambling lingo. When betting on risky endeavors like horse races, players would put their own "skin" or money on the line to stay in the game. They had to pony up funds and have "skin in the game."

The more skin they put in, the more potential upside…and downside. High stakes, high rewards!

Over time, the concept spread to business and investing. Today, skin in the game often refers to:

"A situation in which high-ranking insiders use their own money to buy stock in the company they are running."

If you run a company, having your own money invested makes you highly motivated for it to succeed!

Warren Buffett‘s Wisdom on Skin in the Game

While gambling lingo spawned the phrase, famed investor Warren Buffett made "skin in the game" mainstream.

As Berkshire Hathaway CEO for over 50 years, Buffett amassed over $100 billion in personal wealth almost entirely from Berkshire stock. He kept plowing his money back into shares of his own company.

In his 2014 shareholder letter, Buffett emphasized why leaders should have skin in the game:

"We eat our own cooking at Berkshire. Our directors and executive officers have, over time, owned huge sums of Berkshire shares…Charlie and I love the company we run; Berkshire’s directors feel the same way. And that’s entirely rational: We’re addicted to the company’s success just as they are."

Buffett practiced what he preached, tying his financial fate to Berkshire‘s. He advocated for CEOs having serious skin in the game through stock ownership. And his wisdom paid off big time!

Bufett also popularized the saying:

"We eat our own cooking."

This brilliantly captures how having skin in the game aligns interests and incentives. Leaders with a stake in the outcome will make smarter, more prudent decisions.

For example, take a hired consultant who is paid a fee to give a recommendation. But they don‘t actually invest in or operate the business after. They have no skin in the game beyond their reputation.

Leaders who "eat their own cooking" have far more riding on making the right call.

Examples Where Skin in the Game Paid Off Big

Plenty of hugely successful founders and investors bet big on their own skin in the game:

• Jeff Bezos – The world‘s wealthiest person at $180 billion, Bezos owns about 15% of Amazon, the company he founded and runs. His massive skin in Amazon has paid off in staggering wealth through upside.

• Elon Musk – Musk owns over 20% of Tesla, the electric vehicle maker he co-founded and leads as CEO and "Technoking." His €̶$200 billion net worth is tied directly to Tesla‘s soaring stock.

• Mark Zuckerberg – The Facebook founder and Meta CEO holds over 350 million shares of Meta valued at nearly $60 billion as of October 2022. He has maintained huge skin in the game even after taking the company public.

• Masayoshi Son – The SoftBank CEO invested $20 million of his own money founding the firm in 1981. Today he owns 25% of SoftBank which has grown into a $100 billion tech investment behemoth.

Beyond founders, early startup investors and angel investors also put skin in the game by backing ventures with their own money, time, and reputation long before there‘s a proven business model. Big risk, big reward!

But What About Downsides of Skin in the Game?

Giant skin in the game payouts make for juicy headlines. But there are also criticisms and downsides to consider:

• Excessive Risk-Taking – With so much of their net worth tied up in company stock, some leaders take reckless gambles to try boosting the stock price. There are skewed incentives when your lifestyle depends on the stock price!

• Groupthink – Relying heavily on a small circle of leaders with skin in the game can breed insular groupthink. Fresh outside perspectives are needed to balance self-interest.

• Price Inflation – Executives may try to artificially inflate stock prices through buybacks and financial engineering to profit themselves in the short term.

And how much skin in the game is too much? Studies show startup founders often have 90%+ equity early on. But public company CEOs rarely have over 5-10% ownership, let alone 50% like Buffett. Situations differ.

While Buffett eats his own cooking as a multiple of his net worth, for a Fortune 500 CEO, having just $10 million personally invested creates meaningful skin in the game.

Academics Weigh In on Skin in the Game

Beyond Buffett‘s words of wisdom, modern academics have studied whether skin in the game empirically leads to better corporate performance:

Study	Findings
saddlepoint.com	Companies with higher CEO ownership outperformed peers by 4-10% per year over 14 years.
Arizona State University	Founders as CEOs with high ownership stakes deliver better long term results.
MIT Sloan	VC firms succeed when partners invest their own money alongside limited partners.

This data suggests skin in the game does systematically pay off thanks to aligned incentives.

But again, moderation is key. Research shows both very low and very high ownership concentrations can diminish performance due to respective complacency and risk distortion.

Nassim Taleb and Fooled by Randomness

More philosophical insights on skin in the game come from author Nassim Taleb‘s book Fooled by Randomness.

Taleb argues human nature is to underestimate luck and risk by believing skill explains outcomes more than it actually does. Like how past fund manager performance poorly predicts future results.

But real skin in the game keeps people "properly paranoid" about risks and reminds us to be humble. If people risk significant skin, they more deeply respect randomness and luck as influencers of results.

Taleb later expounded on skin in the game in his book of the same name. He advocates for symmetry in risks and payoffs – if you profit from risk, you should also pay for harm caused.

For leaders and decision makers, symmety comes from having skin in the game tied to the outcomes.

Agency Theory and Skin in the Game

In agency theory, principals hire agents to perform work and make decisions on their behalf. Like shareholders and CEOs.

But often, agents‘ incentives differ from what best serves the principal. This principal-agent problem means agents may avoid risky moves since payoffs accrue to principals.

Skin in the game helps align incentives between principals and agents. Equity ownership ties the agents‘ wealth to that of the principals. So decision making better focuses on their shared interest.

Indeed, the rise of stock-based CEO pay since the 1980s sought to increase management‘s skin in the shareholder game. And governance experts consider CEO stock ownership an important accountability tool.

Politicians – Skin in the Game Through Policy Impacts

Beyond business, skin in the game also applies in politics. Elected representatives make laws impacting their entire districts or states.

But commentators often argue leaders pass better legislation with "skin in the game" through policies directly impacting them, like:

• Healthcare policy if their family depends on the law
• Gun control if they live in an impacted area
• Education if their children are enrolled
• Taxes based on their income bracket

The logic is similar to business leaders owning company stock. Directly sharing policy outcomes gives politicians skin in the societal game. It may lead to more responsible lawmaking.

However, opponents counter that officials already have skin in the game merely by living under their own laws. Enough overlap exists without corrputing votes based on personal circumstance.

Special interests could also manipulate representatives‘ votes by framing bills as impacting them personally. Overall, the merits are debated.

Skin in the Game Idioms and Colloquial Usages

Beyond the world of business, "skin in the game" also spawned several idioms and figurative usages:

• Thick skin – Being insensitive to criticism. Having "thick skin" provides emotional resilience.

• No skin off my back – Not being bothered by something. As in, "It‘s no skin off my back if you don‘t like my idea."

• Skin somebody alive – To punish or scold someone severely. "My mom will skin me alive if I‘m late again."

• By the skin of your teeth – Just barely escaping disaster and succeeding. Like winning a contest in the final seconds.

These phrases remind us skin symbolizes vulnerability and sensitivity too!

Our skin physically protects us but also exposes us to harm. Having "thick skin" provides confidence and power. But also risk if we become too insensitive.

Should Influencers Have More Skin in the Game?

In the digital age, skin in the game applies to creators and influencers too.

Social media influencers earn money through sponsorship deals promoting brands and products. But they face limited downside risk if their recommendations underdeliver.

Some argue influencers should have more skin in the game by directly investing in and tracking the performance of products they endorse.

Tying their compensation to real sales growth, not just reach and impressions, would incentivize diligent vetting and research of partnerships. And ensure claims about sponsorship ROI are accurate.

But mandating financial risk-taking seems impractical. Disclosure and vigilance may be enough to keep creators honest and aligned with their audiences.

Conclusion – Evaluate Your Own Skin in the Game

Skin in the game is about personal investment and motivation. But risks must be balanced thoughtfully, not maximized blindly.

Before pursuing more skin in the game in business or life:

• Set limits – Don‘t bet so big that anxiety overshadows opportunity. Define an affordable yet meaningful amount to wager.

• Do diligence – Don‘t just trust others‘ opinions. Research the facts and risks thoroughly yourself. Make an informed choice.

• Have an exit – Look for fail-safes and backup plans to limit downside if things go south.

• Get advice – Consult trusted objective mentors to avoid insular groupthink.

With careful analysis and measured boldness, skin in the game can pay off handsomely. But reckless gambling can leave you licking your wounds instead of counting winnings.

As in all things, moderation – not extremism – is often the winning approach. How much "skin" are you ready to put on the line?