The Expert Problem — coined by Nassim Taleb — exists where people are public professional advice givers with no skin in the game. It is a matter of ethics. If we’re going to provide advice, we ought to have sufficient skin in the game, whichever game we decide to play at the time. Taleb decries TV commentators who make wild predictions about the future (e.g. economy crashing, recessions, high unemployment) without having any financial backing (skin in the game). This is a problem because they can go on TV or online, shout financial fire, and then check to see whether people run or panic while they sit back, smirk, and wait for the next negative public pronouncement with no consequences to their predictions.
Skin in the game matters can be taken and applied to other contexts. In order for startup founders and early employees to stick around beyond the early few years, companies use stock options to help lock-in talent that vest a over a number of years that people stay on with the company. This gives both the company trying to retain talent and the talent itself skin in the game, aligning interests.
Company partnerships work similarly. An employee works for a certain number of years, lets say, seven. After this period of time, an offer of partnership may come. Through this offer, with a contribution of time and money and effort on the part of the employee, the employer contributes part equity to the employee, providing both skin in the game and aligning interests. If people are willing to work hard for partnership equity offers (they are), this aligns their interests with that of the company.
Areas where interests are not aligned are where we run into trouble: The employee with insufficient reason to stick around; the manager who’s interest is only in himself and not vested in those he manages; the academic who merely theorizes doom but doesn’t have financial interest in the areas in which he prognosticates. This misalignment of value causes unmet needs and unnecessary friction. It is similar to a market being out of whack.
Skin engages the big decision: the investment of time, energy, and money, a career, a move, a long-term relationship. Note that it doesn’t just have to be money. It can be emotional skin. Our emotions are like bank accounts, similar in feeling with positives and negatives. Relationships are one of the most important factors in our happiness, and investments in them help determine our quality of life. We have serious skin in our relationships, whether we see it or not.
Meaningful work. Meaningful relationships.
Uber-successful hedge fund manager, Ray Dalio, discusses the importance of relationships to him in his book Principles. The recurring theme throughout the book Ray focuses on is “meaningful work and meaningful relationships.” If you’ve got those two, you’re on the right track. Anything that detracts from these two ought to be excised from your life. Being a top investment manager, Dalio is all about skin in the game for the financial markets. But he is also all about skin in the game for his relationships because he knows they are one of the keys to living a happy, fulfilling life. If you only have meaningful work and not meaningful relationships, your life is out of balance. (In fact, you cannot have meaningful work without meaningful relationships since good relationships are key to workplace success.) The culture of his hedge fund, Bridgewater Associates, is predicated upon one of honesty and forthrightness and searching for what’s true. The company values they espouse are built around meaningful work and meaningful relationships.
Warren Buffett is an advocate of skin in the game. He teaches that management must be aligned with shareholders in order for publicly traded companies to be successful. By the time Berkshire acquires companies, their founders are already financially successful. They don’t need the money. But they are incentivized accordingly and have emotional skin in the game especially if they are in the founding family. As he states, Berkshire does not provide management. So they have to be in alignment with the new team post acquisition. Both Warren and Charlie have always been hands-off when it comes to active management. They rely on the experts to manage the divisions.
As a negative example of skin in the game, the sunk cost bias works against us. The sunk cost bias states that after we’ve poured money into a bad investment, the skin that we have invested makes us want to pour even more into it, putting good money on top of bad money. No one is exempt from this. It is psychologically difficult for us to simply cut our losses and move on to something else from there. The skin we’ve put in is more than just money — it is emotional investment. It is against our nature to move along after an investment that hasn’t worked out. And yet that is precisely the thing that we must do.
Aside from our financial investments, no other domain exists where there is larger skin in the game than our children. They are the ultimate investment of time, money, emotion, and effort of our lives. They are also our best creative act because we mold and shape them daily. They are our legacy, our proof that we were here on this planet. We ask that they carry on our lineage, our genes, and our blood onto future generations and do so in a manner befitting their ancestors. Not too much to ask, right? Further, our children provide us great pride and happiness in raising them. Almost no other actions generate such pride as raising children you’re proud of. People halt promising careers and completely change their lifestyles in attempts to best raise their children.