Archive for November 23rd, 2014

November 23, 2014

Skin in the Game


To have ‘skin in the game’ is to have incurred monetary risk by being invested in achieving a goal. In the phrase, ‘skin’ is a synecdoche (a part that represents the whole) for the person involved, and ‘game’ is the metaphor for the actions on whatever field of play is at reference. The aphorism is common in finance, gambling, and politics. The origin of the phrase is unknown. It has been attributed to Warren Buffett since in Buffett’s first fund he raised $105,000 from 11 doctors, himself placing a token sum of $100.00 as his ‘skin in the game’ (though New York Times columnist William Safire dispelled the Buffett origin). Another possible explanation is that the phrase is derived from William Shakespeare’s ‘The Merchant of Venice’; in which a money lender demands a pound of actual flesh from a borrower should they default.

The term is used to ask or convey a principals undefined but significant equity stake in an investment vehicle where outside investors are solicited to invest. The theory is that principal’s equity contribution is directly related to the stability of the investment and confidence that management has in the venture and is also (falsely) strongly correlated to the expected yield of the investment. Research has shown that there tends to be a negative correlation between excess ‘skin’ and negative returns. The main issues is the principal–agent problem whereby transparency and fiduciary obligations are disregarded by principals who have capital or excess capital (skin) tied into an entity. Many banks and other financial institutions bar employees from having any ‘skin’ where client capital is managed, principally to address the issue of commingled funds. Hedge funds, private equity, Trusts, and Mutual funds are legally limited to a minority investment positions.