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Skin in the Game

Nassim Taleb argues that 'skin in the game' is one of the most important principles of 'antifragility'

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Feb 28, 2019
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"Skin in the game" is one of the most important principles presented by author Nassim Taleb to achieve "antifragility."

To have skin in the game means to incur in the risk of loss in the process of achieving a goal.

In everyday life, we encounter situations in which there is a transfer of risks to one group while others keep the upside. Eliminating these structures and creating more aligned systems will pave the way for a healthier, more productive and protected society.

To Taleb, skin in the game means,“Every captain goes down with every ship.”

The power of incentives

To have skin in the game means to have the correct incentives in place to achieve the intended objectives.

Charlie Munger (Trades, Portfolio) has repeatedly defended the power of incentives:

“Never, ever, think about something else when you should be thinking about the power of incentives.”

Value investors clearly understand the importance of skin in the game. It is present in many aspects of their investment activity:

1. The agency problem. Taleb’s definition is a “situation in which the manager of a business is not the true owner, and so he follows a strategy that cosmetically seems to be sound, but in a hidden way benefits him.” To resolve this problem, it is essential to align incentives and to create the right corporate structure to achieve objectives. In this regard, value investors tend to prefer to invest in family businesses because of the clearer alignment of incentives.

Non-family owned businesses have also tended to focus over the years on reducing the agency problem by providing stock options or stock ownership plans to managers so that they can increase their long-term stock holdings in the company, by providing financial incentives based on profitability metrics or on value creation for stakeholders, or by other means.

2. Trusting opinions makers, market analysts and stock analysts who don’t have skin in the game is just plaint wrong. One can never know for sure the true incentives for a recommendation or opinion. And if the opinion maker doesn’t have anything to lose from that recommendation, then there is no consequence for his actions. They may have the best intentions, be extremely intelligent and have a coherent argument, but not feeling the pain of being wrong will certainly temper their effort, their judgement of risks and their sense of the necessary commitment to provide the right answer.

3. Beware of complicated solutions. The future is very hard to predict. And it is much harder if one tries to predict many variables and how they will relate to each other. But it is common to have consultants, advisors and investment bankers try to present a difficult situation and propose an even more complicated solution. It is a victory for them to be able to present a solution for such a dire picture. But will the solution be the right one?

In thinking about investments, value investors want to simplify the prediction they are trying to make to its most elementary elements. They want to ignore what they don’t control and focus on a long enough time horizon to produce a good return and predict what is easier to predict.

Hidden asymmetries in daily life

Taleb further developed these ideas in his most recent book, “Skin in the Game: Hidden Asymmetries in Daily Life,” asserting that it is a fundamental principle is to “understand the world, succeed in a profession, contribute to a fair and just society, detect nonsense and influence others.”

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