What Does Skin In The Game Mean?
Skin in the game is a phrase made popular by renowned investor Warren Buffett referring to a situation in which high-ranking insiders use their own money to buy stock in the company they are running.
The aphorism is particularly common in business, finance, and gambling, and is also used in politics.
Skin In The Game Explained
In business and financing, the term skin in the game is used to refer to owners or principals having a significant stake in an investment vehicle, such as shares of a company, in which outside investors are solicited to invest. In this phrase, "skin" is a figure of speech for the person or money involved, and "game" is the metaphor for actions on the field of play under discussion.
It is not unheard of for an executive to receive stock as compensation or to exercise stock options to buy stock at a discount. What is uncommon is for an executive to risk their own money in the company that they work in. When an executive puts skin in the game, it is seen as a sign of good faith or a show of confidence in the future of the company, and it is seen as a positive sign by outside investors.
If principals have also invested their own money in the investment vehicle, then prospective and existing investors will translate this move to mean the investment is stable and will have increased confidence that the company will always put its best foot forward to generate returns for its investors. The idea behind executives putting their skin in the game is to ensure that corporations are managed by like-minded individuals who share a stake in the company. Executives can talk all they want, but the best vote of confidence is putting one's own money on the line just like outside investors.
However, there are limitations that exist when owners and upper management executives are asked to invest their own money in a security. Many banks and other financial institutions bar employees from having any "skin" where client capital is managed, principally to address the issue of front running and commingled funds. In addition, investment structures such as hedge funds, private equity, and mutual funds are legally limited to minority investment positions within the range of 0.5% to 2%.
The Securities and Exchange Commission (SEC) requires that funds disclose annually approximately how much money each portfolio manager has invested in the fund. Using this public information, proponents argue that finding fund managers who put their money where their mouths are can be a reliable way to identify fund managers who could be expected to beat the market over the long run. They believe that capital commitment is the single most important way to align the interests of investors and managers. A 2014 study by Morningstar found that investors are likely to beat the average by some distance if they pick funds from an asset management firm whose portfolio managers are heavily invested in their own funds.