What Is Skin in the Game?
Warren Buffett, a well-known investor, coined the phrase “skin in the game” to describe a situation in which senior insiders use their funds to buy shares in the company they are running. The proverb is very popular in money, business, and gambling. It is also used in politics.
Understanding Skin in the Game
Regarding business and finance, the phrase “skin in the game” describes owners or founders with sizable ownership in an investment vehicle, such as company shares, attracting outside investors’ interest. In this expression, “game” refers to the activities on the playing field being discussed, and “skin” is a figure of speech for the person or money involved.
Executives receiving stock as compensation or exercising stock options to purchase shares at a bargain are not unheard of. It is less frequent for an executive to take a financial risk inside their firm. When an executive takes a stake in the firm, external investors see it as a favorable indication of good faith and trust in the company’s future.
Potential and current investors will see this action as a vote of confidence if the founders or owners have also contributed their funds to the investment vehicle. Insider ownership, also called “skin in the game,” informs investors that the company will probably put a lot of effort into maximizing profits for its backers.
Executives putting money on the line are meant to guarantee that businesses are run by people with similar values who are invested in the business. Executives may speak all they please, but risking one’s own money, just like outside investors, is the ultimate sign of confidence.
Skin in the Game Restrictions
There are some restrictions when owners and top management executives are requested to put their money into security. Employees at many banks and other financial institutions are not allowed to have any “skin” in the customer capital management process. The prohibition deals with front-running, which is the practice of an executive entering a transaction just before an announcement or event—with inside or confidential knowledge—to get a financial advantage.
Additionally, there are limitations on commingled funds, which refer to the combination or pooling of corporate and private resources into the bonds or shares of the firm. In some cases, CEOs are prohibited from investing in the companies they oversee and are required to make decisions impartially.
Disclosure Conditions for Having Skin in the Game
The Securities and Exchange Commission (SEC) requires funds to disclose the total amount each portfolio manager has invested in the fund annually. Proponents claim that by using this publicly available data, identifying fund managers that back up their claims with tangible assets might be a trustworthy method of determining which fund managers have the potential to outperform the market in the long run. Skin in the game proponents contend that capital commitment is crucial in bringing managers’ and investors’ objectives into line.
Additionally, the SEC mandates that businesses disclose any insider ownership or transactions involving their securities.2. Executive, director, and officer transactions have the potential to affect the stock price of the firm, which is why the reports are necessary. The executives are required to submit a variety of paperwork to the SEC. These insider ownership records are available for viewing, and investors may use them to help them decide whether or not to invest in the firm.
An Actual Case of Skin in the Game
Elon Musk is among the best CEOs if investors seek someone with a stake in the business. Elon Musk holds the CEO position at Tesla, Inc. Here is a screenshot of the SEC filing indicating how many shares Tesla’s CEO owns. As of December 31, 2021, according to Musk’s most recent Schedule 13G filing, he had more than 227 million shares in Tesla.
Conclusion
- When owners, executives, or founders hold a significant portion of the firm they oversee, it is said that they have “skin in the game.”
- Investors value skin in the game because it demonstrates that leaders have a stake in the company’s success.
- Reports on insider ownership or trading of a company’s securities are required by the SEC and are made public.
