Have you tried using a product or buying a service from a company where you work? If you have, then you must have experienced that its performance matters to you financially and personally. Having skin in the game has been considered one of the most potent driving factors that work on a concept of people first or investors first in terms of investments.

Every investment company should put skin in the game since it affects the overall performance increasing efficiency and reliability of the investments they are managing.

What is Skin in the Game?

Skin in the game is widely used in finance and businesses. It is understood as a significant share owned by the company’s owners in various investment instruments such as shares, mutual funds, or bonds.

In other words, when a company offers its executives or key employees the shares or mutual funds or bonds or any other investment vehicle by way of a portion of a total salary or remuneration, it is called having skin in the game. It aims to build an organisation being operated and managed by like-minded people who put efforts to improve the company’s performance constantly.

Putting your own money makes it more transparent to work efficiently as the instrument’s underperformance will affect the employee emotionally and personally. Similarly, if the investment instrument outperforms, the employee’s salary or remuneration increases, reflecting positively on his performance.

Advantages of this Element

Personal Involvement - When you have a significant stake in the company’s investment vehicle, you put your heart into improving the company’s financial health.

Effective Motivator - The idea of putting the skin in the game works as an effective tool to motivate executives and key employees to give their 100 per cent for the growth of an organisation.

Robust Cash Flow - Since the employees are given a stake in the company’s capital, the salary or remuneration in cash is not required to be paid to the extent of the stake received. It strengthens the cash flow of the company.

Recently, SEBI has mandated all the mutual fund houses to offer its key employees (board directors, fund managers, etc.) at least 20 per cent of their salary, including bonus and non-cash compensation by way of units of mutual fund schemes.

The new rule by SEBI also suggests having a lock-in period, as in the case of Franklin Templeton Mutual Fund debt schemes, the fund insiders redeemed massive amounts right before the scheme’s closure.

Drawbacks of Skin in the Game

Insider Information - It may turn out to be worse when the key executive uses his power to influence the company’s price illegally.

Restriction by Banks - Many banks do not promote the idea of having skin in the game as they manage their clients’ capital, and it may happen the key executives take undue advantage of the benefit.

Overall Positive Effect

Although Skin in the Game has its limitations, in reality, it works positively for the organisation and the employees as well. It creates a win-win situation for both because it creates symmetry. If the client gets hurt, the employees get hurt and if the client succeeds, the employees succeed as well. So, when the incentives and the monetary penalties of an investment vehicle align with those who the investors work with, it brings in increased discipline among the fund managers which benefits the investing ecosystem at large.

The author is Co-founder, Wint Wealth

DISCLAIMER: Views expressed are the author’s own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.