Skin in the (behavioral economics) game

Kyle Sandburg
Apr 4, 2019 · 7 min read

How ‘skin in the game’ helps describe the outcomes of behavioral economics

Source: Google Images

Intro

I was listening to Nassim Taleb’s book “Skin in the Game” and following along great until the book it hit upon a nerve. That nerve was when Nassim Taleb called out the “IYI” — intellectual yet idiot persona. He has very strong opinions against research professionals, like economists, and the lack of skin in the game they have. He was also pointing to behavioral economists work on irrational behavior that it wasn’t actually true. This sort of antagonist view is great. It challenged my thinking on both sides of the argument. This post looks to unpack both sides of the argument to make sense of their various viewpoints.

What does “Skin in the game” mean

Let’s start with what Taleb describes as “skin in the game” as Taleb describes it:

What is Skin in the Game? The phrase is often mistaken for one-sided incentives: the promise of a bonus will make someone work harder for you. For the central attribute is symmetry: the balancing of incentives and disincentives, people should also penalized if something for which they are responsible goes wrong and hurts others: he or she who wants a share of the benefits needs to also share some of the risks. — Taleb’s Medium Post

Let’s unpack the statement above into its components to create the equation for skin in the game:

One example that stood out to me in the book was around employment, especially in light of the Lyft IPO last week. His argument was that companies that hire full-time employees do so to incentivize ‘skin in the game’. The rise of the gig economy opens up a number of questions around how the dynamic will change. The key question will be whether these gig workers feel they could lose out by not contracting with the platforms, like Lyft and Uber.

“What matters isn’t what a person has or doesn’t have; it is what he or she is afraid of losing.” — Taleb from “Skin in the Game”

Behavioral Economics

I have written recently about this space a lot (see the stories on this part of my blog). The core aspects of Behavioral Economics is that humans don’t make decisions based purely on economics and that the decisions are often systemically predictable.

One of the core areas of behavioral economics that align with skin in the game is the endowment effect. Here is a paper that Kahneman and Thaler worked on to describe this theory. They ran a series of experiments and received data that individuals find it difficult to switch their behavior.

rational models that ignore the status quo tend to predict “greater instability than is observed in the world” (p. 47). We have added the claim that models that ignore loss aversion predict more symmetry and reversibility than are observed in the world, ignoring potentially large differences in the magnitude of responses to gains and to losses. Responses to increases and to decreases in price, for example, might not always be mirror images of each other. The possibility of loss aversion effects suggests, more generally, that treatments of responses to changes in economic variables should routinely separate the cases of favorable and unfavorable changes. Introducing such distinctions could improve the precision of predictions at a tolerable price in increased complexity.

Unpack what this means

Source: Thinking Fast and Slow
Source: Google Images

Can they both be right?

I’m not going to focus on whether economists are wrong due to not having skin in the game. What I’m interested in understanding is whether the notion of “skin in the game” is what causes the irrational behavior that behavioral economists claim. Thus proving that Taleb and Thaler are more alike than their public statements claim (kind of like Democrats and Republicans).

I believe that skin in the game is what contributes to the irrational behavior — note irrational means not economically efficient. Skin in the game is a representation of external (non-economic) forces that impact decision making. This is part of the reason why companies offer stock vesting programs vs. cash. Stock provides skin in the game to increase the friction to pursue another opportunity.

Where they differ

There is much that is aligned, but there are definitely areas where they differ. Taleb is right in his critique that many IYI’s are not held accountable or responsible for their work.

One area that Taleb could also push harder is that many of the behavioral economics studies were done outside of the real world, ie. without real ‘skin in the game’. The researchers often ask hypothetical questions and thus the responses are not always accurate, as responders don’t have skin in the game. These types of approaches are good starting points, but it is important to try real-world tests.

For product professionals, this is a constant challenge. How do you test a product concept? Below are a couple of ways that can work to get ‘skin in the game’:

Closing

Taleb’s and Thaler’s theories are much more closely aligned than they like to admit. Skin in the game is a key factor that drives irrational economic behavior. I will leave with a final quote from Thaler and Kahneman that shows that skin in the game can cause research to be biased.

After more than a decade of research on this topic we have become convinced that the endowment effect, status quo bias, and the aversion to losses are both robust and important. Then again, we admit that the idea is now part of our endowment, and we are naturally keener to retain it than others might be to acquire it.

References

Strategy Dynamics

Posts dedicated to developing strategies that are dynamic…

Kyle Sandburg

Written by

Like to play at the intersection of Sustainability, Technology, Product Design. Tweets represent my own opinions.

Strategy Dynamics

Posts dedicated to developing strategies that are dynamic to market conditions

Kyle Sandburg

Written by

Like to play at the intersection of Sustainability, Technology, Product Design. Tweets represent my own opinions.

Strategy Dynamics

Posts dedicated to developing strategies that are dynamic to market conditions

Medium is an open platform where 170 million readers come to find insightful and dynamic thinking. Here, expert and undiscovered voices alike dive into the heart of any topic and bring new ideas to the surface. Learn more

Follow the writers, publications, and topics that matter to you, and you’ll see them on your homepage and in your inbox. Explore

If you have a story to tell, knowledge to share, or a perspective to offer — welcome home. It’s easy and free to post your thinking on any topic. Write on Medium

Get the Medium app

A button that says 'Download on the App Store', and if clicked it will lead you to the iOS App store
A button that says 'Get it on, Google Play', and if clicked it will lead you to the Google Play store