C. W. Von Bergen & Martin S. Bressler

A Model for Helping: Having Some “Skin in the Game”

The moral hazard literature early on recognized the tradeoff between full insurance and optimal care-level incentives. The idea was simple: if the insured enjoyed only partial insurance coverage, some incentive to take care would be preserved. The literature demonstrated that the most efficient insurance contracts require some sharing of the loss between the insurer and the insured (Shavell, 1979). And insurers do, in fact, commonly share losses with insureds in various ways, including through deductibles, copayments, and other cost sharing methods (Kuperman, 2008; Pauly, 1968). Deductibles require insureds to pay a fixed amount “out of pocket” to cover insured losses before the insurance coverage kicks in to cover insured losses thereafter. Copayments typically require insureds to bear some fraction of each covered loss claim filed by an insured.

Such cost-sharing strategies to reduce moral hazard are designed so that individuals have some “skin in the game.” Several examples of having “skin in the game” have been offered over the millennia. Hammurabi’s code, formulated nearly 4,000 years ago by the Babylonians, specified: “If a builder builds a house for a man and does not make its construction firm, and the house which he has built collapses and causes the death of the owner of the house, that builder shall be put to death” (Harper, 1904, p. 111). Other examples include the Roman heuristic that engineers spend time sleeping under bridges they have built, to the maritime rule that the captain should be last to leave the ship when there is a risk of sinking.

From these examples it is clear that the term, “skin in the game,” means having a significant commitment, share, or interest in a venture or activity. ‘Game’ is a metaphor for actions of all types, and ‘skin’ is a simile for being committed to something because of emotional, financial, psychological, or physical investments in a cause of action. The phrase implies being invested or involved in achieving an outcome. The thinking is that putting one’s own precious resources at risk where one can potentially lose something (whether it is some form of ownership, money, property, life, or respect) means that people have a greater stake in the success of the venture and are incentivized to exercise care and limit irresponsible risk-taking.

Those not having skin in the game have nothing to lose and therefore may more easily walk away in large part because there are fewer negative consequences to them. When decision makers have skin in the game—when they share in the costs and benefits of their decisions that might affect others—they are more likely to make prudent decisions. Skin in the game is what is sometimes called an equity investment. Equity investors are owners and owners value their property. Equity investments do not have to be large to provide incentives that generate desirable responses. Several areas where skin in the game is important are now provided.

Investing

Beginning in 2005, the Securities and Exchange Commission required fund manager investment status to be filed under a statement of additional information. Beyond the symbolic benefits of showing investors that a manager has some of his or her own money in the fund (i.e., some skin in the game), there are real and measurable advantages to having the portfolio manager in the investor pool. According to Morningstar, a well-regarded investment research and investment management firm, the more money a portfolio manager invests in a fund, the better the fund does (Benjamin, 2011). Of the funds at the highest manager investment level of more than $1 million, the average star rating is 3.5 and the average manager tenure is more than 12 years. Conversely, in funds where the manager has no money invested, the average star rating is 2.9 and the average tenure is 4.6 years.

In a recent study Kinnel (2015) looked at mutual fund manager investment levels in their own funds as of 2009. He then looked at the performance of these actively-managed funds over the next five years and then measured each fund’s success rate, which he defined as funds that outperformed their investment category. The results showed that fund managers with a significant amount of his or her personal money (> $1 million) in the fund to do better than one with no investment at all. It is an extra incentive beyond keeping one’s job and getting more pay.

Higher education

The concept of skin in the game has also been applied to colleges and universities. For example, some universities require that faculty pay the first $50 or $100 of the cost to attend an academic conference. With this small fee, there are likely to be fewer requests to attend these “valuable” conferences. Having the faculty put some equity into the process almost surely reduces the number of boondoggle trips. In another education-related area Miller (2015) argues that President Obama’s plan for free community college will reduce the value of a college education while having an equity investment in higher education, even a small one, will provide an incentive for students to make sound decisions. Which courses should they take? How much effort should they put into their coursework? Should they attend class and pay attention? Their answers almost surely depend on whether they have equity in their education and how much.

More importantly, current federal incentives reward colleges and universities for volume (number of students enrolled and associated loan and grant monies) yet federal policy has few, if any, consequences for institutions that leave students with mountains of student debt and defaulted loans. To assist these institutions in reducing excessive and unnecessary student borrowing and debt Senator Lamar Alexander of Tennessee released a Congressional white paper on March 23, 2015 that proposes giving colleges and universities some risk sharing (or skin in the game) in which they would be held partially accountable for financial risks to students and taxpayers (U.S. Senate Committee on Health, Education, Labor & Pensions, 2015). Under these proposals, the risk of enrolling a student would be shared among all those who finance a student’s education: the student, the federal government, and now, the institution. This would ensure that colleges and universities have a clear financial stake in their students’ success, debt, and ability to repay their taxpayer-subsidized student loans.

Current and historical commentary on skin-in-the-game concepts and proposals often revolves around this idea. Former U.S. Secretary of Education Bill Bennett and coauthor, David Wilezol, wrote that each college should pay “… a fee for every one of its students who defaults on a student loan, or have a 10 to 20 percent equity stake in each loan that originates at its school” (2013, p. 54). Similarly, The Economist (2014) indicated that “If [universities] were made liable for a slice of unpaid student debts—say 10% or 20% of the total—they would have more skin in the game.” Support for this comes from a variety of higher education observers across the political spectrum from the right-of-center American Enterprise Institute and the U.S Chamber of Commerce to the Institute for Higher Education Policy.

This would ensure that colleges and universities have a clear financial stake in their students’ success, debt, and ability to repay their taxpayer-subsidized student loans. It would encourage colleges and universities to establish appropriate admissions’ practices for at-risk or uncommitted students, motivate students to complete their degrees more quickly, and graduate students with less debt. Recent legislation sponsored by Senators Reed (D-RI), Durbin (D-IL), and Warren (D-MA) would expand this concept to some U.S. colleges that have high borrowing rates and high student loan default rates (Protect Student Borrowers, 2013).

Mortgages

Every year, the U.S. Department of Housing and Urban Development, through its Federal Housing Administration (FHA), insures billions of dollars in home mortgage loans made by private lenders, very often with low down payments. FHA mortgage insurance helps homebuyers with limited funds to obtain a home mortgage. Homebuyers with FHA-insured loans need to make a 3 percent contribution toward the purchase of the property and may finance some of the closing costs associated with the loan. As a result, an FHA-insured loan could equal nearly 100 percent of the property’s value or sales price—commonly called loan-to-value (or LTV) ratio.

Generally, mortgages with higher LTV ratios (smaller down payments) are riskier than mortgages with lower LTV ratios and a substantial body of economic research indicates that loan-to-value (or LTV) ratio is one of the most important factors when estimating the risk level associated with individual mortgages. For example, the U.S. Government Accounting Office (2005) reviewed 45 economic research papers that examined multiple factors that could be important; of these, 37 examined if LTV ratio was important. Almost all of these papers (35) found the LTV ratio of a mortgage important when estimating the risk level associated with individual mortgages. One study found that the default rates for mortgages with an LTV ratio above 95 percent are three to four times higher than default rates for mortgages with an LTV ratio of 90 to 95 percent.

More recently, Kelly (2008) analyzed a random sample of about 5,000 FHA insured single family mortgages endorsed in Fiscal Years 2000, 2001, and 2002, observed through September 30, 2006, and samples of about 1,000 FHA loans each from the Atlanta, Indianapolis, and Salt Lake City metropolitan statistical areas in the same time period. He found that borrowers who provide down payments from their own resources have significantly lower default propensities than do borrowers whose down payments come from relatives, government agencies, or non-profits. Borrowers with down payments from seller-funded non-profits, who make no down payment at all, have the highest default rates. Additionally, borrowers who do not make down payments from their own resources tend to have higher loss given default in the small subset of loans that had completed the property disposition process. Thus, relieving the buyer of the need to contribute cash to the purchase, via a gift from an uninvolved party, raises the claim rate by 40% to 50%. Relieving the buyer of the need to contribute cash to the purchase, by a “gift” from the seller that results in a higher loan amount, raises the claim rate by an additional 38% to 50%. The extra difference in claim rates for gifts from seller-funded nonprofits is broadly consistent with an equity-based explanation, as a 25% increase in claims for a 3% decrease in equity. This research does make clear that, for whatever reason, borrowers with no “skin in the game” (i.e., aid recipients) are higher credit risks than comparable buyers who bring cash to the transaction. This research is consistent with that reported by James (2010) and Demiroglu and James (2012). In short, skin in the game matters.

Habitat for Humanity

The premier example of the importance of skin in the game is Habitat for Humanity which was founded in 1976 and has more than 400 U.S. affiliates and operates in more than 90 countries. It is dedicated to eliminating substandard housing and providing low-income families with the joy and dignity of homeownership. “Sweat equity” is the single most important strategy Habitat uses to empower future homeowner families and one of the features that sets it apart from other affordable housing providers. Sweat equity to refer to the hours of labor their homeowners dedicate to building their homes and the homes of their neighbors, as well as the time they spend investing in their own self-improvement. Most importantly, by going beyond a mere financial investment in their property and physically working alongside other volunteers and neighbors, Habitat homeowners gain a greater sense of self-worth and become more personally invested in their community (Habitat for Humanity of Broward, 2015).

Sweat equity reduces the amount of paid labor needed for a house, which in turn helps reduce costs. Having the involvement of the families themselves adds a sense of ownership to the building process, and educates families on an entirely different level (Garafolo, 1997). Partner families are also expected to pay it forward and assist others in building their homes. Furthermore, those who receive assistance from Habitat are given the opportunity to improve their financial skills. Budget counseling, homeowner maintenance, and even predatory-lending awareness issues are addressed in offered courses. These programs are run in conjunction with home construction in order to guide new homeowners to a financially stable future. A study commissioned by the Dallas branch of Habitat, found that foreclosures in Habitat’s Dallas market were less than 2% in 2010. Although the report only looked at the Dallas office of Habitat, the findings mirror those found in other Habitat offices across the country, the organization says (Wotapka, 2011).

As can be seen in many of these examples, some sort of exchange is illustrated (e.g., down payment for a house; sweat equity for a home). On an interpersonal level, in some cases an immediate exchange for aid and assistance may not always be feasible. In these cases it may be important to highlight that the helper expects some recompense in the future. This pay back with its accompanying sense of obligation and indebtedness is more formally known as reciprocity and it is a powerful influence mechanism to which human cultures subscribe (Gouldner, 1960). Indeed, world-renowned paleoanthropologist Richard Leakey indicated “unequivocally that “We are human because our ancestors learned to share their food and their skills in an honored network of obligation” (Leakey & Lewin, 1978, p.16). Thus, to maximize the likelihood that the favor doer will be paid back in the future he/she should invoke the reciprocity rule and not diminish the help given. These subtle reminders should occur as part of a natural and equitable reciprocal arrangement.

Summary

For thousands of years various religious, moral, philosophical, and cultural perspectives have appealed powerfully to individual’s humanitarian impulses and have encouraged helping others—particularly the less fortunate. Over the last 40 or so years calls for this has been amplified in what some call a “compassion boom” (Berland, 2010; Hoang, 2015). This movement is almost universally accepted as virtuous and constructive and calls for altruism, and other prosocial acts have been lionized. In some cases such help has been interpreted as a duty or obligation. For example, noted moral philosopher, Peter Singer, makes a compelling case that individuals should be doing much more to aid the needy than they are (Singer, 2015). Singer’s main principle first stated in 1972 is that “if it is in our power to prevent something bad from happening, without thereby sacrificing anything of comparable moral importance, we ought, morally, to do it” (p. 231). Such a position has been promoted by many modern philosophers, theologians, and social scientists who often assume that aiding the disadvantaged is an absolute good. Help, it is said, can be experienced as an expression of meaningful belongingness between the beneficiary and the benefactor, eliciting positive feelings, favorable self-perceptions, and gratitude (Fisher et al., 1982). Although giving behavior is said to benefit givers and takers and organizations, and ardently praised in the abstract by leaders, it often comes at the expense of those who receive it.

The receipt of aid constitutes a mixed blessing and often those helped may experience “the curse of aid” (Djankov, Montalvo & Reynal-Querol, 2008, p. 169). The worthy aims of altruism and other prosocial behavior may have long term socially detrimental effects and that initiatives to engage in good acts are sometimes problematic (Kalman, 2010). A more refined analysis that examines both the possible positive and negative effects of aiding the needy is required. Usually, helping is looked at from an idealistic perspective and as such it is more a reflection of what individuals would like it to be and not necessarily reflective of what could happen. What is needed is not such a one-sided perspective but a search for unintended consequences that may create surprising, unfortunate, and counterproductive effects. Indeed, a growing body of research indicates that virtues can wreak havoc. Experiments by economists in The Netherlands have demonstrated the dark side of fairness (Abbink & Sadrieh, 2009); psychology professors have discovered how passion for work can become an unhealthy obsession (Seguin-Levesque, Laliberte, Pelletier, Blanchard, & Vallerand, 2003); and a political science professor researching the marksmanship of female marines showed how aiming for excellence can backfire (Archer, 2010). Moreover, virtuous behavior may have both positive and negative effects depending on levels. For instance, Grant and Schwartz (2011) noted that excessive levels of numerous virtues often create problematic situations.

Research on helping has focused primarily on the persons who give the help. In comparison, very little research has been done on recipients of help and the consequences of their receiving help. Although positive outcomes frequently occur following aid, unhelpful effects may also ensue including loss of independence and a sense of indebtedness (Greenberg, 1980), a loss of freedom and chronic dependency on others (Nadler & Fisher, 1986), and aversive psychological states such as “reactance” (Brehm, 1966). Helping others is indeed a real virtue but individuals and firms must not hold that it is beyond question, scrutiny, or criticism but should approach the idea of giving with a healthy dose of mindfulness lest they become blind to the ways virtues sometimes hurt people.

We recognize that few people have bad intentions and agree with noted poet and literary critic, T. S. Eliot, who said that “Most of the evil in this world is done by people with good intentions” (n.d.). However, good intentions alone are not enough to make actions moral. This paper discusses how helping others can exact an unintended toll on the needy and how the failure to recognize this represents a disservice to the truth. It appears that every action and decision has unintended consequences. Because of its pervasiveness Levitt and Dubner (2009) have elevated unintended consequences to the status of a law (“… one of the most powerful laws in the universe …”, p. XIV). Every action has both seen and unseen consequences, obvious and not so obvious effects, positive and negative, and short and long-term outcomes.

Good intentions do not automatically lead to moral actions. Individuals must consider the possible negative consequences before they give and help others. If individuals’ interventions cause more harm than good, then they are morally questionable regardless of the loftiness of their intentions. Just because kindness and compassion may appear praiseworthy people must consider the possible harm that their proposed aid may cause. Individuals and organizations must stop implementing programs and activities that can be shown to create more injury than good. Whether the long term assistance and help come from government, parents, a rich uncle, or the lottery, the effect is the same—people will make no effort to become self-sufficient. Those who are dependent have few choices; they must accept whatever is “given” to them. An inconvenient truth illustrated here is that giving people something for nothing, that is, providing unearned advantages not contingent on accomplishment, achievement, or merit fuels the likelihood that such individuals will become increasingly dependent, entitled, lazy, and privileged. Daniels (2001) has coined the aphorism, “If you give people something for nothing, you make them good for nothing” (p. 77), to describe the harmful effects of sustained unearned aid.

The Habitat for Humanity model suggested here appears to be consistent with Nadler’s model of intergroup helping (Nadler, 1997, 1998, 2002; Nadler & Halabi, 2006), which distinguishes between autonomy-oriented and dependency-oriented help. The Habitat model, which emphasizes autonomy-oriented assistance, appears to be consistent with two classic maxims that are commonly supported: 1) “Give a man [sic] a fish and you feed him for a day. Teach a man [sic] to fish and you feed him for a lifetime;” and 2) “Give a hand up, not a handout.” Unfortunately, “helping people help themselves” rhetoric simply takes the idea as being the same as “helping people” and there is often little or no suspicion that assistance can be unhelpful in the sense of overriding or undercutting self-help and is thus quite antithetical to helping people help themselves.

We believe that autonomy-oriented assistance can restore an aid recipient’s agency. In the absence of meaningful behavior on the recipient’s part to earn some benefits, long term and repeated charity (not cases of crisis relief) is likely to impede rather than promote growth, autonomy, and development. When there is no apparent link between behavior and rewards, individuals may begin to believe that they deserve rewards regardless of how they perform. Having skin in the game makes the connection between performance and rewards more noticeable and reduces the erosion of the aid recipient’s work ethic and problematic feelings of entitlement and dependency.

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