Agency problem

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The agency problem addresses the intrinsic conflict of interest any agent working on a commission faces — any introducing broker, broker/dealer, asset manager, architect, building contractor — and that is that once it have received its commission, it doesn’t really care a hill of beans what its principal gets, however much it might protest to the contrary. In a sense, this is a basic articulation of the prisoner’s dilemma and so shouldn’t surprise anyone — and should be cured by repeat interactions — your clients have memories and will remember when you ripped them off.

But the iterated prisoner’s dilemma has a couple of natural limits. One is that it relies on repeated interactions with an indeterminate end. When the sky is falling on your head, it looks like a final interaction, and the calculus is different. Second, it takes no account of convexity effects. I can build up my reputation incrementally with thousands of small transactions — I can look like a five-star collaborator — only to bit on a big position and defect. This is what Nassim Nicholas Taleb calls the “Rubin Trade”.

Skin in the game problem: Agents paid no matter what. Investment managers take a slice of your pie - a small(ish) slice, admittedly, but they put no capital up, and they take out their fee first, whatever the performance.