What Happened to Goldman Sachs An Insiders Story of Organizational Drift and Its Unintended Consequences by Steven G. Mandis
There are two easy and popular explanations about what happened to the Goldman culture. When I was there, some people believed the culture was changing or had changed because of the shifts in organizational structure brought on by the transformation from a private partnership to a publicly-traded company. Goldman had held its initial public offering (IPO) on the NYSE in 1999, the last of the major investment banks to do so. The second easy explanation is that, whatever the changes, they happened since Lloyd Blankfein took over as CEO and were the responsibility of the CEO and the trading-oriented culture some believe he represents.
Some at Goldman have even claimed that having many alumni in important positions has disadvantaged the firm
The philosophy behind the firm’s rise was best expressed by Gus Levy, a senior partner (with a trading background) at Goldman from 1969 until his death in 1976, who is attributed with a maxim that expressed Goldman’s approach: greedy, but long-term greedy.15 The emphasis was on sound decision-making for long-term success, and this commitment to the future was evidenced by the partners’ reinvestment in the firm of nearly 100 percent of the earnings.
Another common misperception among the public is that today Goldman primarily provides investment banking services for large corporations because the firm works on many high-profile M&A deals and IPOs; however, investment banking now typically represents only about 10 to 15 percent of revenue. Today, the majority of the revenues come from trading and investing its own capital. The profits from trading and principal investing are often disproportionately higher than the revenue because the businesses are much more scalable than investment banking. Today about 40 percent of Goldman’s revenue comes from outside the United States and it has offices in all major financial centers around the world, with 50 percent of its employees based overseas
There’s always a natural tension between business owners who want to make the highest profits possible and clients who want to buy goods and services for as low as possible, to make their profits the highest possible. Being a small private partnership allowed Goldman the flexibility to make its own decisions about what was best in its own interpretation of the long term in order to help address this tension.
Goldman and McKinsey compete for the best and brightest graduates every year, and there are elements of the McKinsey culture that are similar in many ways to Goldman’s, especially to the Goldman I knew when I started. When attending McKinsey training programs, I could have closed my eyes and replaced the word McKinsey with Goldman, and it would have been like my 1992 Goldman training program all over again. McKinsey has an intense focus on recruiting, training, socialization of new members, and teamwork. It also has long-standing, revered, written business principles. Lastly, it has an incredible global network.
Shared Principles and Values
Our client's interests always come first.
Our assets are our people, capital, and reputation.
Our goal is to provide superior returns to our shareholders.
We take great pride in the professional quality of our work.
We stress creativity and imagination in everything we do.
We make an unusual effort to identify and recruit the very best person for every job.
We offer our people the opportunity to move ahead more rapidly than is possible at most other places.
We stress teamwork in everything we do.
The dedication of our people to the firm and the intense effort they give their jobs are greater than one finds in most other organizations.
We consider our size as an asset that we try hard to preserve.
We constantly strive to anticipate the rapidly changing needs of our clients and to develop new services to meet those needs.
We regularly receive confidential information as part of our normal client relationships.
Our business is highly competitive, and we aggressively seek to expand our client relationships.
Integrity and honesty are at the heart of our business.
Goldman executives were conscious of sustaining this culture when recruiting and tried to hire the best of the best, but not just for their intelligence, drive, or experience. The partners looked for people who fit a certain profile: people who had all the requisite skills and knowledge were hardworking and driven, and also espoused a value system consistent with Goldman’s
Goldman’s practice was to hire directly from top business schools rather than from other firms because recent MBAs were more malleable; the plasticity of a young MBA’s character made it easier to inculcate the Goldman ethos.
Soon after I was hired, I was asked to review résumés from Midwestern schools for candidates to interview. When I was given hundreds of them bound in three-ring folders, I asked the vice president who had given me the assignment, How should I go about choosing?
He shrugged and told me to take anyone who didn’t have a certain grade point average and SAT score and throw them out, and then get back to him.
I did that, but I was still left with what still seemed like hundreds of résumés. So I asked, Now what do I do?
Take out anyone who doesn’t play a varsity sport or do something really exceptional or substantive in public service, he told me, waving me out of his office.
Once again I culled the folders, but still, I had too many. So I went back again.
Now throw out any that don’t have both sports and public service, and raise your grade and SAT requirements.
After this round, I came up with the thirty people we would interview to select the one or two who would get an offer.
Partners also created stronger networks because of the trust. Building a network involves connecting the dots, or rather connecting Goldman people to each other and to important people outside the firm. Almost a decade before he crafted the firm’s business principles, John Whitehead wrote a set of guidelines for the investment banking services area, one of which was, Important people, like to deal with important people. Are you one? Gaining access to important people requires introductions from people willing to make the call.
A Harvard Business School case study about Goldman’s training found that Goldman used the Socratic method to explore questions through discussion and debate.
Another significant innovation in the late 1980s and early 1990s was the heavy use of the emerging technology of voicemail, adopted much earlier and used more effectively at Goldman than at other firms. Voicemail helped improve coordination and teamwork because multiple people could be given information simultaneously and they could hear the tone of a message. The technology resulted in better execution for clients and gave Goldman a competitive advantage. Goldman continued to rely on voicemail heavily even after it had e-mail capability because e-mail lacked the inflection and expressive capacity of the human voice and was less effective in maintaining the firm’s social network.
Goldman people responded quickly to voicemail (and later e-mail messages) because the culture demanded that they do so. A quick and comprehensive response was and still is the norm; it would be culturally unacceptable not to respond as soon as possible.
AT A GOLDMAN PARTNER MEETING, THE STORY GOES, A SENIOR partner asked the new partners to identify the two men who were most important to the firm’s business. The new partners responded with last names: Goldman, Sachs, and Weinberg. The senior partner then revealed the answer: Senator Carter Glass and Representative Henry Steagall.
Between 1987 and 1994, the firm had downsized six different times in different divisions in response to different earnings
Equity-holding partners were now called managing directors, as were almost one hundred of the thousands of vice presidents (the more experienced ones). Those who were partners in the firm were internally called partner managing directors, or PMDs.
Non-partner managing directors are likely to earn $2 million or more each, recruiters say. Additionally, the firm changed its compensation practices. All MDs received participation shares, whose value was tied to the overall profitability of the firm and not to an individual or departmental performance.
Along with limited liability, however, the firm instituted changes to the capital obligations of those leaving the partnership; under the new regime, retiring partners were required to keep their capital in their firm for a longer period, on average six years
In 1995, the firm revamped its governance structure, forming two new eighteen-person decision-making groups: the partnership committee and the operating committee. The operating committee focused on the coordination of strategy and operations among the firm’s departments, divisions, and geographies. The partnership committee oversaw the firm’s capital structure as well as the selection of partners. Soon afterward, the firm established an executive committee—the ultimate decision-making group—which was much smaller than its predecessor, the management committee. The executive committee’s charter included all issues that did not require a vote by the full partnership or a partner’s individual consent
In addition, two new eighteen-person committees were formed. The six individuals on the executive committee had much more power than the management committee had enjoyed, including the ability to change the leadership
Less than six months after Goldman went public, in 1999 certain provisions of the Glass–Steagall Act were repealed by the Gramm–Leach–Bliley Act, and President Bill Clinton signed the legislation that year. Former Goldman co-senior partner Bob Rubin was secretary of the Treasury at the time, and he later joined Citigroup.
The repeal meant that commercial banks, investment banks, securities firms, and insurance companies could be combined.43 Commercial banks started to buy investment banks, spawning a massive consolidation in the banking industry. Some believed it was inevitable that Goldman would be bought. The firm suddenly looked small compared to its new direct competitors, and, with its market position, brand, and relationships, it would have been a prize. Rather than be taken over, the partners decided to grow.
Morgan was considered a white-shoe firm, referring to white buck shoes—laced white suede or buckskin shoes with red soles, which stereotypically were worn at Ivy. League colleges, while Dean Witter Reynolds was a firm with strong retail distribution: nine thousand stockbrokers serving more than 3 million customers. Dean Witter also owned Discover Card. Generally, white-shoe investment bankers often looked down on retail stockbrokers, whose alma maters typically were not the elite schools.
Hedge funds also changed the landscape. Unlike many traditional mutual funds, which had a buy and hold mentality, many hedge funds went in and out of securities with high frequency. They typically borrowed money from investment banks to buy securities, and they shorted securities.
Goldman established Goldman Sachs Asset Management (GSAM) to serve institutional and individual investors worldwide.GSAM became a strategic priority, in part, because it was not as capital intensive as proprietary trading and it offered consistent fees, which were a percentage of assets under management. When Goldman went public, establishing the asset management business proved to have been a wise strategic decision for this reason. Institutional investors buying the stocks of investment banks, and research analysts covering investment banks, liked the consistency of earnings and gave a higher valuation to the earnings from asset management divisions than to trading earnings
In its quest for growth and profits, Goldman also began to adjust its business mix. The prioritized opportunities for growth required more capital: trading, proprietary trading, merchant banking/principal investing, and international. Trading and principal investments grew 20 percent annually from 1996 to 2009, whereas investment banking grew 7 percent.
The changing business mix at Goldman, with so much more revenue beginning to come from trading in particular both reflected and contributed to organizational drift. The balance between banking and trading was changing. Also, international growth started to become a challenge. From 2005 to 2007, trading and principal investing accounted for about 70 percent of revenues, and investment banking had plunged to 15 percent.
How big and important are proprietary trading and principal investing activities at Goldman? Glenn Schorr, a Nomura Securities equity research analyst covering Goldman stock, estimated that the Volcker Rule, which is intended to restrict proprietary trading and principal investing at investment banks, would impact 48 percent of Goldman’s total consolidated revenue. To put this into context, he estimated the impact at 27 percent, 9 percent, and 8 percent of total consolidated revenues of Morgan Stanley, Bank of America, and J.P. Morgan, respectively.
One of the basic principles of the financial system is that risk is rewarded. Exactly how well Goldman partners were rewarded—what they earned or owned—had been a closely guarded secret, but it became public information in the filings for the IPO.
Goldman still has its leading market share, in part because it effectively manages conflicts to its advantage—and it also faces reputational and legal questions and consequences, because conflict management is an art and not science. If Goldman had not managed conflicts, its ability to grow and maintain market share would have been challenged. The management of conflicts maximizes opportunities to access scarce resources.
After Sarbanes–Oxley passed, and in compliance with new requirements of the NYSE, Goldman added two outside directors. Thus, the majority of its board (60 percent) was comprised of outside, independent directors.
Whether Goldman would have survived without government intervention is debatable[2008 fin. crisis]. In fact, in the days immediately following the collapse of Lehman, it became apparent that both Goldman and Morgan Stanley could have shared the same fate as Lehman.
dissonance is the term used by Columbia University sociologist David Stark to describe the ability of those in an organization to challenge one another, to ask questions, and explain their own views. The dissonance of this type leads to more scrutiny of decisions as well as greater innovation and performance. The financial interdependence of partners during Goldman’s partnership days, as well as the social network of trust among them and the less hierarchical structure, encouraged this, and though the new organizational and incentive structure of the company has limited this residual dissonance, a strong enough social network among executives at the firm still exists that these were key factors that differentiated Goldman during the credit crisis. They helped to break through structural secrecy, and that, combined with more expertise at the top of the firm in trading and risk assessment, enabled Goldman to do a better job of perceiving and managing the risk that led to losses.
Goldman was the only firm that had so many risk experts in the highest levels of management. As mentioned earlier, Goldman had learned from its 1994 experience. Value at Risk (VaR) is a widely used measure of the risk of loss on a specific portfolio of financial assets, expressed in terms of a probability of losing a given percentage of the value of a portfolio—in mark-to-market value—over a certain time. For example, if a portfolio of stocks has a one-day 5 percent VaR of $1 million, there is a 0.05 probability that the portfolio will fall in value by more than $1 million over a one-day period.
During an interview for this book, an executive at a competing firm (who had earlier worked at Goldman) explained that his firm simply did not give the same attention to risk management. He explained that Goldman’s biggest advantage was that its top people were real traders and risk takers or had access to and dialogue with such traders, as well as the culture to support investment in the systems and the dialogue. He explained that this was why he hadn’t been surprised when Hank Paulson and the board had bypassed John Thornton and John Thain (to whom Paulson allegedly had verbally promised the CEO position) and picked Blankfein to succeed him as CEO. Thornton and Thain did not have as much real-time and extensive expertise in trading and risk. The firm gained trading expertise at its top with Blankfein, and that helped it navigate the credit crisis.
In late 2006, Goldman recognized the need to de-risk and moved swiftly to do so without warning clients or the government. After a period of mounting concern about Goldman’s overexposure to mortgages, in late 2006 Viniar and a group of executives drafted a memo describing their course of action for reducing that exposure. Goldman’s critics are quick to point to this statement: Distribute as much as possible on bonds created from new loan securitizations and clean previous positions. Matt Taibbi translates this to, Find suckers to buy as much of [the] risky inventory as possible. Taibbi then provides an apt analogy: Goldman was like a car dealership that realized it had a whole lot full of cars with faulty brakes. Instead of announcing a recall, it surged ahead with a two-fold plan to make a fortune: first, by dumping the dangerous products on other people, and second, by taking out life insurance against the fools who bought the deadly cars.32 According to Taibbi, within two months of the memo, Goldman had gone from betting $6 billion on mortgages to betting $10 billion against them—a shift of $16 billion.
Despite public outcry and even disappointment among clients, Goldman doesn’t lack business. Its brand is still highly rated, and Goldman offers a unique value proposition to clients for several reasons, primarily related to access, information, risk management, and people. Goldman is in the center of a large information flow that it gathers from clients. Goldman uses its risk management capabilities and its culture of teamwork to gain insights and then packages the insights and information, makes timely introductions, and executes smart trades. According to client interviews, the firm will continue to excel and dominate, because, relative to its competitors, it generally provides better advice, information, access, and liquidity.
with trading and principal investing contributing 68 percent of the company’s 2007 revenue, compared with 9 percent from advisory fees, some clients questioned whether they could count on Goldman to provide unbiased advice
There is also strong competition for the best talent. Many talented individuals interested in finance go to private equity firms and hedge funds, which offer attractive opportunities.69 Many smart people are going into technology or other fields. But clients felt that Goldman would probably be considered the best alternative generally, not necessarily in every area of specialization, if one is interested in banking or wants training and credentials.
Many at Goldman subscribe to the notion that because the firm serves a higher purpose, they are more driven to excellence and are more dedicated than their peers at other firms. The pursuit of profit is portrayed as virtuous, and hard work is viewed as a kind of, for lack of a better phrase, religious duty.
The sense of higher purpose is reinforced by the relationship between Goldman and the government. The White House has often looked to Wall Street experts for advice, and Goldman partners have advised several presidents and cabinet members, leading to an incestuous web between government and Goldman—hence the nickname Government Sachs. Goldman also realized the wisdom of hiring former senior government officials. At the highest levels within Goldman, there was, and is, a conscious effort to build and maintain relationships with important people.
A concerning issue about the organizational drift toward a legal definition of ethics is that Goldman and the other banks have a significant influence or role in determining the legal line. For example, Goldman has reportedly spent over $15 million in lobbying related to Dodd-Frank and less than two-thirds of the regulations have been implemented.2 Securities and investment firms spent more than $101 million lobbying regulators in 2011, according to the Center for Responsive Politics, a nonpartisan research group. That is on top of $103 million spent lobbying lawmakers and regulators in 2010
The following summary should help leaders and managers think about the organizational drift that has, is, and will be happening at their own organizations
Shared values, whether codified or uncodified, tie an organization together.
Social networks can create competitive advantages and improve performance.
Financial interdependence is important as a self-regulator.
Public disclosure supports an organization’s values and strengthens the organization itself.
Generating dissonance or perplexing situations that provoke innovative inquiry can create competitive advantages and improve performance.
A sense of higher purpose, beyond making money in a materialistic society, can help people make sense of their roles.
An organization’s culture is transmitted from one generation to the next as new group members become acculturated or socialized.
Organizational exceptions may address short-term issues but may cause long-term ones.
The ability to make rational decisions is limited, or bounded, by the extent of people’s information.
Firms must think about long-term greed and what it means. Through actions and training, leaders must explain the pressures on short-term thinking and how the firm resolves the conflicts of short- and long-term goals.
Leaders must understand that external influences can shape the culture.
An organization needs to understand to what extent models impact behavior, decisions made by business leaders, and organizational culture.
Leaders get too much credit and too much blame. Leaders need to uphold the firm’s shared values—and that is a key component to leadership.
An organization’s structure, incentives, and values last longer and have more impact than those of individual leaders.
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