What Happened to Goldman Sachs: An Insider's Story of Organizational Drift and Its Unintended Consequences (11 page)

Corzine sought to open offices around the world during this time. “Jon wanted to do business in every country, everywhere, and wanted to be big,” one partner said. “He was like the guy going through a cafeteria and he wanted to take everything and put it on his tray. That concerned people.”
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In 1995, Goldman opened offices in Shanghai and Mexico City and created joint ventures in India and Indonesia. Paulson and many others thought Corzine was moving too fast. Lloyd Blankfein, the current Goldman CEO, used to joke that “he was going to go away someday and wake up and find out we were opening up an office in Guatemala.”
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(I discuss selected other organizational changes during Corzine’s leadership and their intended and unintended consequences later.)

From Partnership to LLC

Corzine raised the idea of an IPO in January 1996, and it was again rejected. But in lieu of an IPO, the management committee took several steps to shore up the firm’s capital base and limit the partners’ legal and financial liability. The firm became a limited liability partnership in 1996.
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The potential liability to partners was now restricted to their capital in the firm. The “partner” title was formally abandoned. It was believed that the term could be misinterpreted or could place implied personal partnership-like liability on the partners. 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. Nonpartner managing directors were referred to as “MD-lites.”

Partners told me they believed that the title change for the chosen vice presidents conveyed practical management responsibility on par with that of their peers at other firms. According to news reports, “The 128-year-old investment-banking partnership created the title of managing director last year and elevated 87 employees to the rank. They get a boost in pay and benefits, but unlike Goldman’s 190 partners, they don’t own a share of the firm’s $5.8 billion in capital. Goldman executives say the new title recognizes able bankers and traders who face tough competition rising to partner, considered the pinnacle of Wall Street. Non-partner managing directors are likely to earn $2 million or more each, recruiters say.”
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The addition of so many people at once and with the same titles now started to impact the social network of trust.

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 individual or departmental performance. Several partners told me that their change in title altered their perspective. They no longer had the cachet and status of the title “partner,” something they believed differentiated them from peers at firms like Morgan Stanley; there were now many “managing directors” at Goldman.

As a result of this change, only the capital partners retained in the firm, and not their personal assets, could be used to repay the firm’s creditors.
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Although the change would greatly reduce the risk of personal bankruptcy, the retained capital was estimated to be around 70 percent to 90 percent of a partner’s assets, capital that could not be accessed until retirement. 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.
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The change in legal structure was accompanied by other changes in the firm’s organizational structure, processes, tasks, and systems. Goldman became a bit more hierarchical.
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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 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.
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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. When I asked partners why they went along with these changes, some admitted that some were promised committee appointments, elevating their own status, or some were afraid they might be departnered if they didn’t go along with the changes. (Ironically, the organizational change by Corzine to a smaller and more powerful group would lead to a coup against Corzine; this is discussed later.)

Many things changed as a result of and around the time of Goldman’s transformation into an LLC. The competitive and other external pressures fueling the demand for growth did not.

From LLC to Public Company

Some of the firm’s senior partners did not share Corzine’s enthusiasm for abandoning the partnership structure. Corzine was strongly in favor of an IPO, but Paulson insisted on a cautious, well-informed decision-making process. According to my interviews, three of the six members of the operating committee were in favor of an IPO, and Paulson, John Thornton, and John Thain were against the idea. A strategy committee, led by Paulson, was charged with determining what Goldman should look like down the road and how best to ensure it remained on top. Input was actively solicited from partners, and Corzine tried to speak personally to most. After six weeks of study in 1998, the strategy committee submitted a plan for “vigorous expansion.”
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The study supported Corzine’s conviction that Goldman needed to go public to take advantage of competitive opportunities in businesses other than traditional investment banking. Although Corzine and Paulson did not get along, Corzine eventually gained Paulson’s support.

Some people in the press have speculated that Paulson’s ultimate agreement to support the IPO was connected to his being made co-head of the firm. The operating committee and partnership committee, which together accounted for 39 of the 189 partners, supported an IPO for reasons related primarily to the perceived pressures to grow, and grow quickly, citing the threat posed by larger competitors and the ability “to bind more employees to the firm through equity ownership.”
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After the executive committee agreed to pursue an IPO, co-senior partners Corzine and Paulson released a statement that reflects both capital and liability concerns: “As a public company, Goldman Sachs will have the financial strength and strategic flexibility to continue to serve our clients effectively as well as respond thoughtfully to the business and competitive environment over the long term. This action will also meet a fundamental objective of the partners—to share ownership, benefits and responsibilities more broadly among all of the firm’s employees.”
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During hours of discussion over a two-day general meeting in 1998, the partners registered their opinions with the executive committee, which was empowered to recommend for or against an IPO.
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In the end, they reached consensus, and the partners voted to go ahead. (See
table 4-1
; for more details on the value of partners’ stock at the time of the IPO, see
appendix D
.)

Again, the change in structure was described as a direct response to competitive and external pressures to expand.
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Expansion required large amounts of capital—more than the partners could or would contribute personally. The partners concluded that the best alternative was to raise capital by offering shares of the firm for sale to the public. I asked partners why they didn’t push to raise more outside private capital while remaining private, following up with the question, Wouldn’t the higher cost of capital be worth the benefits of maintaining the partnership structure? Most of them didn’t have a good answer, but they said it was considered and dismissed. A few said that only a limited group of outside private minority investors and capital would be willing to invest without gaining a say in management into perpetuity. A few disputed this argument. They also said that by then the culture had changed enough for the IPO to go forward because of everything that had happened in the 1990s. One former partner went so far as to insinuate that in the end the real pressures were enough, and enough had changed, that their decision to vote for the IPO could be rationalized both to the outside world and to themselves. He thought this did mark a change in the culture because previous generations could have made the same rationalizations, especially in 1986.

Soon after the decision to go public was made, economic conditions took a sharp turn for the worse. The stock market was experiencing erratic swings, the economic chaos in Russia carried the prospect of enormous losses to investment banks, the stock prices of Goldman’s competitors were falling, and there was virtually no market for IPOs. The firm’s earnings took a nosedive in the last quarter of 1998 as trading losses soared. Goldman put its IPO on hold, but there was no doubt it was coming. The prospect of enormous personal gain from the IPO prevented another mass exodus of partners like in 1999, who would have had difficulty withdrawing their capital if they had wanted to leave the firm. However, suddenly and unexpectedly, in January 1999, Corzine, whose working relationship with Paulson had always been uneasy, resigned as co-CEO, remaining as co-chairman—but only to help the firm get through the IPO.

Another sign that the culture had already changed significantly was a Hank Paulson–orchestrated management coup that forced Corzine out and put Paulson in charge. According to interviews, he and other partners were worried that Corzine “was going off the reservation.” They had found out that Corzine had merger/sale conversations with other parties without the direct consent of the executive committee. Over the Christmas holiday in 1998, while Corzine was away, Paulson made his move. Corzine had made the organizational change of consolidating power into a small executive committee versus the larger management committee, and there were some recent changes in the membership, which together opened up the possibility for a coup. In what was eerily similar to Paulson’s alleged quid pro quo support for the IPO to be named co-head of the firm, allegedly Thain and Thornton agreed to support Paulson in return for what they believed was an informal promise: Paulson would be the CEO for only a few years (the time was debatable) and then transfer the CEO job to both Thain and Thornton. Thain was a longtime lieutenant and friend of Corzine. According to interviews, he justified the decision with the argument that he was doing what he thought was best for the firm in the long run. In early to mid-January, Goldman partners received an e-mail from Paulson and Corzine: “Jon has decided to relinquish the CEO title.”
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Corzine remained co-chairman, but only to help the firm complete the IPO. Several partners I interviewed said that in hindsight they believed the alleged coup sent a bad message regarding behavior and highlighted how much the firm’s culture had changed. It would also affect how the next CEO would organize the firm (discussed later).

With the markets and Goldman’s earnings recovering, Goldman went public on May 3, 1999, pricing the stock at $53 per share, implying an equity market valuation of over $30 billion. In the end, Goldman decided to offer only a small portion of the company to the public, with some 48 percent still held by the partnership pool, 22 percent of the company held by nonpartner employees, and 18 percent held by retired Goldman partners and Sumitomo Bank and the investing arm of Kamehameha Schools in Hawaii. This left approximately 12 percent of the company held by the public.

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.
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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. It turned out that Goldman CEO Jon Corzine and others held merger discussions at the time, talks that were disrupted by Hank Paulson’s ouster of Corzine (to be discussed more later). Rather than be taken over, the partners decided to grow.
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The dismantling of Glass–Steagall led to many changes in the ways banks competed, changes that put a great deal of pressure on Goldman to rapidly evolve its own ways of operating. The changes in practices and in the firm’s culture were greatly accelerated. These new powerhouses began challenging Goldman with “margin-reducing, risk-heightening competition.”
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The impression was that competitors like J.P. Morgan or Citigroup would tell their clients, “If you want a corporate loan, you have to hire our M&A bankers.” This bundling of low-margin commercial banking product offerings (such as revolving lines of credit) with higher-margin investment banking products (such as M&A work and equity underwriting) threatened Goldman’s most lucrative businesses. In short, the investment banking business was becoming commoditized. In addition, clients put a premium on retail distribution—that is, selling securities to the general public, who were willing to pay ridiculous prices for tech stocks to cash in on the technology boom.

Even before the repeal of Glass–Steagall, in 1997, Morgan Stanley had responded to this pressure by merging with Dean Witter Reynolds. 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 stock brokers serving more than 3 million customers. Dean Witter also owned Discover Card. Generally, white shoe investment bankers often looked down on retail stock brokers, whose alma maters typically were not the elite schools. I remember when the deal was announced, a Goldman associate called his Ivy League business school classmate working in investment banking at Morgan Stanley and teasingly asked him if he could now help him get a Discover credit card. Little did he know that I had worked on a project to evaluate whether Goldman should buy a retail distribution firm or build a scalable internet-based technology platform to access retail investors for distribution.

In the early 2000s Goldman divided most of its M&A department into industry groups. A lateral M&A partner told me that client CEOs couldn’t tell the difference between excellent and average M&A advice or banks’ business practices, but they could tell whether you knew their industry.

Competitive pressures forced Goldman to reexamine and modify its strategy. For example, Goldman redesigned and restructured into industry groups. Industry knowledge was so valued that, for example, I worked on projects evaluating whether Goldman should buy a consulting firm with deep industry knowledge and CEO contacts, or a boutique investment bank focused on an industry-like technology. Goldman also put greater emphasis on expanding its powerful network of key decision makers (CEOs, chief investment officers, government officials, etc.) and on trying to ensure that the relationships and information were highly coordinated and selectively and tactically shared. Access and information were strengths of Goldman’s, as they required a culture of serious teamwork. This was highly valued by clients and a key distinguishing factor in hiring Goldman. In addition, Goldman focused more on coinvesting with clients. A coinvestment relationship was seen to have many advantages, including establishment of a closer relationship than did a merely advisory one.

The industry consolidation brought about in part by the changes to Glass–Steagall resulted in fewer but much larger banks—banks that many would later argue were “too big to fail,” so large that their failure was deemed a risk to the stability of the entire banking system. Another result was that the pace at which these companies now had to grow in order to stay competitive challenged their organizational cultures. Companies growing via acquisition have significant cultural and integration challenges.