A Harvard Business School case study about Goldman’s training found that Goldman used the Socratic method to explore questions through discussion and debate. One senior manager described a typical discussion: “That was a good argument. But next time, it would actually be really interesting if you also added these three things.”36 One partner expressed his delight in this learning environment: “Goldman Sachs when I started was a fantastic place to be planted and grow. They treated me the right way, encouraged me the right way … It’s a Socratic, collaborative style. Bouncing things off of each other is fun, and you encourage that at every turn.”37
According to a former management committee member, the dialogue was predicated on collaboration: “We were always taught that the odds are high you’ll have better outcomes with a shared work effort than with that of a single individual. At Goldman Sachs it’s pretty rare that an additional perspective doesn’t give you a better outcome. As problems become more complex, the ability for a single individual to have the best perspective declines dramatically.”38
David Stark, a Columbia University sociologist, argues that dissonance, or friction, over competing values promotes an organizational reflexivity that makes it easier for a company to change and deal with market uncertainty.39 Dissonance prevents groupthink: what happens psychologically when a group is so concerned with maintaining unanimity in the face of opposition that alternatives and options fail to be identified or properly evaluated.40 Stark notes that dissonance can become resonance, a “dangerous form of cognitive interdependence,” when too many people overlook a key issue, giving “misplaced assurance” to those who think similarly.41 A partnership structure seems to mitigate against this phenomenon in part because of the financial interdependence and social network of trust among partners. One researcher explained this effect well in describing the era of the private investment banking partnerships as one in which “no one could take excessive risk with the firm’s capital, because of the vigilance of the partners. If Partner A wasn’t comfortable with a new business or a new client, Partner B would have to convince him of the merits of the business—and to do so, partner B would have to go well beyond the argument that it would generate a lot of short-term fees.”42
Stark points out that the “ability to keep multiple evaluative principles in play and to exploit the resulting friction of their interplay” is a competitive advantage. Organizations typically try to avoid the perplexing situations that arise “when there is principled disagreement about what counts,” when, in fact, they should embrace such situations and “recognize that it is legitimate to articulate alternative conceptions of what is valuable, what is worthy, what counts.”43 Partners I interviewed generally agreed that this is a good description of the productive dissonance that characterized Goldman’s partnership culture model.
Goldman excelled at adapting to change and dealing with market uncertainty not so much because of specific individuals but because the organization’s partnership structure and culture sustained ongoing and productive discussion and disagreement. Stark notes that when faced with uncertainty, “instead of concentrating their resources for strategic planning among a narrow set of senior executives or delegating that function to a specialized department, heterarchical firms [flat organizations or those with a limited hierarchy] embark on radical decentralization in which every unit becomes engaged in innovation.”44 Therefore, hierarchical firms—those with a long chain of command—are less supportive of innovation and entrepreneurship. Dissonance—supported by the flat organizational structure that facilitated interaction and information transfer, and the financial interdependence of partnership that fostered trust and aligned interests—gave Goldman a significant competitive advantage. Based on my interviews, dissonance of this degree did not exist at most Wall Street firms, because there was no financial interdependence, earnings were distributed, or the partnership was dominated by a few individuals, decreasing the financial interdependence. Goldman’s culture of debate took on special significance during the credit crisis, as discussed in a later chapter.
If dissonance encourages entrepreneurship, innovation, or flexibility in meeting competitive pressure, why was Goldman in the 1980s not considered innovative? For the most part, Goldman had a long history of watching and waiting while others did the innovating; then it moved in with an improved or enhanced version. Whitehead said, “[As] far as new products were concerned, I never felt that we had to be first when we did something. We had a reputation for being absolutely first-class in everything we did, but we didn’t have to be first with every idea. In fact, I enjoyed it when our competitors had the new idea and tried it out first.”45
Whitehead pointed out to me another reason Goldman was not the first to innovate: constrained capital limited what the firm was willing and able to do, something that changed as it first began raising more outside capital and then accelerated when it went public. It took bigger financial risks and grew more quickly. When I discussed innovation with partners and competitors, most said they did not see Goldman as an innovator in the 1980s and early 1990s, but they thought that dissonance added to the firm’s superior financial and competitive performance and allowed it to get to the best answers for the firm and for clients.
When I asked Whitehead about the perception of Goldman in the 1980s of not being an innovator, he pointed out a nuance that many people were missing: Goldman’s strength was not a matter of investing in and potentially taking new risks by developing new products per se. Instead, its strength lay in the ability for people to come together as an organization to figure out how to change and adapt and market products that were better for clients, no matter who created them. To Whitehead, that practice was as innovative as developing products or investing in innovations that might not work or benefit clients—but much harder to execute because of the barriers to getting people to work together, and a lot less risky.
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. No matter the hour, you can get a partner or junior person on the phone to help you think about a problem or speak to a client. That was true when I was at Goldman, and my interviews confirm it is still the expectation.
Many people from other firms were (and are) shocked at the speed and amount of information shared, often mentioning their need to adjust to Goldman’s urgent voicemail (e-mail) culture.
Financial Interdependence and Risk Management
As a private partnership, if Goldman suffered large trading losses, lost a lawsuit, or received fines for criminal or illegal practices, then the partners were personally liable. Their equity was at risk every day. Even with the protection afforded personal assets by the LLC structure, which Goldman changed to in 1996, partners still faced the risk of losing their invested capital, which for many represented the bulk of their wealth.46
When one’s own money is at stake, management of risk, both financial and reputational, is a key concern.47 According to the partners I interviewed, managing risk for one’s entire net worth, and that of all the partners, brings a higher level of intensity than managing risk for shareholders and a longer-term orientation than today’s typical three-to-five-year equity vesting period. That is pro
bably why, in Goldman’s own accounts of its culture, risk management often is not included: it was so obviously a no-brainer that it was assumed.48 As mentioned earlier, Peter Weinberg stressed this issue in his Wall Street Journal op-ed, “right down to their homes and cars,” noting that “[t]he focus on risk was intense.”49
The firm’s culture and principles, combined with the partners’ financial interdependence and the risk to their own capital, ensured that collective risk management and reputational risk management would be a priority. The structure of Goldman’s pre-IPO partnership resulted in financial interdependence and a social network of trust, virtually ensuring teamwork and dissonance; in turn, the business practices, policies, and values supported it.
Part Two
DRIFT
Chapter 4
Under Pressure, Goldman Grows Quickly and Goes Public
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.1
Congress passed the Glass–Steagall Act (formally known as the Banking Act of 1933) to provide Depression-era deposit bank customers protection against the additional risks involved in trading and investing.2 Its intent was to separate the consumer deposit–based commercial banking industry from investment-banking activities by prohibiting well-capitalized commercial banks from getting involved in the securities business. It also had the unintended effect of protecting the profitable underwriting business of the investment banks.3 The act explains why both a J.P. Morgan and a Morgan Stanley now exist.4 J.P. Morgan had to spin off its investment banking business, creating two entities: J.P. Morgan became the commercial bank, whose business was deposits and lending, and Morgan Stanley was spun off as the investment bank, handling the securities and underwriting businesses.
However, in 1999 the act was repealed. Such deregulation and other external pressures—such as competition and technology—as well as pressures from within the organization, had a transformative effect on how Goldman did business and on the organizational culture. From then on, Goldman had to compete more vigorously for scarce resources—capital, talent, clients, reputation, and more—against larger, publicly traded competitors (discussed later). In addition to having limited personal liability or capital constraints, these publicly traded competitors had more, and permanent, capital and didn’t espouse the same business principles or have the same financial interdependence.
These combined pressures had one major effect: the leaders of Goldman felt that the firm needed to grow—and grow fast.
I have had lengthy, spirited philosophical discussions with Goldman and McKinsey partners about growth. Growth in itself is not a bad thing. But as Goldman navigated its environment, the rapid pace of its growth had dramatic (and often unintended or unanticipated) consequences—many of which were not fully understood inside the firm or out—and they compounded over time. In essence, Goldman’s response to the various pressures in a dynamic environment—in particular, rapid growth—made it even more difficult to notice that the firm was drifting away from its traditional interpretation of its principles. The rapid growth, combined with multiple, conflicting organizational goals, resulted in a series of many small everyday decisions happening so quickly that most people didn’t notice (or were too busy to notice, or didn’t care).
Regulatory Pressures
A great many rules and regulations govern banking in the United States: the Glass–Steagall Act, the Sarbanes–Oxley Act, exchange rules, and so on.5 I focus here on the key regulatory changes that had a particularly strong influence on Goldman.
Public Trading of Investment Banks in 1970
Even before the repeal of Glass–Steagall, Goldman was facing increasing competitive and other pressures, and those combined pressures led ultimately to the decision to go public, which the partners voted to do in 1998, before the act’s repeal (the IPO didn’t actually happen, though, until 1999). Much emphasis has been placed on how the IPO affected Goldman’s culture, and that’s true, but the organizational drift had started well before that. Goldman had been feeling the increasing heat of competition and other external forces for years.
The public listing of investment banks is a relatively new development. Investment banking, for most of its history, was conducted by firms organized in partnerships. But before the 1970s, some partnerships decided they wanted to go public to raise capital, reduce the risk of loss of partner capital, and improve liquidity, sparking a significant change in the organizational structure of the banks.
In 1970, the NYSE repealed provisions that had prevented publicly listed companies from being members of the exchange, and the floodgates opened. That year, Donaldson, Lufkin & Jenrette was the first to list on the exchange, with Merrill Lynch, Reynolds Securities, and Bache & Co. following in 1971. Salomon Brothers listed a decade later, and Morgan Stanley went public in 1986. Goldman, in 1999, was the last major full-service investment bank to be publicly listed.6
Goldman followed much later for two key reasons: first, unlike most of the others, it had no retail banking business, wherein banks deal directly with consumers on smaller transactions like mortgages and personal loans rather than big institutional clients or corporations executing large transactions. Second, Goldman didn’t distribute the firm’s profits to partners annually, as the others did. The differences between Goldman and the others were illuminated by a 2004 study by Alan Morrison and William Wilhelm Jr.7 In the decade before the banks started to go public, because of increasing technological and regulatory pressure to scale up (an example of the interrelationship between these pressures), those with retail business units increased the number of partners, the capital employed per partner, and the number of employees per partner, according to the study. They also needed to raise considerable sums to invest in computers and data management technology to facilitate faster handling of administrative activities to support the smaller size, but higher volume, of transactions.
Going to the market (to the outside equity capital markets or private investors) to raise this cash was considered the best, if not the only, option. Without outside capital, the only ways to infuse new capital into a partnership were to admit more partners or to increase the amount of capital contributed by each new partner (while balancing the retiring partners’ capital withdrawals). Each approach has limits. Also, because these banks typically distributed their profits to the partners annually, they had less capital to work with. Going public offered the cheapest cost of capital, because equity investors in the public markets were willing to receive a lower return on their capital, in part because their investments are so liquid, than private equity investors. But it was appealing for one other crucial reason. Under a partnership model, all partners are personally responsible for all the firm’s liabilities. As a public corporation, it is all of the shareholders who are liable (and liability is not personal liability).
According to interviews I conducted, Morgan Stanley had no retail banking at the time, but it generally distributed a meaningful portion of its profits to partners annually, and this meant that it faced pressure to go public earlier than Goldman. As a Goldman partner explained to me, because Goldman required partners to keep their capital in the firm until they retired, the firm had more capital to invest to stay competitive.
In 1986, when Morgan Stanley went public, Goldman had about $1 billion of equity capital, twice that of Morgan Stanley. Even so, the competitive and other pressures were such that the Goldman partners gave consideration to an IPO at that time. The first serious proposal to go public was presented by the management committee at Goldman’s partnership meeting that year. It was championed by Bob Rubin and Steve Friedman, who at the time were on the management committee, and it was met with serious opposition from the partners. John L. Weinberg distanced himself
from the proposal, remaining silent during the meeting. After Jimmy Weinberg spoke against it in the meeting, it was not brought to a vote.8
Although the proposal was set aside, it was clear from the meeting that Goldman’s decision to expand to pursue a global business strategy “placed additional capital pressures on the firm, making its remaining a partnership less and less feasible.”9 In my interviews, however, some partners said the firm had enough capital at the time to fund international expansion, albeit at a slower pace, or that it could continue to take outside private capital. Although outside private capital was more expensive than capital from the public markets, it would allow the firm to stay a private partnership.
Ultimately in 1986 the partners decided to accept a $500 million private outside equity investment from Sumitomo Bank in exchange for 12.5 percent of the firm’s annual profits and appreciation of equity value. The deal with Sumitomo was appealing because, according to the terms of the deal and the Bank Holding Act of 1956’s preclusion, Sumitomo could not have any voting rights or any influence over the firm’s operations.10
Goldman was growing rapidly in both size and complexity at this time. The firm ballooned from a few thousand people in a few offices in 1980, to thirteen thousand at the time of the IPO, with much of that growth overseas. At the time Whitehead codified the firm’s values, Goldman’s business was entirely within the United States. It was strictly a New York firm. By 1996, international employees constituted 35 percent of Goldman’s workforce. Further, the total number of international employees was now larger than the total number of employees in the previous decade.
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