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

by Steven G. Mandis

  In 1987 a member of the management committee voiced a common opinion: “Everyone is uncomfortable with the rate of growth. We all feel that if we don’t keep expanding, we’ll lose our position. But if we keep growing at a certain rate, we’ll lose control.”11 As early as the late 1980s and early 1990s, Goldman was having meetings, even hiring a consulting firm, to discuss the consequences of hypergrowth.12 However, Goldman’s growth was phenomenally successful. Earnings nearly doubled between 1990 and 1992, funding the opening of new offices in Frankfurt, Milan, and Seoul. In 1992, the Kamehameha Schools/Bishop Estate, a Hawaiian educational trust, invested $250 million for around a 5 percent stake.

  In 1994 Goldman suffered big trading losses and the unprecedented wave of resignations among the partners that followed, starting with the sudden resignation of then senior partner Steve Friedman, who cited health reasons. Making Friedman’s departure all the more disruptive and unsettling was that it followed Bob Rubin’s abrupt resignation after a short tenure (1990–1992) as co-senior partner with Friedman to become assistant to President Clinton on economic policy. Friedman had refused to accept a co-leader in running the firm and left the choice of successors in the hands of the management committee.13

  Almost every partner I interviewed who worked at the firm in 1994 said that, in hindsight, the sudden departures of Friedman and Rubin, who had been handpicked by Weinberg and Whitehead to lead the firm, had significant unintended consequences for Goldman. Some even believe that the timing, circumstances, and handling of the departures caused a greater impact on culture than the IPO and were one of the main reasons behind the IPO itself.

  The 1994 departures also raised serious issues of trust among the partners. In addition to the senior partner, almost one-third of the other partners retired, giving their capital preferential treatment and more protection than that of the general partners who stayed and allowing the retirees to begin cashing out their capital. The resignations would remove hundreds of millions of dollars of partners’ capital from the firm, requiring a larger influx of new partners than in the past. This situation upset what had been a stable, cohesive group that traditionally had seen just enough partner turnover to balance junior and senior partners. The fifty-eight new partners, the largest partner class Goldman had ever announced, now also formed a large voting bloc on key firm decisions, and they had just seen the firm at its worst with the old partners jumping ship.14

  Discussing the resignation of a senior partner who had been running the financial institutions group and was generally considered one of the most knowledgeable about the financial sector and the firm’s prospects, one partner expressed the sentiment of many of them: “Aren’t these the guys that I’ve been slaving with—not for? I mean really working hard with for a long time, and they are quitting? I don’t get that. How can you leave? I mean, just how does that square? When it gets tough, you are supposed to get tougher.”15

  Based on the accounts of partners at the time, when the old guard—many of them viewed as culture carriers—started bailing and looking out for themselves, it shook the belief in the core values and principles of the firm. The resignations caused people to think more about themselves, their own interests, and their own personal ambitions—and materialism began to grow.16 With Friedman’s sudden resignation and no succession plan, a fierce power struggle ensued, increasing the instability and prompting personal reflection.

  Corzine, a trader in the FICC department who also had a CFO-type role (which at the time was typically the head of fixed income and chief risk allocator), aggressively announced to the management committee that he wanted to be senior partner (and be given the title of CEO) and for Paulson to be the number two, with the title of COO. In recent memory there had always been co-head senior partners, reflecting a culture of teamwork. There were “the two Johns” and then “Steve and Bob.” Many divisions and departments had co-heads. The firm had never had CEOs or COOs (it had senior partners or co-senior partners); the CEO title didn’t make sense in the context of a partnership (it typically was used in public corporations with a hierarchy and organization charts). Although the people with the senior partner titles were everyone’s bosses, everyone on the management committee had a vote, so no one person could dictate.17

  In the end, Corzine got what he pushed for. Paulson did not have enough support on the management committee to push for a co-senior partner role. Some people said it was in part because Paulson was not based in the New York office 100 percent of the time and lacked experience in trading, where the greatest profits and risk were. But the partners I interviewed said that they recognized the need for a balance or compromise between banking and trading (and a few said they needed someone to “watch” Corzine, who they worried could be too aggressive). In hindsight, partners said, the precedent of having no co-senior partner, along with the power struggle, sent a poor message to the troops, especially in view of the defections.

  Interviewees explained that once he became CEO, Corzine convinced some partners to stay, rather than retire, by leading them to believe they would get rich when the firm went public in the near future.18 For a variety of reasons—including alleged promotion promises, guilt, and John L. Weinberg’s pleading—more partners stayed than initially had been predicted. But they told me the trading losses, combined with the defections, dramatically affected the culture.

  In addition to significant trading losses in 1994, throughout that year the firm worked to settle suits with a number of pension funds related to Goldman’s involvement with publisher Robert Maxwell.19 Eventually it was settled for $253 million.20 This cost was borne by those who had been general partners between 1989 and 1991, and the size of this settlement surprised many of them.21 A November 1994 AP article made this prediction: “The general partners may find themselves sitting with a smaller capital account at year’s end than they had starting off. That rude and unfamiliar prospect explains why persistent rumors have been circulating on Wall Street that Goldman’s management has recently put pressure on the firm’s general partners to ante up additional capital. (One partner’s capital account was reportedly wiped out completely.)”22

  Layoffs were announced for traders, analysts, and support staff.23 An unintended consequence was the emergence of “a culture of contingency … a sense not only that each day might be your last, but that your value was linked exclusively to how much revenue was generated for that firm on that day—regardless of its source.”24 Between 1987 and 1994, the firm had downsized six different times in different divisions in response to different earnings.25

  Despite the instability, the partners opposed going public at the time. It was commonly thought, however, that there was an IPO in Goldman’s future: “Down the road Goldman will surely revisit the idea of going public, thereby gaining permanent capital. But Corzine has said that a stock offering isn’t ‘practical’ right now. You need profit updrafts, not downdrafts, to go public.”26 Goldman had been stressed by the events of 1994; it would recover, but the partnership showed signs of vulnerability.

  Goldman’s problems at that time were not related only to costs and “bad bets”; one partner noted, “[A] culture of undisciplined risk taking had built up over many years.”27 That same partner named other “stuff [that] built up,” such as “the lack of a risk committee, trusting individual partners, model-based analytics, [thinking] that by God, you can be smart and figure it all out, and letting traders become too important and being afraid to confront them if they’ve been money makers.”28 When I asked partners about this, they said the statement was probably relative. They admitted that changes in business practices needed to be addressed, but they believed Goldman was still much better than its competitors. And, more importantly, the adjustments to the losses helped Goldman “strengthen” its risk management culture, and that is one reason Goldman did better than its competitors in the credit crisis, discussed later.

  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.”29 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.”30 (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 1996.31 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.”32 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.33 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.34

  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.35 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.36 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.”37 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.”38 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.”39

  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.40 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.41 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.

  TABLE 4-1

  The top eleven: percentages, shares, and value at IPO

  Name Percentage Implied shares outstanding Value at IPO price ($53) First closing price ($70.38)

  Henry M. Paulson Jr. 1.100% 2,915,210 $154,506,120 $205,172,466

  Jon S. Corzine 1.100% 2,915,210 154,506,120 205,172,466

  Robert J. Hurst 1.100% 2,915,210 154,506,120 205,172,466

  John A. Thain 1.050% 2,782,700 147,483,114 195,846,445

  John L. Thornton 1.050% 2,782,700 147,483,114 195,846,445

  Daniel M. Neidich 0.900% 2,385,172 126,414,098 167,868,381

  John P. McNulty 0.900% 2,385,172 126,414,098 167,868,381

  Lloyd C. Blankfein 0.900% 2,385,172 126,414,098 167,868,381

  Michael P. Mortara 0.900% 2,385,172 126,414,098 167,868,381

  Richard A. Friedman 0.900% 2,385,172 126,414,098 167,868,381

  Robert K. Steel 0.900% 2,385,172 126,414,098 167,868,381

  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.