For example, Peter Weinberg, who is the grandson of senior partner Sidney Weinberg and nephew of senior partner John L. Weinberg, and is a former Goldman partner, made a proposal in a September 2009 Wall Street Journal op-ed that focused on incentives. He proposed a “10/20/30/40” compensation plan under which “junior employees would receive regular competitive pay, but senior employees would be paid as follows: 10 percent of annual compensation in cash now; 20 percent of annual compensation in cash later; 30 percent of annual compensation in stock now (with a required holding period); and 40 percent of annual compensation in stock later.” Now means immediately at the end of a compensation period. Later means after a period during which a cycle can be evaluated and the award maintained or adjusted accordingly. The other main aspect of his plan was that the people who manage trading or asset management businesses should have some of their own capital at risk in the business. Weinberg’s proposal is based on the premise that success should be viewed in hindsight and wealth creation should occur on the back end, to ensure that “through-the-cycle compensation [is] linked to through-the-cycle value creation. Requiring those who manage a business or fund to have some of their own money invested in it would “better align the pocketbooks of Wall Street with the pocketbooks of financial markets and our economy.”6
Assuming that the banks won’t be broken up or forced back to private partnerships, I would suggest examining ideas on locking up capital for longer similar to Peter Weinberg’s, but perhaps complementing them with a greater emphasis on organizational elements. I would examine some sort of quasi partnership-partner compensation plan with an election for banks.
A partnership compensation plan could offer a degree of financial interdependence if it had a greater emphasis on fixed percentages of profits versus discretionary compensation for those in the partnership plan. That might lead the partners to place a greater emphasis on the whole enterprise than on themselves or their group. Financial interdependence and personal liability—forcing those in the partnership to disproportionately share in fines, settlements, compliance or risk management failures, or certain losses with shareholders—might make risk management and ethical standards a higher priority and reemphasize a social network of trust while creating an environment for dissonance.7
In discussing the ramifications of the personal liability of executives having been limited, a retired Goldman partner rhetorically questioned, why is it that when one person or a handful of senior persons at the firm does something bad that costs the shareholders and possibly puts the public at risk, that one person gets fired (maybe with some clawbacks of compensation) but the managing directors of the entire firm don’t have their compensation significantly affected? Another person I interviewed suggested that if Goldman partners collectively had to disproportionately pay the $550 million settlement with the SEC out of their bonus pool, or if J.P. Morgan had a partnership structure and the partners together had to disproportionately pay the losses from the “London whale,” perhaps they collectively would take stronger action to prevent such behavior. He pointed out that when Goldman paid settlements related to Robert Maxwell, all the partners paid, not just the one responsible for the relationship, and the firm went back retroactively to those who were partners at the time for payments. Enacting individual clawbacks that hold one person accountable has taken away the emphasis on organizational elements of financial interdependence and social networks of trust by which the executives could be holding each other accountable and self-regulating.
Some critics of the banks have suggested that bankers who do not like the idea of increasing their personal liability or risk “should look at the portraits on the wall of their predecessors who, as partners of the very same firms, worked and prospered under such a personal liability rule every day of their lives.”8
The regulatory focus on the banks has been on quantifiable and measureable factors like minimal capital requirements and certain business restrictions. These are important; however, they alone will not address the issues of the banks, including Goldman. This may be in part because these regulations typically have some ambiguity and motivated organizations with a certain culture can seek to circumvent the spirit of the regulations.
As I mentioned before, this study is much more than a case study on Goldman, or even systemically important, publicly traded banks. It has much broader implications for organizations generally. This sociological study opened my eyes to the organizational elements as they relate to a culture and the importance of understanding them as they relate to organizational, competitive, technological, and regulatory pressures. The organizational elements help form the culture, the incentives and behavior—they can help a firm be “long-term greedy.” In addition, organizational elements can help constrain or manage organizational drift.
Lessons Learned
As I consider what I’ve learned about Goldman, and the sociological theory that supports my analysis and conclusions, I am mindful that this book has implications that resonate beyond Goldman. 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. A firm should determine its own basic set of nonnegotiable values, the minimal constraints. Leaders, not just boards of directors, should look to the meaning of a firm’s principles to define corporate ethics and guide employees’ actions, and try to determine objective ways in which to check deviations from the original meaning (for example, attrition rates, independent client interviews, independent exit interviews with departing employees).9
Social networks can create competitive advantages and improve performance. An organization should consider creating some sort of partnership or sharing that is bound by financial or other interdependence and focus on improving the trust among the group members through socialization. The election or promotion into a leadership group should put a greater emphasis on culture-carrying qualities in the process.10 Leaders and board members should also monitor changes in the nature of the members of the group, cognizant that they can have an impact on the social network.
Financial interdependence is important as a self regulator. Leaders’ compensation should be based more on collectively generated profits and culture carrying. Leaders should disproportionately and jointly share in fines, settlements, and other negative consequences out of their compensation plan or their stock. Meaningful restrictions on leaders’ ability to sell or hedge shares should be imposed, which can lead to better self regulating and longer-term thinking.
Public disclosure supports an organization’s values and strengthens the organization itself. An organization should consider making personnel decisions more public. When people are dismissed or specifically not promoted because of bad behavior, it should be more public. There is a value to having public signals when behavior is not acceptable. Conversely, culture carriers, those that represent the values, even if they may not be the firm’s biggest revenue producers, must be promoted as a signal of what’s important.11
Generating dissonance or perplexing situations that provoke innovative inquiry can create competitive advantages and improve performance. Having some sort of interdependence should help create an environment that supports discussion and debate. Complementing this debate is balance between groups. Getting the input of leaders from different areas or regions, who have worked together and have good working relationships, is also important in encouraging dissonance. At the board level, in many situations, an independent lead director or independent chairman can add to dissonance.
A sense of higher purpose, beyond making money in a materialistic society, can help people make sense of their roles. A firm needs to give employees a clear understanding of its values, its social purpose, and its sense of responsibility. However, leaders need to be conscious of not using the good works of their employees or of the firm to rationalize behavior that is inconsistent with its pr
inciples.
An organization’s culture is transmitted from one generation to the next as new group members become acculturated or socialized. It is crucial to recruit people who have the same values and socialize them into the firm’s culture. Even if this restricts growth in the short run, it is important not to undervalue recruiting, interviewing, training, mentoring, and socializing. This is also very important in international expansion.
Organizational exceptions may address short-term issues but may cause long-term ones. Early promotions and outsized compensation can indicate that a firm is a meritocracy, but they can also encourage behavior inconsistent with principles. Leaders need to be cognizant that sometimes letting top performers go, if they do not have a long-term perspective and buy into the system, may be better for the overall organization in the future.
The ability to make rational decisions is limited, or bounded, by the extent of people’s information. To broaden employees’ understanding, a firm should promote a tradition of teamwork and interdependence and develop future leaders by rotating them among work assignments in different departments and geographic locations. In order to reduce structural secrecy, there may be short-term opportunity costs, but the long-term benefits are significant.12
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. Potentially conflicting or confusing organizational goals, such as putting clients first while also having a duty to shareholders, require strong signals from leadership as to what is acceptable and unacceptable behavior. These nuances cannot be left to statements of principles; they must be modeled by leaders’ actions each day.
Leaders must understand that external influences can shape the culture. For example, there are competitive, technological, and regulatory pressures. Responses to them can have unintended consequences, including drifting from principles. This can increase the probability of an organizational failure.
An organization needs to understand to what extent models impact behavior, decisions made by business leaders, and organizational culture. For example, boards of directors of public companies should ask questions if earnings per share (EPS) estimates are too consistent with analysts’ estimates. They should ask whether the firm is managing to models or to what is in the best long-term interests of the firm.
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.13 But too little emphasis is given to the organizational elements that shape behavior or provide an environment for leadership or change.
An organization’s structure, incentives, and values last longer and have more impact than those of individual leaders. Usually when there is a change or loss or failure there is a tendency to blame one thing or one person, when typically there are complex organizational cultural reasons. It is the duty of leaders and board members to examine what is responsible, not who is responsible.
One of the most difficult issues in guarding against organizational drift is that adaptation is critical to the survival of an organization, and the difference between healthy adaptation and organizational drift is very, very difficult to discern. And when a business appears to be successfully reaching its organizational goals, it is especially challenging, and most likely unpopular, to start questioning whether the culture has drifted. What is the incentive to do so? But it may be precisely at this time that changes may be occurring that are setting a firm up for failure. Leadership requires a “curiosity that borders on skepticism” and that “questions are answered with action.”14 Examining your own organization will be messy, but I hope the observations from sociological analysis outlined in this book will provide useful guidelines and inspire the risk taking required to tackle the challenges.
Appendix A
Goldman and Organizational Drift
Ship captains set out an intended course and use sophisticated tools for navigation to constantly revise their speed and direction based on an analysis of the external conditions under which they’re sailing. They know that otherwise, no matter how carefully they aim the prow of the ship when they leave port, the cumulative effect of ocean currents and other external factors over long periods will cause the ship to veer off course.
Organizational drift is akin to that deviation from an intended course; it’s the slow, steady uncoupling of practice from original procedures, principles, processes, and standards or protocols that can lead to disasters like the space shuttle Challenger explosion or the Black Hawk shoot-down incident in northern Iraq. As Harvard Business School professor Scott Snook argues, detecting organizational drift requires a sensitivity to the passage of time; single snapshots won’t do.1
To understand what’s happened to Goldman since the writing of the business principles in 1979, then, we have to look back to its performance over time, how its interpretation of the principles has changed, and the conditions in which it operates. But before we get to that analysis, it’s worth developing a deeper understanding of organizational drift and its implications.
Drift into Failure
Sidney Dekker, a professor who specializes in understanding human error and safety, has used complexity theory and systems thinking to better understand how complex systems “drift into failure” over an extended period of time. His theories are worth exploring because they, and the ideas of other researchers, provide us with a clear understanding of how systems interact and drift away from intended goals. In some cases, this can end in disaster. In the case of Goldman, it means that there’s a distinct gap between the principles by which the firm purports to steer itself and what it’s actually doing in the world.
Earlier theories, Dekker argues, have been tripped up by their tendency to explain instances of failure in complex environments by blaming flawed components rather than the workings of the organizational system as a whole.2 Dekker concludes, by contrast, that failure emerges opportunistically, nonrandomly, from the very webs of relationships that breed success and that are supposed to protect organizations from disaster. Dekker also observes that systems tend to drift in the direction of failure, gradually reducing the safety margin and taking on more risk, because of pressures to optimize the system in order to be more efficient and competitive.
We are able to build complex things—deep-sea oil rigs, spaceships, collateralized debt obligations—all of whose properties we can understand in isolation. But with complex systems in competitive, regulated societies—like most organizations—failure is often primarily due to unanticipated interactions and interdependencies of components and factors or forces outside the system, rather than failure of the components themselves. The interactions are unanticipated, and the signals are missed. Dekker points out that empirical studies show that reliable organizations with low failure rates tend to have a distinct set of traits: safety objectives and a safety culture promoted by leadership, appropriate internal diversity to enable looking at things from multiple perspectives and deploying a variety of responses to disturbances, redundancy in physical and human components, decentralization of safety decision making to enable quick responses by people close to the action, and the ability to continually and systematically learn from experience and adapt. The attitudes in such a safety culture include a preoccupation with avoiding failure, reluctance to simplify, deference to expertise (while recognizing the limits of expertise), sensitivity to operations (with vigilant monitoring to detect problems early), and suspicion of quiet periods. Last, Dekker recommends that when investigating why a failure occurred, we need to remember that what appears clearly wrong in hindsight appeared normal, or at least reasonable, at the time, and that abnormal data can be rationalized away by participants. As investigators of system failure we need to put ourselves in the shoes of the people who were involved.
Dekker argues that drift is marked by small steps. He puts it like this: “Constant
organizational and operational adaptation around goal conflicts, competitive pressure, and resource scarcity produces small, step-wise normalization. Each next step is only a small deviation from the previously accepted norm, and continued operational success is relied upon as a guarantee of future safety.”3 Of course, not all small steps are bad. They allow complex systems to adapt to their environment, producing new interpretations and behaviors. It’s important to remember, too, that the steps are small. “Calling on people to reflect on smaller steps probably does not generate as much defensive posturing as challenging their momentous decision.”4
Dekker explains that organizations also drift due to uncertainty and competition in their environments. Organizations adapt because of a need to balance resource scarcity and cost pressure with safety. Resources to achieve organizational goals can be scarce because their nature limits supply, because of the activities of regulators and competitors, and because others make them scarce.5
What about the protective infrastructure that is designed to ensure against failure? Dekker warns, “Complex systems, because of the constant transaction with their environment (which is essential for their adaption and survival), draw on the protective structure that is supposed to prevent them from failing. This is often the regulator, or the risk assessor, or the rating agency. The protective structure (even those inside an organization itself) that is set up and maintained to ensure safety is subject to its interactions and interdependencies with the operation it is supposed to control and protect.”6
Interestingly, the protective infrastructure, with uncertain and incomplete knowledge, constraints, and deadlines, can contribute to drift—as well as failing to function when it should.7 Its functioning or lack thereof is legitimized.
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