This policy changed slowly in the mid- to late 1990s as talented people left for tech firms or hedge funds and, later, regretting the move, wanted to return. Goldman was desperate for talented people, and in many instances made a “bid to match or top” the offer from competitors to keep them. By the time I left banking, there had been several exceptions to the “no rehire” rule. One of the more visible cases was Michael Sherwood, known internally as Woody, currently vice chairman and co-CEO of Goldman Sachs International. He left for a few weeks in 1994 before quickly changing his mind and returning to the firm.
As one partner explained, in the 1990s the bids to keep people were another example in the changing culture. Some employees had come to believe they needed to produce an offer from a competitor and have Goldman match or top it; otherwise, they would be lost in a crowd of many talented people. Those who were good soldiers—formerly viewed as important role models (because they didn’t complain, worked hard, didn’t politick or lobby for promotions or compensation)—were now considered either naive or not desirable enough to get another offer.
An example of the change was John Thornton, who was quoted in the New York Times as saying he would consider going to work at Lazard, a competitor, but “only for the top job.” At the time, a Goldman banker being singled out or quoted in the press was highly unusual, possibly a reason for getting fired, much less what was generally interpreted as public negotiation for a promotion. But surprisingly, there were no visible repercussions, and, in fact, Thornton would become copresident, which signaled that something had changed.32
Changing Compensation and Promotion Practices
When I started at Goldman, compensation and promotion were handled by class, according to the year one graduated from business school and started at Goldman. The vast majority of a class (I would guess 90 percent) was paid within a tight range. Associates in banking got bonuses that increased by about $100,000 per year; the range was less than 10 percent to 25 percent when I started. As competitive pressure to retain people increased and there were large differences in backgrounds, the ranges expanded. According to interviews, the original 90 percent had dropped to 75 percent, and the range was more like 25 percent to 100 percent. The goal was to retain and reward people, but the changing ranges also reflected the fact that the quality of the talent, which was very consistent across a class when I started, now varied more widely as more people were hired.
The way the partners were compensated also changed. I was told that in the 1980s partners were generally paid by class, according to the year they were elected. If two people were elected partner—one in M&A and the other in IT or operations—I was told they generally made the same amount at least in the first few years, because the attitude was that everyone worked hard and contributed, and, to succeed in IT or operations, a person had to be truly exceptional. But this changed over time. Steve Friedman and Bob Rubin tied partner compensation more closely to performance in the early 1990s. Also, to strengthen the link, to extend the policy to other employees, and to create a new source of developmental feedback, Goldman instituted 360-degree performance reviews in the early 1990s.
Promotions to partner typically were made a certain number of years after business school; usually it took eight to ten years after business school before someone was up for partner. Exceptions had often been made in trading. The rationale was that traders made enormous sums of money for the firm and possessed a specialized skill that was transferable to any firm (a hedge fund or another bank). Not so for bankers, whose only choice upon leaving Goldman would be to work for a competing firm, which would be a step down in social prestige. Traders did not care as much about prestige and could work at hedge funds or start their own, so exceptional traders began to make partner early. (One of the most notable exceptions was Eric Mindich, who ran equity arbitrage proprietary trading and made partner at the age of twenty-eight.)
The new attitude began to seep into other areas and then into banking. The idea that Goldman had stars and had to promote them earlier or compensate them differently set into motion a different dynamic. Some partners told me there was a deliberate effort to make exceptions and make a few people partners early, thereby creating more incentive, demonstrate a meritocratic culture, and drive people harder.
I see now that the changes—in compensation and in promotion—represent a fundamental shift in the 1980s’ practices of the firm.
Lateral Partner Hires from Other Banks
When I started at Goldman, it was unusual for the M&A department to hire senior bankers from other firms laterally, because, as I was told at the time, their deal experience, training, habits, and sacrifices would not be on par with those of their Goldman peers. When I was an analyst in the early 1990s, I remember a department meeting to discuss hiring an exceptional associate from another firm—a meeting of the entire department about one associate lateral hire. In contrast, by the time of the IPO, when the firm hired three outside senior M&A professionals as partners there was no department meeting to discuss it, even though Goldman probably had fewer than a dozen M&A partners worldwide.
As the firm grew, it needed more partners. It also needed to replace pre-IPO partners who wanted to “take the money and run—I mean, retire,” in the paraphrased words of one partner I interviewed. Goldman especially needed partners in FICC and in proprietary investing areas where it seemed there was tremendous growth, but a disproportionate percentage of partners retired and sought to start their own investing businesses. The IPO provided the currency to attract people from competitors. Goldman had hired laterally before, as it did with a few trading partners from Salomon Brothers in 1986, but this was a deviation from the norm.
The lateral partner hiring accelerated after the IPO. When I was in FICC, I noticed that several lateral partners were brought in at senior positions to replace departing pre-IPO partners.
Turnover Increases
In the early 1980s, Goldman’s staff grew at an annual rate of approximately 8 percent. Over 90 percent of the new growth came from entry-level hires, such as analysts from college and young associates out of business school.33 During the 1980s, annual turnover averaged only about 5 percent compared to typical turnover rates in the industry of approximately 20 percent. In the mid-1990s, however, Goldman’s annual turnover rate rose to between 20 and 25 percent.34 From 1994 to 2000, the firm’s staff grew from about 9,000 people to close to 22,000, an annual growth rate of over 20 percent. At the time, it was estimated that the majority of employees had been with the firm for less than three years. Most of the partners I interviewed said that this issue was often discussed at the senior level. However, growth was viewed as imperative to the survival of the firm, and the increased turnover impacted culture and morale, and most of the partners I interviewed said this issue was discussed at the senior level. But the argument was that the increase was primarily due to the growing allure of hedge funds, private equity firms, and technology companies—not as much about Goldman itself. Goldman adjusted its practices and hired more people to compensate for losing more people.
Recruiting and Hiring
Many partners with whom I spoke thought Goldman has been much better than most firms in terms of senior commitment to recruiting. They also pointed out that Blankfein and Cohn have been very active in recruiting at all levels. When I interviewed executives at other firms, most agreed that it was less common for one of their managing directors to attend a recruiting event on a college campus, while at Goldman it is more common. Executives at competitors felt it didn’t impact their promotion or pay, they explained, and their behavior reflected that lack of incentive. Managing directors were expected to produce revenues, and that was what drove their performance evaluations. A few who worked at larger investment banks that participated in industry consolidation also explained that they were unsure of the value proposition they were presenting and didn’t want to sell something they didn’t believe in. Before the mergers and consolidations, they felt as if their
firms had distinct reputations and cultures; today, they think their reputations and cultures are muddled.
Despite Goldman’s typically stronger commitment to recruiting, the quick pace of growth leading up to the IPO did result in more lenient hiring policies and less mentoring due to the larger number of new employees. When I was sent to Hong Kong to help build the M&A department, I was told I was chosen in part because of my technical skills and entrepreneurial spirit. What I quickly found out was that they should have sent someone with a human resources background. I spent half of my time interviewing people. We hired and grew at such a pace that it was challenging to keep up. Many of the people we hired would probably not have been hired at that level in New York.35 But there was fierce competition for candidates who had language skills combined with top American MBAs.
One time I played a practical joke on an associate in Hong Kong who was originally from the New York office. We were interviewing a candidate who had grown up in China and had just graduated from an Ivy League school. Her family had made enormous sacrifices for her education, and she was an excellent candidate. The associate left on vacation, and while he was gone, we wound up hiring her. She was ensconced in a cubicle with a nameplate on the outside. (Analysts and associates worked in cubicles and vice presidents and partners had offices.) The morning the associate was due to come back from vacation, I took the new analyst’s name plate off the cubicle wall and put it on the door of an empty vice president’s office. When he walked in, he noticed the nameplate and asked what it was doing on a vice president’s office. I explained that, although she had never worked before, there was tremendous competition for her and Morgan Stanley had offered her a VP position, so HR agreed to match their offer. The associate went nuts and started to march down to the head partner’s office to complain before I stopped him and confessed. But we were so desperate for talent, my practical joke was believable. The increased demands for talent and increasing competition for the best talent available raised further cultural issues regarding hiring standards and to what extent a value fit was considered in the selection process.36
All of the new hiring further taxed the social network of trust. One investment banking partner explained that once he had his stock, he did not care as much if the traders wanted to bring in “rainmakers” from “second rate” firms, even if they didn’t fit the culture. During the mid- to late 1990s, he explained, the firm gave up on making sure each lateral hire was a perfect cultural fit and a confirmed success, even in banking. Many of the new people would eventually adapt to the culture, add new ideas, add new businesses, add new relationships, and make significant contributions, but some would fail miserably. The “dilution” in culture and quality of people, as he called it, was just the “cost of the pace of growth.”
Socialization of New Employees in International Offices
When I started at Goldman in the early 1990s, there was an unwritten policy that to grow internationally the firm would generally hire foreign students at top American business and law schools, require them to stay in New York for a year to get socialized to the culture of Goldman, and train them to go to a foreign office. At the same time, American vice presidents (even those lacking foreign language skills) who had been at the firm for a decade and were considered culture carriers were often sent to international offices along with junior employees for a rotational period, with the goal of maintaining a cohesive network and continuing the socialization process.
But international growth accelerated, and regulatory, competitive, organizational, and technological changes put pressure on the policy. For example, in Europe, economic unity and the use of a common currency allowed massive consolidation of banks, which thereby became more competitive with Goldman across Europe. European banks also began setting up large presences in the United States. So the training and socialization period was changed from one year to six months, and then to a few weeks, and finally to none; new hires would finish their training and immediately be sent abroad. Over time, the visiting American partners, who were there to help in part with the socialization process, were resented for taking partnership slots and Super League clients from locals. According to interviews, many of them, seen as out of touch with local customs and values, were marginalized, and, with no opportunities back in New York, many of them left.
Staple Financing
Staple financing is a prearranged financing package offered by investment banks to potential bidders during an acquisition. Financing terms are literally stapled to a deal’s term sheet in the context of a structured deal. Essentially, a firm advises a company on its sale and also provides financing to the buyers. So the firm plays two roles. Typically banks argue that staple financing creates for sellers a convenient negotiation floor.
Goldman has used staple financing successfully, but the practice raises ethical issues. Clearly, the practice carries the potential for conflict by casting the investment bank in dual roles, on opposite sides of the table.37 (In fact, it was one of the practices identified by the business standards committee in 2011 for review.)
One case that focused critical attention on staple financing involved the 2005 acquisition of Toys “R” Us by a club of private equity sponsors. Credit Suisse First Boston (CSFB) advised the group of buyers, led by Kohlberg Kravis Roberts (KKR). When CSFB first raised the possibility of offering a staple financing package to the KKR-led group and other potential bidders, the Toys “R” Us board objected and insisted that the bank not discuss potential financing until a merger agreement was in place. Once there was an approved merger agreement between Toys “R” Us and the KKR-led buyers, CSFB again asked permission to finance the buyers, and Toys “R” Us agreed. Consequently, CSFB earned $10 million in financing fees in addition to its $7 million sell-side advisory fee.38
The public stockholders of Toys “R” Us made the staple financing an issue when they challenged the proposed acquisition. The Delaware court that heard the matter did not find any impropriety but commented on the “possible perception that CSFB’s advice to the seller throughout the auction process was tainted by a desire on the part of CSFB to obtain additional fees from financing the successful bidder.”39 Although the court did not find that CSFB acted improperly, it cautioned, “[I]t is advisable that investment banks representing sellers not create the appearance that they desire buy-side work, especially when it might be that they are more likely to be selected by some buyers for that lucrative role than by others.”40 Goldman also was the sell-side adviser in another deal involving staple financing—the sale of Neiman Marcus in 2005—that became the subject of a Harvard Negotiation Law Review case.41
Goldman’s decision to accept the practice is yet more evidence of its shifting culture resulting from various pressures, even though it did so “carefully and reluctantly and with the right disclosures,” according to a partner I interviewed. A business standards committee report in 2011 stated, “Goldman Sachs will carefully review requests to provide staple financing when IBD is selling a public company. This review will occur as part of the firm’s customary staple financing approval process.”42
Changes in the Business Mix
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.
Trading Becomes a Dominant Percentage of Revenues
Goldman already had leading market share in M&A and most areas of high-value-added investment banking, so the tremendous opportunities for growth, profits, and returns were in trading. For th
is reason, Bob Rubin and Steve Friedman initiated a greater push into trading, well before the IPO, and trading became a much larger percentage of Goldman’s revenues. In 1996, trading and principal investing represented about the same percentage of revenues as investment banking (about 40 percent), but from 2005 to 2007, trading and principal investing accounted for about 70 percent of revenues, and investment banking had plunged to 15 percent.43
Banking gave Goldman access to key CEOs and information—maybe not directly to the traders, but at the very top, where people set risk limits and oversaw all the risks. It began to become clearer to me, though, that there were different values and approaches among traders and bankers and that trading made the money and would come to dominate the thinking and culture.
The new emphasis on trading caused a cultural shift not only at Goldman but on Wall Street generally. Rob Kaplan explained: “As trading came to be a bigger part of Wall Street, I noticed that the vision changed. The leaders were saying the same words, but they started to change incentives away from the value-added vision and tilt more to making money first. If making money is your vision, to what lengths will you not go?”44 The shift may also have contributed to turnover. For example, according to Kaplan,
Wall Street was historically more balanced between trading business and client business. I ran investment banking and oversaw investment management. But as the trading business got bigger and bigger, the client side made up less of the firm’s overall work. This was going on at every single firm, not just at Goldman Sachs. I began to believe I could add more value in the world by doing something else. It was a difficult decision. However, I realized I had lost some passion for what we were doing, and that’s when I talked to the CEO, Hank Paulson, about leaving. It was traumatic, but I felt like I had to make a change.45
Trading entailed a different view and definition of “clients,” and that difference became more significant at Goldman as its trading activities intensified. Blankfein explained the difference in an interview with Fortune: “We didn’t have the word ‘client’ or ‘customer’ at the old J. Aron [the metals trading division where he worked with Gary Cohn for years]. We had counterparties—and that’s because we didn’t know how to spell the word ‘adversary.’”46 Former Bear Stearns asset management CEO Richard Marin described a Goldman executive’s attitude as arrogance and said that it was at “the root of the problem” at Goldman: “When you become arrogant, in a trading sense, you begin to think that everybody’s a counterparty, not a customer, not a client … [and] as a counterparty, you’re allowed to rip their face off.”47 A counterparty is the person on the other side of a transaction or trade—not someone you are advising. So Goldman may see its role, as the firm has said, as a market maker (see chapter 1), and that is fine. But Goldman can get into issues when the client believes Goldman is acting as an adviser and proclaims that “our clients’ interests always come first.”
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