In politics, the tripod is the most unstable of all structures.
— Frank Herbert, Dune
Today, O Dearest of Long-Suffering and Put-Upon Readers, Your Temperate and Even-handed Critic of All Things Vampyromorphida was led by circuitous paths to an interesting post by a former denizen of that penumbrous region of the abyssal plain known as Goldman Sachs. Said exile, Jacki Zehner, wrote a long, rambling, but ultimately fascinating disquisition entitled “Why I Left Goldman Sachs” in response to Greg Smith’s now-famous self-immolation last week in The New York Times.
By her own description, Ms Zehner was the first female trader promoted to partner at the Squid, a 14-year veteran of the firm, and a proud member of both the Executive Office and the all-powerful Partnership Committee. In other words—and in addition—she was a self-described “culture carrier” of the firm. This, as you may suspect, is very important at Goldman Sachs.
Since she joined in 1988 and left in 2002, Ms Zehner was witness to the transformation of Goldman from pre-IPO partnership into globe-straddling colossus. In her later years, she participated firsthand in the all-important deliberations of the Partnership Committee, that august body entrusted with the consideration and elevation of those found worthy for entry into the pantheon of pecuniary and socioeconomic greatness. She enjoyed, as it were, a perch in the catbird seat.
So what was my story? In my later years at Goldman I was promoted to a position wihin the Executive Office where I was responsible at some level for the people processes of the firm. As mentioned, I served on the Partnership Committee, which was a HUGE honor. I witnessed people getting promoted who were not positive “culture carriers,” and I knew exactly where people were ranked and what was said about them by their bosses, peers and more. I also knew what every managing director got paid. I sat and listened to arguments about how commercial people HAD to be promoted despite being poor team players, downright jerks or much more. That really pissed me off.
I also heard business leaders fight passionately for their people who were amazing positive culture carriers and less strong commercially. These same leaders fought against promoting the commercial animal/jerks and often won. That made me happy. For both categories of people, there was frequently a fight and the more powerful leaders’ candidate often won. Not surprisingly, partners who were great culture carriers generally had people working for them who were as well and vice versa. What made the firm GREAT for so long is that one held the other in check. You need people who are very commercial but they cannot dominate or you risk the outcome that Mr. Smith described.
During my time at the firm, there were a lot of people in that optimal category who were both great commercially and culturally, and those were the people who were quickly and unequivocally promoted. If you were to ask me, “Did people get promoted who should not should not have?,” I would say yes. There was always tension but, more often then not, the right decisions were made. Great people got deservedly promoted. Was it perfect? Of course not, but it was pretty damn good.
In retrospect, it seems clear Ms Zehner was present at the beginning of the end of the firm she knew and loved as Goldman Sachs. She just didn’t know it at the time.
Your Dedicated Bloggist has emphasized time and time again, O Dearly Beloved, that culture in an investment bank matters. More to the point, he has argued that the first and last line of defense of a firm’s culture against the necessary and ineluctable stresses and strains working against it is the executive management of an investment bank. If they do not enforce the principles and aspirations of their firm’s culture, that culture dies, and it is replaced by the lowest common denominator substitute: every man for himself.
It is the firm’s culture, and senior executives’ complete commitment to that culture, which makes these mechanisms successful. 360-Degree review systems, 24-hour response voice mail, and rotation of bankers through different departments only work when senior managers refuse to make exceptions to the rules. There are a nauseating number of investment banks which profess an undying commitment to teamwork and a dedicated focus on cultivating client relationships rather than chasing transactions. But these banks fall short time and time again because they do not enforce these principles. If Mr. Big Swinging Dick Managing Director who brings in a billion dollar IPO or a ten billion dollar merger throws a hissy fit and threatens to stomp out the door if he has to share credit, or a successful M&A banker refuses to manage a group in Capital Markets, or a Group Head inflates the review scores of all his subordinates to boost their pay and his power, senior management can either hold firm and preserve the culture, or they can cave. If they hold firm, everyone else at the bank hears about it, and they learn that the rules and the culture will be enforced. If they cave, everyone knows that too, and it’s off to the bad old races of “what’s in it for me.” Sadly, most investment bank executive teams cave.
The amazing thing is that Goldman Sachs was known for years for not caving on its principles. This, while simultaneously running one of the most successful and storied investment banks on the planet, was no mean accomplishment.
Ms Zehner’s story is fascinating for what it reveals of the stresses and strains Goldman contended with in trying to perpetuate its traditional culture in the face of changing markets. Cognoscenti have always likened managing an investment bank to herding cats. It is an apt analogy. Senior bankers, from corporate finance to M&A to sales and trading, each run little businesses focused on tiny segments of the global financial markets, whether it be healthcare M&A, mortgage-backed securities trading, or investment grade debt underwriting. Most of these businesses have very little to do with each other, and each requires a different focus and business model for success. Strange as it may seem to the uninitiated, a giant, trillion dollar asset business like Goldman Sachs, when properly understood, looks a lot like a very large, very awkward aggregation of hundreds if not thousands of tiny little cottage industries. And Ms Zehner is correct in characterizing the trading businesses within investment banks as far more driven by zero-sum, counterparty relationships than the client-focused, service-oriented businesses on the corporate finance and M&A side of the house.
Ms Zehner is also accurate in describing the essential tension that an investment bank must balance and sustain between its more commercial, “rip-the-faces-off-your-counterparties” side and the “oh-mr-client-i-couldn’t-possibly-dream-of-charging-you-for-this-strategic-advice” relationship-building approach in order to be successful. Investment banks require both of these attitudes and skill sets, if for no other reason than they straddle markets, serving both buyers and sellers, and are uniquely positioned to intermediate between liquidity providers and seekers in the trading side of capital markets and capital providers and seekers in the investment side of same.
The tension arises from the fact that it is often more profitable to rip a customer’s face off in the short term than to defer potentially larger profit opportunities with the same client in the long term. When bankers whose personal franchises, careers, and compensation depends on the former are evenly balanced with bankers whose interests are aligned with the latter, an investment bank perches profitably if precariously on the knife’s edge of sustainable profitability. Notwithstanding industry critics’ perception that all investment bankers are all looking for a quick and easy score, those of us who actually work in the relationship side of the business know that our best personal outcome depends on a sustained career success lasting over a decade or more. Unlike, perhaps, traders who transact daily with equally ruthless hedge fund counterparties on a no-regrets, no-grudges basis, bankers like me in corporate finance and M&A transact with the same limited universe of clients year-in and year-out. We simply cannot afford to screw them over, because they do hold a grudge.
So how does an investment bank maintain this essential tension? Well, one way is how you promote bankers to positions of power and influence, like Ms Zehner did on the Partnership Committee. Another, equally important way is how you pay them. But, as Ms Zehner’s account demonstrates, these are highly contentious decisions. Ambitious, driven people like the ones who populate the exalted regions of Goldman Sachs fight hard for their own interests and the interests of their loyal subordinates and lieutenants. Who will cast the deciding vote, in the case of irreconcilable differences? Senior management, of course.
Which is why, at the end of the day, the conversion of Goldman Sachs and other investment banks from private partnerships owned and run by their employees for the benefit of their employees to publicly-traded corporations beholden to third party shareholders permanently and irrevocably upset the historical balance at the core of my industry. For all of a sudden, a third party was introduced, one whose interests were firmly and irrevocably aligned with the short-term perspective of the more “commercial” (i.e., sales and trading) side of the house. Public shareholders care for nothing but the present value of their holdings. They don’t really care what the share price of Goldman Sachs will be in five or ten years. And, unlike the high-paid bankers whom they employ, shareholders can exit their investment and exposure to the firm at any time. Why should they care about the long-term franchise of Goldman Sachs? Especially if selling that toxic CDO, squeezing that last drop of fees from an underwriting client, or discounting conflicts of interest to weasel your way into two or more sides of an M&A transaction can boost profits—and, presumably, the stock price—in the near term.
And the kicker is that senior management of the firm, now that it is owned by the public, has a fiduciary duty to maximize value for the shareholders. Even executives who might otherwise be inclined to preserve long-term franchise value at the expense of short-term profits will be persuaded to sign onto the short-term game, because it is their legal duty to do so. Introducing public shareholders into the capital mix inevitably tilts the tenuous balance between short-term and long-term orientations critical to a balanced investment bank decisively toward the former. Add to this the structural changes in the global financial markets over the past decade, which presented huge opportunities to exploit structured products, derivatives, and proprietary trading to bank enormous current profits at the expense of increasing numbers of former clients, and you have the institutional incentive structure which led to our current pass.
It is an open question whether investment banks can ever return to their prelapsarian partnership structures. For many reasons, I have severe doubts on that score. But it is important to realize just how much Goldman Sachs—and other investment banks—sold their legacy, franchise, and long-term value down the river by offering shares to the public.1 Conversion from partnership to publicly-traded investment banks was not a sufficient cause for the recent financial crisis or our ongoing struggle with the proper form and function of the industry, but it certainly was a contributing factor.
Greg Smith and Jacki Zehner may be too polite to say this, O Public Shareholders of Goldman Sachs, but I am not:
I blame you.
Related reading:
Jacki Zehner, Why I Left Goldman Sachs (March 16, 2012)
The Fish Stinks from the Head (June 30, 2009)
Hypocrisy as a Business Model (March 15, 2012)
1 Of course, they were in actual fact monetizing, or cashing out, the long-term accumulated value of their franchises for cold, hard cash. Think about that for a minute, and I believe you will see what I’m getting at.
© 2012 The Epicurean Dealmaker. All rights reserved.
