From the outside, it’s impossible to assess the accuracy of the recent public statements of Greg Smith, a former Goldman Sachs executive director, about the demise of the Goldman Sachs culture. Only Goldman Sachs’ insiders know whether or not the firm’s culture, which, as highlighted in its IPO prospectus in 1999, emphasized “placing our clients’ interests first”, has devolved to the point that “the interests of the client continue to be sidelined in the way the firm operates and thinks about making money.” Only Goldman Sachs’ management knows if it, as Smith accused, has lost hold of the firm’s culture, causing a decline in its moral fiber that “represents the single most serious threat to its long-run survival.” Smith does, however, point out a truth fundamental to every service business: “if clients don’t trust you, they will eventually stop doing business with you”. Corporate cultures are fragile, intangible assets whose true worth is often undervalued and overlooked because they don’t show up as assets on the balance sheet.
In the interests of full disclosure, I once had a positive experience with the Goldman Sachs culture and its social conscience. The firm was the lead underwriter for my client Cobalt Networks in its 1999 IPO. Upon the IPO, Cobalt’s stock soared from its initial offering price of $22 per share to a price somewhere above $120. Cobalt’s founder had died in a motorcycle accident in 1997 and his widow wanted to donate some shares to his beloved high school in his memory to help it build a new science center. Goldman Sachs quickly released some of the founders’ shares from the underwriter’s lockup to enable the donation. When I heard about the widow’s generosity and Goldman’s willingness to release some shares from the lockup, I asked Goldman to release some of my shares so that I could add to her gift, and without hesitation, Goldman let me make a similar gift.
In the wake of Smith’s statements, Goldman Sachs is reportedly conducting an internal investigation, including reviewing internal correspondence for references to its clients as “muppets”, as Smith alleges they are commonly called. The firm may also want to investigate whether or not its culture was damaged unwittingly in the transition from a privately held partnership to a public corporation. Converting to the more streamlined governance structure of a corporation may have weakened the glue that had preserved the culture and provided a check and balance to the unbridled pursuit of profit without regard to social costs.
Simultaneous with its IPO, Goldman Sachs engaged in a number of transactions, which resulted in a new public corporation, Goldman Sachs Group, Inc., succeeding to the business of Goldman Sachs Group, L.P., a limited partnership. These transactions resulted in the partnership, a private, consensus-driven legal entity managed by a management committee of 17 partners and 221 partners, re-organizing as a corporation, a chain-of-command driven legal entity managed by a handful of executive officers and a board comprised of seven directors, only two of whom were independent, outside directors. As a result of these transactions, power and governance became concentrated in the hands of a few with their executive authority no longer constrained by the cumbersome, consensus driven architecture of a limited partnership with many partners. The more cumbersome governance structure of the former partnership likely provided hidden glue that held the culture together.
Many iconic companies such as Goldman Sachs have great cultures and core values, but such cultural assets are vulnerable to rapid destruction because they are rarely incorporated into the formal governance architecture. Hewlett Packard, for example, had a great culture with the HP Way, but by most accounts the HP Way has disappeared because, in part, it was never codified into the articles and bylaws as a code of conduct. Without a formal succession plan for the culture integrated into the legal documents, a change in a corporation’s leadership can jeopardize its culture, especially if the new leadership’s ethics don’t measure up to the culture’s values.
Goldman Sachs’ client oriented culture may have been especially vulnerable in the transition from partnership to corporation because the prevailing corporate architecture is imbued with ancient mercantile DNA that tends to direct corporate behavior towards profit making without regard to the consequences. We’re doing business in corporate entities whose form has changed little from the Middle Ages. Corporations contain the hidden intention of the ancient kings of Europe who designed the corporation as an agent of empire to conquer and exploit foreign territories and to provide revenue for the royal treasury. The outdated assumptions underlying this architecture are that the commons has an infinite capacity to absorb harmful behavior and that resources are infinite. As a result, the legal architecture of corporations contains only a limited, self-serving mercantile conscience that is often expressed in the maxim that corporations exist solely to maximize profit for stockholders.
Given this historical context, Goldman Sachs cannot be faulted for brilliantly optimizing its operations to maximize profit for its stockholders, which is precisely what the corporation was designed to do. The client-oriented culture of the Goldman Sachs partnership may have become a victim of the mercantile intentions inherent in the corporate form. Goldman Sachs may have amplified this force when it became a public company subject to all the pressure of providing profitable quarterly results for its stockholders and by adopting the prevailing belief that corporations exist solely to maximize profits for stockholders. A corporate culture that puts clients first would tend to counterbalance this force and provide the foundation of a social conscience that trumps a mercantile one. If clients no longer come first, as Smith suggests, Goldman Sachs may well have lost its social conscience and defaulted to a purely mercantile one.
It’s fun to imagine a bold way for Goldman Sachs to re-affirm its culture and its commitment to its clients: re-incorporate as a New York benefit corporation. New York recently became the seventh state to adopt benefit corporation legislation. Benefit corporations have legal architecture that contains a social and environmental conscience that transcends and includes the prevailing mercantile conscience. A benefit corporation is a regular, for-profit corporation that is required to pursue a general public benefit, defined as a material positive impact on society and the environment as measured against a third party standard. If permissible under applicable banking regulations, becoming a New York benefit corporation would not be a stretch for Goldman Sachs because the corporation is already a generous supporter of the arts and other charitable causes. Goldman Sachs could become a global leader of the emerging interdependent economy by unleashing its considerable brain trust to optimize its profits while providing a material positive impact on society and the environment.