The Goldman Sachs IPO

About the Company The Goldman Sachs Group is a leading global investment baking, securities and investment management firms that provide a wide range of financial services to a substantial diversified clients that include corporations financial institutions, Government and high net worth individuals. Founded in 186 , the firm has its !ead"uarter in #ew $ork and maintain offices in all ma%or financial centres around the world. The& were dealing in four business segments in 1 '() 1. -. 1. 5. *+, ,dvisors .ebt and /"uit& 0nderwriter 234 0nderwriter 6ommon share offering underwriter

Firm Heritage and Leadership 186 ) Started b& *arcus Goldman and later %oined b& his Son)in)7aw, Samuel Sachs 8 Started as a broker of promissor& notes and processors to commercial papers. ) The capital grown to -.: *illion ; ) 0nderwrote first public offering for 0nited Sigar *anufacturers. This transformed Goldman Sachs into an investment bank. ) Firm was led b& <addil <einberg who established investment trust named Goldman Sachs Trading 6orporation. The share price plunged ver& low and it effected Goldman=s reputation. ) 7ed b& S&dne& <einberg 8 !e worked hard to restore Goldman=s reputation and worked tirelessl& to get new clients including handling Ford *otor 6ompan&=s 234 in 1 :6. ) 7ed b& Gus 7ev& 8 7ev& was risk taking trader unlike conservative bankers. !e revolutioni>e the trading business. !e limited the role of *anagement 6ommittee which was set up earlier b& *r. <einberg to oversee strategic and budgetar& decisions. ) 7ed %ointl& b& ?ohn <einberg and ?ohn <hitehead 8 The& led the firm ver& well and reinstituted the role of *anagement 6ommittee, both of them placed importance to long term relations and followed S&dne& <einberg legac& that short term profit never be earned at the

1 99 1 96 1 -8

1 1-)1 6

1 6 )1 '6

1 '6)1

cost of long term relationship. This philosoph& helped them not to venture into risk& business like bridge loan, bu&ing %unk bonds, putting capital in takeover etc. which had damaged their competitors in 1 89s. @oth of them cultivated the culture of true work, integrit&, honest& and long term client relationship. Thus compan& also decided not to get involved with hostile takeovers. 1 9)1 5 ) 6ompan& was led b& Stephen Friedman and Aobert Aubin 8 during this period the compan& followed the philosoph& of no risk no profit and the& began to venture be&ond its traditional role of client agent and became increasingl& involved in principal transactions, risking its own capital in eBchange of high return. 2n 1 5 the firm suffered substantial financial losses because of higher annual eBpenses and high risk taking activities. Friedman retired in 1 5 while Aobin had left the firm in 1 - to %oin the 6linton=s administration. ) The organi>ation was led b& ?on 6or>ine and !am 3olson 8 both of them %oined at a ver& difficult time for the firm when the profits were disappointing and the entire business needed restructuring. @oth of them took drastic measures to improve the operational profit. 19C staff was asked to leave and there was a pa& cut ranging 59C to 69C across the compan&. These measures helped the compan& to grow the e"uit& through profit and capital infusion from number of investors b& 1 : and regain its lost reputation. or! "n#ironment

:)1

Goldmans

Goldman set ver& high standard with respect to recruitment and retention of high "ualit& talent. The& alwa&s took emplo&ees who have personal sense of eBcellence and fire to persue it. The& alwa&s hired the best talent and worked hard to retain them through intensive training and mentoring. The firm was traditionall& promoting the talent within its own ranks. 3artners were chosen from Goldman own in ever& - &ears through ver& rigorous process. 3artners were top "ualit& professionals with normal working hours of 15 8 18 hours per da& with the salaries lower than what the& earn elsewhere but the main attraction was the price of partnership and which would give them profit sharing. 3artners were supposed to reinvest significant portion of their profit into firm=s capital. The firm had historicall& paid partners on seniorit& not performance. 2n 1 9, the firm started the s&stem of grading the partners into 1 grades and 3erformance *anagement S&stem D3*SE was implemented. To retain the top talent the firm decided in 1 1 to introduce 169 degree review of compensation link to performance.

Fuestion 1. <h& Goldman Sachs has en%o&ed the greatest reputation among its peersG ,nswer ( 2t en%o&ed the reputation among its peers because of various factors as under() aE The compan& had strong heritage and credibilit& since 186 . bE The firm followed the philosoph& of cultivating long term client relationship and belief that there should be no short term profit at cost of long term relationship. cE 2t followed the philosoph& where it was not working in the area of hostile merger. dE The firm had uni"ue culture where it was structured as close)knit famil& environment of partners. eE The firm had top class recruitment, training and retention s&stem. fE The& alwa&s recruited emplo&ees who have personal sense of eBcellence and fire to persue it. Fuestion -. <h& it took so long to decide on the 234 issueG ,nswer ( 2t took long because the partners were apprehensive that if the& go public then it would effect adversel& their strong culture of eBcellence, famil& like environment of working and the& would be sub%ected to public scrutin&. The& also felt that if the& are able to grow without public mone& then what is the need to go public. Further, going public would also effect taB efficienc& of partnership structure and invite increase regulator& scrutin&. The& also felt that too much public mone& in the hands of eBpensive management can be misused if there is no discipline. This sentiment was correctl& eBpressed in a letter written b& two ?ohns DHif it aren=t broke don=t fiB itIE. 3artners also felt that after giving public *organ Stanle& has lost some of its old aura. Fuestion 1. .id Goldman Sacks had enough capital to growG 6an it grow faster enough to retain its positionG ,nswer( Till 1 ' Goldman Sachs en%o&ed #o.1 position in various businesses indicating that it was growing in spite of the fact that it had not gone public. !owever, even if it had not gone public it had managed a capital of 6 @illion ; e"uit& from various sources like partners, limited partners, non partner emplo&ees and private investors like Sumitomoto @ank etc. Dwithout voting rightsE. This capital helped the firm to grow, however, it was felt that the firm should aggressivel& go for ac"uisition of other companies to maintain its leadership position and for that capital would be re"uired.

$es, the firm can grow faster enough to retain its position provided it has more capital to attain leadership position in asset management business. Fuestion 5. 6ould the& retain their capital baseG ,nswer( $es, the& could retain their capital base b& putting restrictions on the withdrawal of capital b& partners on retirement and also ensuring that the profits of the partners is converted into e"uit&.

Fuestion :. <ould *+, be a better routeG ,nswer( #o, *+, not be a better route because through *+, firm would loss its identit& and uni"ue culture and heritage. 2t would also impact adversel& towards retaining top talent.

Fuestion 6. <ould increased scrutin& in going public damage Goldman SachsG ,nswer( #o, increase scrutin& would alwa&s put pressure of management and leadership team to benchmark themselves with the best in the industr& and follow best corporate governance practices.

Fuestion '. <hat will be impact 234 on senior partners, non partner emplo&ees, Sumitomoto + @ernice, 7imited partners, shareholders, customer, competitorsG ,nswer( Senior 3artners 8 The& would benefit from the high book value to market value ratio and would be able to realise high value of their shares in the firm. ,s per our estimate senior partners would potentiall& realise upward of 199 million ;. #on partners would also benefit as the& would get :9C of their 1 ' or 1 8 compensation in addition of their bonus for each &ear of service. ,s per the shareholders agreement both Sumitomoto + @ernice estate would agree to treat their share as common stock in the same manner as a ma%orit& of share held b& *anaging .irectors. The& would also gain in the same ratio as other partners. 7imited partners would be paid a premium over the book value of the investment an&where from -:C to ::C depending on whether the& choose cost or stock. Shareholders 8 The& get an opportunit& to participate in the growth of the firm and reap dividend from the future upside of the valuation. Fuestion 8. <ould the agenc& problems increase or decrease after 234G !ow moral

ha>ard + selection D/S43sE might ariseG ,nswer( The agenc& would certainl& increase after an 234 because there would be now more diversion between the owners and the managers running the compan&. !owever, there are wa&s and means through which this agenc& problem can be dealt with b& aligning the interest of owners and managers through outcome based compensation structure and robust management control s&stem through @oard of .irector etc. Firm would issue /S43 to emplo&ees which would make him part owner and so emplo&ee=s interest would be aligned to the owners interest.

Fuestion . <ould the contract monitoring be based on outcome or behaviour based Dbefore and after the mergerEG ,nswer( @efore the 234 the contract would be based on behaviour because most of the partners were working for a long time and their interest alread& aligned with the outcome. !owever, after the 234 the contract should be based on outcome so that the shareholders have better mechanism through rewarding the agents as the& can not monitor the behaviour part effectivel&.

Agency Problem This case relate to the issue of agenc& problem. 4ne view of agenc& theor& is how capital markets can affect the firm. ,genc& theor& describes the risk sharing problem as one that arises when cooperating parties have different attitude toward risk. ,genc& relationship arises when one part& DprincipalE delegates work to another Dthe agentE who performs that work. ,genc& theor& attempts to describe this relationship using the metaphor of the contract. ,genc& theor& helps in resolving two problems that can occur in agenc& relationship() aE .esire or goals of the principal and agent conflict. bE 2t is difficult or eBpensive for the principal to verif& what the agent is actuall& doing. 3roblem also arises if both agent and principal have different attitude towards risk. To resolve the above problem the theor& suggest two t&pe of contract 8 behaviour oriented contracts or outcome oriented contract.