Goldman and the problem with incentive compensation

Cite this Article
Larry Ribstein, Goldman and the problem with incentive compensation, Truth on the Market (January 19, 2011),

We have heard a lot about the need to give investment bankers skin in the game to constrain the kinds of counterproductive risk-taking that led to the meltdown.

The NYT describes a firm that has been doing that — Goldman Sachs.

Unlike other Wall Street firms, Goldman retained a partnership system when it became a publicly traded company in 1999. Goldman’s partners are its highest executives and its biggest stars. * * *The partnership system is a vestige of Goldman’s days as a private firm. Most Wall Street firms shed their partnerships after going public. But Goldman, one of the last big investment banks to sell shares to the public, created a hybrid model, as an incentive for employees.

The article describes a firm tightly controlled by a relatively small group of people who have a lot of money stuck in the firm for years in the firm and are highly motivated to make the firm successful for the long term.

This approximates what I’ve called the “uncorporation” (read the book), which I suggested as an option for investment banking firms in my article, The Uncorporation’s Domain.   This is more than just corporate incentive stock options, which can be manipulated by a corporate board to dilute risk while maximizing reward.  This is big risk plus big reward. 

But there seems to be a problem for the NYT:  the partnership-like firm structure has made Goldman’s partners a lot of money.  Since Goldman’s public offering its stock has returned almost 175% (while the S & P was losing 2.9%) and its 860 current and former partners have each cashed out an average of $24 million of stock. 

The stock options have been particularly lucrative since the 2008 crash, when shortly after the Lehman bust Goldman cut cash compensation and awarded 36 million options — more than ten times the previous year. The options could be exercised in one-third installments in January of 2010, 2011 and 2012 and shares can’t be sold or transferred until January 2014.

The article ends with words that will bother some people:

“It is a very Darwinian, survival-of-the-fittest firm,” said one former Goldman partner

These revelations will likely prompt more cries to regulate or otherwise punish Goldman for its success.  And, true, Goldman got rich while many others were hurting.  But this is significantly because they had the guts to double down in the darkest days and the discipline and savvy to make the most of it. 

The lesson here is that if we’re going to push for incentive compensation, are we prepared to live with the fact that it’s “Darwinian,” and that its recipients might actually get rich?