Tuesday, January 29, 2008

Stepping Down of Jon Corzine as CEO of Goldman Sachs - Strategic Issues

January 1999

On January 11, 1999 Jon S. Corzine, the leader of Wall Street's most prestigious investment bank, Goldman, Sachs & Co., called clients and regulators to tell them that he was no longer chief executive of Goldman Sachs.

Later that morning, Goldman put out a terse press release, with the news that Corzine ''has decided to relinquish the CEO title.'' He would remain co-chairman to help with the initial public offering of Goldman's stock, which was postponed when the stock market plunged in August and September.

Insiders and competitors felt that Corzine was ousted in a coup within Goldman's all-powerful five-man executive committee. Corzine was forced aside by a troika of senior bankers: his co-chief executive, Henry ''Hank'' M. Paulson Jr.; Goldman's top investment banker, John L. Thornton; and Corzine's protege, Chief Financial Officer John A. Thain.

Paulson, now became Goldman's sole chief executive.

Move toward public ownership has brought to the fore conflicts that generally had remained suppressed. A key example is the split between the trading and investment banking divisions, with their very different cultures in Goldman Sachs. Corzine is a trader. Paulson and Thornton are career investment bankers. Thain is a hybrid, working as both a banker and trader.

Reasons for leadership change

In planning for an IPO, they knew that securities firms focused on stable revenues, including investment banking fees, are accorded higher multiples than those that rely on high-risk trading. But a huge slice of Goldman's earnings come from proprietary trading. An analyst says: 'Embedded in the center of Goldman Sachs is a hedge fund.' No surprise, that Paulson and Thornton, along with Thain, want to put as much of an investment banking face on the firm as possible.

There were trading-related mistakes in 1998. The firm earned near-record pretax profits of almost $3 billion, with a hefty chunk from investment banking. But Goldman's vaunted ability to manage risk took a hit as it lost an estimated $500 million to $1 billion when the market cratered last summer. Corzine took a lead role in the Long-Term Capital Management bailout because of Goldman's own exposure. He bid for the overleveraged hedge fund and then shelled out $300 million for the rescue. And after finally announcing that the firm would go public in June, 1998, Corzine was forced to pull Goldman's offering in September.

There was discontent among the investment bankers. They were unhappy that their lush profits got flushed down the toilet in the bond market fiasco. In mergers and acquisitions, Goldman racked up $960 billion in global deals, which was almost three times its 1997 record total. Still, Goldman's pretax earnings were down 81% in the fourth quarter, while those of rival Morgan Stanley Dean Witter (MWD) were up 6%.

The public issue concerns

Investors penalize firms that depend on proprietary trading because it is so unpredictable, producing huge profits one quarter and huge losses the next. By marketing itself as an investment bank and deemphasizing its proprietary trading prowess, Goldman can sell its stock at a higher price. Investors are willing to pay more for the stock of companies whose earnings come from stable fees from commissions, mutual funds, and underwriting.

As Goldman gets set for the IPO, it may be better to have an investment-banker CEO pitching the firm to investors than one who is a trader. If Jon had to get removed, it was an opportune time. Paulson, a reserved, highly organized Midwesterner, is one of the best bankers in the business. He spent his entire career as a banker until being promoted to chief operating officer in 1994. A Goldman partners admires both by saying, Jon is a brilliant, intuitive leader. But Hank embodies a quality that distinguishes a Goldman banker. His ability to execute is legendary.

Corzine was a natural leader with a low-key style. it was Corzine who stepped into the breach in 1994, when Goldman was struggling with trading losses and the sudden resignation of senior partner Stephen Friedman. Thirty-six other Goldman partners fled, taking their capital with them. Corzine was named chairman, and Paulson was his No. 2, though the two maintained that they enjoyed a partnership in the style of former Goldman chiefs Robert E. Rubin and Stephen Friedman. It was Corzine who stabilized the firm and helped it raise morale and profitability. He also instituted better risk-management procedures.

The experience left Corzine even more deeply convinced that Goldman needed to protect itself from market instability by going public and securing permanent capital--rather than remaining hostage to fickle capital that partners could withdraw. Paulson never embraced the idea. On May 27, the executive committee decided to promote Paulson to co-chairman and co-chief executive, just two weeks before the entire partnership voted to go public. Some insiders and competitors say Paulson's vote was bought--that he was promoted to be Corzine's equal in exchange for supporting the IPO.

Another long-simmering issue between Corzine and the troika was how the IPO process would be handled. Corzine was committed to having about 200 voting managing directors cast ballots on the IPO, since they own the firm. However, Paulson and Thornton believed that this was too unwieldy and time-consuming an approach and that the executive committee should make a decision for the full partnership, say sources close to the firm.

In June, 1998, Corzine did put the issue of the IPO to the full partnership, and it was approved. But the process of Corzine and others circling the globe to meet with Goldman's far-flung partners to win their support for an IPO delayed the offering. After the markets crashed, Goldman was forced to cancel its offering, a major embarrassment to a firm that advises clients on IPOs. It was a humiliating experience for Goldman--an intensely proud institution.

Delaying the IPO may have damaged Goldman's reputation with clients, even though by that time, the firm had little choice. It may just be market sniping, but competitors in London think they detect a falloff in the firm's performance. They say that Goldman's senior investment bankers did not seem to be covering important clients with quite their usual thoroughness. Some sources say that not being chosen to represent BP, a frequent Goldman client, on the $52 billion Amoco deal was a blow. Despite their huge success in M&A everywhere in the world, in the U.S., Goldman has slipped in the IPO rankings from No. 1 in 1997 to No. 3 in 1998, with market share falling from 15.7% to 9.4%, says Securities Data Co.



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