The Goldman Sachs IPO

Go or No-Go

PRESENTED BY :IPMX08002 : ANAS

IPMX08018 : GIREESH

Introduction : Case Facts

Question1 : Why did Goldman Sachs enjoy the greatest reputation among its peers?

Organizational structure encouraged aspiration : Partnerships

Business with ethics – No to hostile deals

Honesty, integrity, trust building

Part of historic IPO (Ford)

Willingness to go over the board. Beyond call of duty

“No to short term gains at expense of long term relationships”

Well defined coded institutionalized ethical code of conduct.

Strong long term client relationships

Ambassador culture

Sidney Weinberg himself was part of over 30 boards.

Emphasis on selection of best people

Intensely trained and customer focused workforce.

Focus on retention.

Encouraged promotion to home grown talent rather than lateral hires

Question 2 : Why it took so long to decide on the IPO issue?

“If it ain’t broke, don’t fix it”

- John Weinberg, Managing Partner, Goldman Sachs

Inertia :

In the early stages, good operating levels and year on year growth negated the need

for capital infusion.

Partner-cum-employees had been more tolerant of the losses, if any (eg. as in 1994)

than general public would be.

Resistance to the idea of the challenges posed by possibly going public :

Regulatory scrutiny increases.

IPO could possibly dilute culture and work ethics.

Agency Theory Problem (Internal) : Dissolution of partnership model would lead to

reduced benefits for current stakeholders.

Dilution of voting rights of partners.

Question 3 : Did Goldman Sachs have enough capital to grow?

NO!

Capital Sinks:

Led by an aggressive “risk taker” leader, 1990-94 era saw Goldman change its

operational philosophy.

Encouraging financial gains led to opening up of global offices – presence in

Frankfurt, Milan, Seoul, Beijing, Mexico City and Shanghai

Increased expenses

By 1994, expenses had risen to $3.6 billion (2 x of that in 1990).

Losses around $42 million in a quarter!

Rats leaving a sinking ship? Over 40 partners (with roughly 30 % equity shares) left.

Including resignation of Stephen Friedman.

Assets fell from $115 Billion in 1993 to $95 Billion in 1994. Capital to assets ratio

halved.

Question 3 : Could it grow fast enough to retain its position? Question 4 : Could they retain their capital base?

Scanning the changing business and competitive environment

A consolidating industry and larger competitors to deal with.

Stable revenues through asset management.

Large debt-fueled capital of Newer firms like: Merrill Lynch, Morgan Stanley, Salamon Smith, Lehman

Brothers, Bear Stearns, Paine Webber.

Goldman Sachs was losing ground on the competition

Maintaining or retaining capital base was possible but competition was already doing better and

comparative performance was poor.

The current capital base was high-risk due to partnership capital.

Watershed year (1994) raised strong questions on the ability to retain & manage the capital base, due to:

Annual expenses = $3.6 billion (twice of 1990).

Poor risk management.

High attrition and low confidence.

Question 3 : Could it grow fast enough to retain its position? Question 4 : Could they retain their capital base?

Question 5 : Would M&A be a better route?

Pros

Access to new market segments

New innovation opportunities

New revenue streams and new capabilities

Stronger positioning at merger time,

thereby maximizing ROI

Cons

Legal costs

Short term opportunity cost

Cost of takeover

Compatibility issues

Potential devaluation of equity

Intangible costs

Our recommendation:

Question 6 : Would increased scurrility in going public damage Goldman Sachs?

Impact of going public :

Uncertain about impact on its unique culture.

Large size might erode excellence and might dilute prestige and uniqueness.

Employees might lose motivation.

Harder to retain employees in a public firm – incentives are comparatively measured

and constrained.

Like Morgan Stanley, Goldman Sachs could lose its charm after IPO

Partners were of the opinion that going for an IPO would cause loss of value –

both tangibly and intangibly and would negatively affect the image.

While some concerns are genuine, some may be driven by agency problems

(more in question 8).

Cumulatively, the concerns are outweighed by the need for more and lower-risk

capital that will come with an IPO.

Question 7 : What will be impact IPO on senior partners, non partner employees Sumitomoto & Bernice, Limited partners, shareholders, customer, competitors?

Question 7 : What will be impact IPO on senior partners, non partner employees Sumitomoto & Bernice, Limited partners, shareholders, customer, competitors?

Question 8 : Would the agency problems increase or decrease after IPO? How moral hazard & selection (ESOPs) might arise?

Increasing Agency Problems

Only 14% equity is diluted to the public

Employees will be more concerned with increasing personal transactional profits than with the long-term shareholder wealth.

The loss of lucrative pay packages at partner level may lead to greater employee turnover.

Lack of accountability of capital will lead to reckless and unwarranted spending.

Hence Goldman incorporated ESOP’s with lock-in period to reduce agency problems.

Issues arising out of ESOPs:

Employees’ decisions will be flavoured by the gains from increase in short term share prices.

Unregulated and riskier decisions would be taken to improve annual profitability metrics.

Firm’s values may be compromised to meet targets and personal goals.

Hence ESOP’s could be a source of increased moral hazard

Question 9 : Would the contract monitoring be based on outcome or behavior based (before and after the merger)?

Before Merger:

No monitoring mechanisms. Higher personal discretion.

Equity of agents at stake.

Partners are principals – decision making is driven by niche closed group.

Hence Behavior Based

Post Merger:

Effective in curbing agent opportunism.

Actions and decisions are much more regulated and output driven.

Hence Outcome Based

THANK YOU!

Questions?