Org Leadership & Ethics Group Project

Salomon Brothers Case Analysis 1

Salomon Brothers Case Analysis

By

Ken Bedell

Ben Byo

Owen Carter

Christopher Robinson

Ivy Williams

A Paper Presented in Partial Fulfillment

Of the Requirements of

LEAD 505 ORGANIZATIONAL LEADERSHIP & ETHICS

June 2008


History has shown us how sub-standard leadership can bring a successful

organization from success to disaster. It has also shown us how good leadership can

bring an organization out of the ashes and into success. While we may perceive an

organization to be strong and successful, the reality may be that it is self destructing from

the inside. If ever there was a case that would substantiate this it would be the Salomon

Brother’s case.

A leader is an advertisement of his company. Often times they are the face of the

company as people will associate an organization with its leader. Therefore anything the

leader does or fails to do is a direct reflection of the organization in which they are

affiliated. The Salomon Brothers case shows how a leader’s self interest and selfishness

brought down an entire company. This case shows how a leader’s lack of integrity had

an adverse effect on an entire organization. The integrity of the employees who work for

this organization was also compromised as was the company’s reputation. Ultimately,

decades of solid performance, dedication, and good business practices were jeopardized

by the greed and self serving interest of its leader.

Once exposed, the question becomes whether or not the organization can recover

from a scandal that compromises the very values in which it was built upon? How do

you rebuild the reputation of a corporation that has been destroyed? What steps do you

take to place a company back on the winning track? Can it even be done? True leaders

should take responsibility for their actions but, as a new leader, where do you start?

Warren Buffet believed the reputation of Salomon Brothers could be restored and he

started by re-establishing the integrity of the company. This paper will compare and


contrast the leadership that led to the demise of Salomon Brothers with the leadership that

revived Salomon Brothers.

Salomon Brothers Case

Salmon Brothers unethical leadership dilemma, as told by Ronald Sims, is the

thought provoking tale of how organizational culture can imprint ethical or unethical

behavior within the organizational structure. In the case of Salmon Brothers, such

behavior resulted in public scrutiny for security and exchange commission violations and

the misgivings from a company that was once revered as the epitome of banking and

investments in the corporate world. Their sin was quite simple: “bottom line greed.”

They placed illegal bids for government securities.

Leadership sets the tone and writes the script for every organization and the

unethical behavior that resulted in the debacle at Salmon Brothers rests on the shoulders

of its leader John Gutfreund, CEO and chairman. As Dr. John Maxwell (1993) says,

“Everything rises or and falls on leadership” (p. VIII). When the leaders of an

organization participate in unethical behavior it promotes such behavior throughout the

organization. The proverbial adage of “when in Rome do as the Romans do” comes to

mind.

When faced with increased trading competition, traders at Salomon Brothers even

sacrificed legal business practices in pursuit of the “bottom line” which, to them,

validated their criminal activity. The importance of trust in the financial industry is

clearly described in the Solomon’s (2004) article, Ethical Leadership, Emotions, and

Trust: Beyond “Charisma” (pg. 98):


“Banks have been the target of distrust and abuse by American populist and

political activists since the last century. President Andrew Jackson even sought to outlaw

them. And yet, the amount of trust taken for granted by anyone who has any business

with banking at all is astounding. We trust that the money we deposit will be returned to

us as promised. We trust that the bills and most checks we receive are valid and genuine.

The fact that we ask for a “bank check” or cashier’s check” for absolute security is

further evidence our level of trust in banks, however great our distrust may be on some

more abstract level. And yet, we all have seen the consequences of even a minor bank

scare. Not just that bank but all banks are suddenly under scrutiny, under suspicion.”

Gutfreund withheld information from government regulators and had a

questionable agenda when firing others within the organization. According to Ed

Locke’s (Avolio & Locke, 2004) letter on leader motivation, Gutfreund would be labeled

the typical pragmatic, amoral, “big shot” who tries not to earn money but to get away

with some money before he or she gets caught. Gutfreund is one who will hold on until

the evidence is so overwhelming that he has no choice but to concede. He was

instrumental in sowing the seed of greed in the organization which ultimately led to the

sanctions against Salomon Brothers. It is no small wonder that this scandal rocked the

banking industry and has left a measure of doubt in not only investors but the general

public. Change at Salmon was necessary to resurrect a company that was on the verge of

dying.

New Managements response

Warren Buffett was called upon to resurrect Salomon Brothers and his approach

as a leader was the complete opposite of Gutfreund’s. He immediately terminated top


managers of the firm. Some left voluntarily while others were forced to resing..

According to Buffett, his job was to clean up the sins of the past and to capitalize on the

enormous attributes that the firm had built up over the years; he commented on the fact

that the firm had to earn back its integrity, which was destroyed by its previous CEO. To

set this in motion Buffett opened Salomon’s doors to government regulators and

promised to waive the attorney client privilege by turning over all reports and notes

prepared by the firm’s lawyers investigating the government trading desk’s

transgressions. With this gesture, Buffett sent a message to all employees that remained

with Salomon that the transactional leadership of Gutreund was no longer tolerated in the

firm. Transactional leadership is characterized as immobilizing, self-absorbing, and

eventually manipulated in that it seeks control over followers by catering to their lowest

needs (Burns, 1978).

While trying to appease their federal and state investigators, stakeholders,

employees and customers, Buffett sent the firm’s senior managers a letter informing them

that they were “each expected to report, instantaneously and directly to me, any legal

violation or moral failure on behalf of any employee of Salomon” (Paine & Santoro,

1994, p.117). He exempted “only minor…failures (such as parking tickets or

nonmaterial expense account abuses by low-level employees) not involving a significant

breach of law by our firm or harm to third parties” (Paine & Santoro, 1994, p.117). This

letter was intended to reaffirm that all unethical conduct was to be reported immediately.

As Buffett started restructuring the firm, he had to deal an increase in employee

turnover rate due to the turmoil that the company was currently facing. While many

would view the loss of such tenure an unfortunate event, Buffet interpreted this high


turnover rate as a good thing as it allowed him the opportunity of ridding Salomon

Brothers of the remaining unethical employees. It also allowed him to hire intelligent

and ethical new employees that shared similar ethical values and would assist Buffet in

changing the stakeholders and publics view of the firm.

The reward system that was in place by the previous regime rewarded employees

for their wrongdoing, which created a win at all cost culture. Under this system

promotion and pay was based on recent performance. Buffett revamped this system by

reducing compensation and attaching it in conjunction with department performance.

While top performers were still nicely rewarded the rewards were directly tied to the

ethical behavior that what necessary to succeed as an organization. Buffett used this

reward system for resorting honesty, integrity, and trust to the firm.

The final restructure of Salomon was completed in two phrases. Phrase 1

consisted of the creation of a new Executive Committee that included executives from all

the firms businesses, local and internal. This was done mainly to keep the firm legally

and ethically correct with the stakeholders, employees, customers, and public. Citing

Federalist No .10, according to Madison, “there are two ways of curing the mischiefs of

faction: one, by removing its causes; the other, by controlling it effects. There are, in turn

two ways of removing the causes of faction: the first, by suppressing the freedom of

persons to advance their own interests; the second, by persuading persons to share the

same interests” (as cited in Ciulla, 2004, p. 156). This Executive Committee was

responsible for the firm’s checks and balance system of ethical behavior that would help

to ensure that the past would not repeat itself.


Phrase 2 concludes with a Risk Management System. This formalized

management system addressed not only market risks, but also regulatory risks, credit

risks, operational risk, and environment risk. This system was designed to provide senior

management with a companywide perspective on exposure prior to execution.

Ethical Emphasis

Ethics involves moral issues and choices. It is concerned with right versus wrong,

good versus bad and many shades of gray in supposedly black and white issues. Moral

implications spring from virtually every decision, both on and off the job. Managers are

challenged to have more imagination and the courage to do the right thing. In the case of

Salomon Brothers John Gutfreund consistently chose to lead and tolerated unethically

performance and behavior by with him and employees. The firms ethical codes of

conduct and organizational culture, clearly contributed to enhancing the frequency of

unethical behavior.

Unsuccessful in concealing the misdeed of the firm’s unethical ventures

Gutfreund was terminated. Business may be business but ethics set the moral tone in the

organization for business leader to abide by a practice that was not in existence at

Salomon Brothers. Top managers failed establish key organizational values in the form

of policies that reinforces ethical practice and behavior. Schein (1985) noted that

leadership is a critical component of the organization’s culture because leaders can

create, maintain, or change culture; this would seem to coincide with the fact that

leadership is critical to organization ethics.

Based on Gutfreund’s demand for short-term financial results, Salomon Brothers

exhibited an organization that showed little concern for employees, laws, or ethics.


Gutfreund essentially created a win at all cost mentality. The firm’s culture encouraged

and rewarded unethical behavior, its managers, and employees acted unethically due to

benefits of their short-term financial gains. Trevino and Nelson (1999) noted that if the

organization’s leaders seem to care only about short term financial results, employees

quickly get that message and act accordingly.

Within Salomon Brothers, the decision-making authority was concentrated in the

hands of Gutfreund and a few top-level mangers and little authority was delegated to

lower level managers. By maintaining this authority, Gutfreund created and atmosphere

where getting ahead was the number one priority, and the firm’s commitment to ethical

behavior was suspect.

To avoid the tribulation of the Salomon Brothers, organizations can become

ethically empowered by implementing the following procedures:

- Behave ethically themselves. Managers are potent role models whose habits and

actual behavior send clear signals about the importance of ethical conduct.

- Screen potential employees. Ensure that they bring experience, knowledge, and

ethical fortitude to the organization.

- Develop a meaningful code of ethics. These codes must be supported by top

management, distributed to every employee, and enforced with rewards for compliance

and strict penalties for noncompliance.

- Provide ethics training. Employees can be trained to identify and deal with

ethical issues during orientation and through seminar, and internet training sessions.

- Reinforce ethical behavior. Behavior that is reinforced tends to be repeated,

whereas behavior that is not reinforced tends to disappear.


- Create positions, units and other structural mechanism to deal with ethics.

Ethics needs to be an everyday affair, not a one-time announcement of a new ethical code

that gets filed away and forgotten.

Organizations that wish to define their identity and communicate their values to

employees, stockholders, and customers must do more than simply limit legal and public

relations problems. A compliance programs will be more successful when connected to

positive values with which employees can empathize. For any ethics program to work,

the evidence is strong that merely having a formal code is not enough. Any such

statement must be synchronized with the company’s organizational structures, its culture,

and its leadership.

Scholarly Literature Review

The Solomon case study raises many of the issues found in the extensive literature

on ethics and business. More specifically, the ethical contrasts between John Gutfreund

and Warren Buffett offers a historical example that raises many of the issues discussed in

the ethics of leadership literature. In this analysis three specific lessons are considered:

Top Leaders Set Ethical Tone, All Leadership Decisions have Ethical Implications and

Ethical Actions Must Be Based on Long Term Considerations.

Top Leaders Set Ethical Tone

Kotter (1990) points out that one of the distinctive features of leadership is that

“for leadership—keeping people moving in the right direction, despite major obstacles to

change, by appealing to basic but often untapped human needs, values, and emotions.”

(as cited in Harvard Business Review on Leadership, 1998,p. 41).


Badaracco (1998) goes even farther in claiming that a leader is the one who has

learned from defining moments and translated that experience into character. In the case

of Warren Buffett he came into leadership after having already established a reputation

for having personal values and his immediate actions were consistent with his reputation.

Gutfreund, on the other hand, was faced with a possible defining moment and he fell

back on his previously well honed skills as a manager. The literature on leadership ethics

presents different opinions on whether taking the position of enlightened self-interest is

ethical moral ground or not. Superficially, it appears that Gutfreund was operating out of

an ethic that was “egoistic (selfish)” (Avolio & Locke, 2004, p. 105). However, as things

turned out it is now clear that Gutfreund did not realize that the basis of egoistic ethics is

the premise that “Their main means of survival is reason.” (Avolio & Locke, 2004, p.

107) It turned out that Gutfreund’s actions were not well reasoned.

All Leadership Decisions have Ethical Implications

Bass and Steidlmeier (2004) point the ethical implications of all leadership

decisions when they discuss the difference between transactional and transformational

leadership. They connect transactional leadership with a “world view of self-interest.” (as

cited in Ciulla, 2004, p. 177). Their definition fits Gutfreund. Bass and Steidlmeier

(2004) claim that this approach is flawed, “the exclusive pursuit of self-interest is found

wanting by most ethicists,” (as cited in Ciulla, 2004, p. 177). By their definition Buffett

is a transformational leader where leadership decisions “grow out of authentic inner

commitment.” (as cited in Ciulla, 2004, p. 177)

Ciulla (2004) makes a similar argument when she claims that honesty is the

foundation of empowering leadership (p. 60).


Ethical Actions Must Be Based on Long Term Considerations

Gutfreund was acting as a manager as Zaleznik (1977) points out, “Where

managers act to limit choices, leaders develop fresh approaches to long-standing

problems and open issues to new options” (as cited in Harvard Business Review on

Leadership, 1998, p. 69-70). Common sense favors the argument that ethical behavior of

leaders require that they take a long term view. However, critics of transformational

leadership are not always supportive of this position. For example, Keeley (2004) argues

that “transformational leadership produces simply a majority will that represents the

interests of the strongest faction” (as cited in Ciulla, 2004, p. 160). He believes that

leaders, even leaders like Buffet need to be held in check by structures that provide for

the balancing of powers.

What can we learn from the Salomon Brothers Case?

When analyzing a case such as the Salomon Brothers it is easy to walk away with

“lessons learned.” On one hand, some of these lessons are rather obvious: admitting

wrong doings when they happen and not covering up mistakes comes to mind. On the

other hand, less obvious lessons such as anticipating how followers may interpret the

priorities of their leaders are equally important. This section will focus on some of the

less obvious ethical lessons learned from the Salomon Brothers case and the practical

application of these lessons.

Ronald Sims and Johannes Brinkmann (2002) suggest “the personal values of top

leaders, powered by their authority, set the ethical tone of an organization” (p. 327). This

statement is, perhaps, the most important lesson that can be learned from the Salomon

Brothers case as, at the end of the day, all actions reflect upon the priorities set by


executive leadership. Fortunately, the Salomon Brothers case provides an excellent

example of the good and bad results associated with the focus exemplified by leadership.

John Gutfreund’s desire to show quarterly profits and his special treatment or “under the

table” deals laid the foundation for an organization that believed such behavior was

acceptable. As previously discussed, Gutfreunds’s behavior ultimately opened the door

for unethical behavior by the organization which led to the problems Salomon Brothers

faced. Conversely, Warren Buffett and Deryck Maughan’s emphasis on moral behavior,

above everything else, saved the Salomon Brothers and rebuilt society’s confidence in the

organization.

In addition to the emphasis put on the actions of leadership, another lesson

learned from the Salomon Brothers case is the idea that leader’s should always be aware

of the costs associated with their actions. Gutfreund’s use of rewards is an example of

how his actions could unintentionally lead to unethical behavior. Giving Gutfreund the

benefit of doubt we could assume he had good intentions by paying extremely high

bonuses to those who provided results. Unfortunately, these bonuses provided further

incentives to otherwise ethical associates to behave unethically. After all, as Larimer

pointed out “you get what you measure and pay for” (as cited in Sims & Brinkman, 2002,

p. 333). Another example could be the emphasis put on hiring. Buffett and Maughan’s

leadership resulted in a number of associates being dismissed or voluntarily leaving.

While some of these associates were Salomon Brothers top performers Buffett and

Maughan stood firm in their belief that they could hire newcomers who shared their

moral beliefs and would help to eliminate the cultural persistence that remained from

Gutfreunds’s leadership. Overall, Gutfreund’s actions sacrificed he morality of the


organization in favor of results while Buffett and Maughan’s actions sacrificed some

performance in favor of morality. Both leadership regimes took action but only Buffett

and Maughan understood the long-term impact of their actions.

The final lesson learned from the Salomon Brothers case is the need for top

leaders to focus on the future rather than the day-to-day actions of the organization. Sims

(2000) suggests Gutfreund’s emphasis on short-term results opened the door for unethical

behavior. On the other hand, actions taken by Buffett and Maughan removed the short-

term mindset of the organization. For example, Buffett and Maughan encouraged

associates to purchase Salomon Brothers stock that would be redeemable in five years

which game them incentive to help ensure the organization is successful over time.

While there is no evidence that long-term planning eliminates unethical behavior such

incentives certainly help to deter it.

While it’s easy to point out the lessons learned in an example such as the Salomon

Brothers case we must also consider the application of these lessons in our own actions.

First, we must be aware of the things we emphasize and prioritize with our followers and

ask ourselves and our followers what behavior our priorities drive. Do we leave work a

couple hours early to go golfing without understanding that we’re promoting similar

behavior for our followers? Second, we must consider all of the costs associated with our

actions. Do we consider the safety of our followers when we cut spending? Finally, we

must ensure the long-term stability of our organization. Do we discuss ethics and values

with our followers or simply assume they are known? While these questions may appear

to be common sense it the common sense behaviors that can led an organization down a

path similar to that taken by Gutfreund and the Salomon Brothers. Perhaps Warren


Buffett offered a question we should ask ourselves in any situation that makes us question

our morals, ethics, or values: when “contemplating any business act, an employee should

ask himself whether he would be willing to see it immediately described by an informed

and critical reporter on the front page of his local paper, there to be read by his spouse,

children and friends” (as cited in Paine & Santoro, 1994, p. 131).

Conclusion

The Salomon Brothers case is a story of two different leaders and two different

leadership styles. The unethical practices of one leader, John Gutfreund, were driven by

selfishness and self interest which compromised the integrity of the organization. His

leadership style forced his followers to focus on the short term success objectives.

Although the name on the door said Salomon Brothers it was clear that the company was

being run by John Gutfreund. Unethical practices and short cuts were acceptable as long

as the end result matched his intent. Those who would comply with these practices found

rewards for their loyalty. Those who did not agree found themselves out of a job.

John Gutfreund’s leadership style change and tainted the culture and perception of

a once stellar company. His ego and his self ambitions led to the down fall and

embarrassment of the Salomon Brothers. He placed his organization’s entire focus on the

next quarter’s profits. When the unethical practices were discovered, Gutfreund

attempted to cover it up. By doing this he furtherdestroyed the reputation of the company

as the morals of the company were shattered. Gutfreund left this company in a state of

emergency. This crisis would not only affect the Salomon Brothers but everyone who

had conducted business with them as well. How do you fix a scandal that appears to be

impossible to recover from?


Enter Warren Buffet. Here is a leader whose self interest was not self centered

but rather sought to change the culture and image that had been tainted by previous

leadership. His arrival in itself was a step in the right direction. Buffett’s focus on

morals and ethics was critical in the restructuring of the culture and atmosphere within

the company. Buffet chose to lead by example. His character was above reproach as he

sought to change the face of the company. His immediate dismissal of all those involved

in unethical behavior sent a positive message throughout the company that these

unethical practices were a thing of the past. This company would now take on the

personality of Warren Buffet. His transformational style combined with a few

transactional practices helped to rebuild the reputation of the company.

Whereas one leader focused on amoral practices the other leader sought to build a

solid ethical climate through integrity and good moral character. Gutfreund’s leadership

practices placed the Salomon Brothers at risk. Buffet’s practices brought the Salomon

Brothers back to respectability. His arrival brought credibility back to the firm.

In conclusion, the ethical practices of a leader will effect an organization in many

different ways. Short term objectives will always have a long term effects as is evident in

this case. The short term focus of an unethical leader severely wounded the integrity of

the firm but the long term ethical plans and actions of an ethical leader ultimately helped

to rebuild the reputation of that firm.


References

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Sims, R.R. & Brinkman, J. (2002). Leaders as Moral Role Models: The Case of John Gutfreund at Salomon Brothers. Journal of Business Ethics, 35, p. 327-339).

Solomon, R.C. (2004). Ethical Leadership, Emotions, and Trust: Beyond “Charisma.” In J. Ciulla (Ed.), Ethics, the Heart of Leadership, West Port, CT: Praeger Publishers.

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