One Former Investment Banker's Take on Restoring the 'Financial Quality, Integrity and Soundness of Our System'Published: March 18, 2009 in Knowledge@Wharton
At the recent World Economic Forum in Davos, Wharton management professor Michael Useem talked with Suzanne Nora Johnson, vice chairman of Goldman Sachs until 2007, about the global crisis, executive compensation, the Goldman Sachs culture and CEO succession, among other topics. Johnson currently serves on a number of for-profit and non-profit boards, including AIG, Intuit, Pfizer, Visa, Women's World Banking and the American Red Cross.
An edited transcript of the conversation follows.
Michael Useem: Suzanne, thank you for taking the time to talk with us today. I'm going to begin with a question about your background. You worked for Goldman Sachs for 22 years, but left the company before the crisis really hit in full force. Goldman has been one of the investment banks that people thought would survive and yet it has faced its own meltdown in recent months. When you were there, did you see any signs in the financial services industry that we were headed for the type of global disaster we are experiencing now?
Suzanne Nora Johnson: Mike, thanks very much for the opportunity to speak with you today. I think that the most important warning sign was the fact that if you look back several years ago -- and even as late as 2007 -- the only undervalued asset class that you could find was risk. Literally, you could go to traditional asset classes, whether it was real estate, commercial/residential, whether it was emerging market debt or equities, whether it was private equity alternatives from venture capital to private equity -- clearly the risk premiums were mispriced.
Why I say they were mispriced, literally, [is that] there were no differentials from one very sterling credit to one lousy credit. That was a warning sign. You also had the warning sign that volatility was at an historic low. There were, again, no differentiations on the volatility front. The flipside of it was that we were going through an extraordinary period of time when the globalization revolution actually had created quite [a lot] of profound change -- meaning many countries around the world were part of an active trading regime. Around the world, you saw many people pulled out of poverty. The two kinds of macro trends that were positive were that you were going through a period of historically low inflation around the world and also low interest rates -- which, again, for the average man or woman around the world, was a positive in terms of their standard of living. That said, this produced profound imbalances. Those imbalances really were the underpinning of the asset pricing problem that I referred to when I first answered your question -- which really was kind of a tip off that something was probably amiss.
Useem: We have often heard it said that J.P. Morgan Chase and Goldman Sachs had taken more steps [than others] to protect themselves, especially from the subprime mortgage meltdown when it did come. We've often heard it said that at Goldman in particular, a management culture had developed over many decades which helped people in the ranks bring bad news up to the top. So therefore the CFO and CEO at Goldman, in effect, had more early warnings than might have been the case at other firms.
Johnson: Goldman Sachs was extraordinarily lucky and fortunate that, in fact, it had come relatively recently from a partnership culture. If you remember, the firm went public in '99. But there was still a large number of people -- both in the partnership and non-partnership ranks -- who had grown up with a partnership structure. That partnership structure meant that there was relative transparency from one division to another, from one desk to another. People could ask questions about what was going on. And you knew the real live individuals there who had everything on the line. It wasn't just their own personal capital, it was the livelihoods of thousands of employees.
That was a great foundation going into both the expansionary period at the beginning of the decade, and then the problems toward the end. You don't lose that overnight. Also, there was a view in [recent] years that we didn't need to be biggest. We wanted to be "Best in Class," and we wanted to be very good at what we were doing. So there was extraordinary accountability inside. In terms of -- were you good at what you were doing? What kinds of risks were you taking to get there? How high-quality were the activities that you were exercising? I would also say that, just from a diligence perspective ... it was fortunate that you had ... market share leadership positions in so many businesses. You didn't have to stretch everywhere. And, again, if you look at many people in the financial services industry, it was clear that they were stretching very, very far afield.
Useem: When you joined Goldman, you were the inheritor of a culture, a way of doing business that had put Goldman on top for many, many years. But as you rose up through the ranks -- as you became vice chair -- you were also the maker of the culture. So, thinking back about how you and other executives helped create and sustain a culture that you just described very tactically -- what does it take to create that kind of ownership, of everybody taking responsibility, everybody feeling they are a leader, wherever they may be in the bank? It's a cultural statement, but that was the mindset created. The question is, how do you create and sustain that kind of a culture of ownership and responsibility?
Johnson: I know this sounds too simplistic an answer, but at the end of the day, it comes down to: Do you walk the walk, not just talk the talk? In an organization as large as Goldman Sachs -- it was several thousand when I joined and close to 25,000 when I left -- when you have that large an enterprise, everyone who's in a leadership position is watched very, very closely to see what their actions are. So starting with Hank Paulson, he put in some very formalized what I'll call "ethics training programs," or kind of "true north programs," that were cross-firm, cross-divisional, where they were taught by both Hank and the other members of the management committee and then other partners. Again, there was formal training with real live situations discussed. But also, in everyday business, people felt comfortable talking about kinds of moral dilemmas -- not just compliance dilemmas or legal dilemmas, but really, "Were there ethical issues?" I can think of a number of situations where people celebrated if someone turned down a piece of business, or decided not to go all the way on it.... Once you could celebrate or reward non-revenue generation -- or risk-avoidance, is another way of looking at it -- that helped reinforce the messages.
Useem: Given that culture, given that mindset, given that dominance of the markets, the last 12 months have not been kind to Goldman -- along with everybody else. I realize you have now been gone for a couple of years, but looking back on the company, what do you think has happened that led it to become officially, now, a commercial bank? Just comment on the events of the last 12 months, as Goldman, along with everybody else, has struggled to get through them. What happened at Goldman?
Johnson: Again, with the very fair caveat that I haven't been there formally in the last two years, the observation I would make is that, historically, the business's success was highly correlated to what global GDP looked like and how active the capital markets were. As you know, in the last 12 months, we've seen a significant reduction in global GDP growth, and also a real quieting of the markets, a lack of market activity. So, that being kind of the soup, if you will, from which they fed, it being greatly reduced also made it much more challenging for them. One, you just have to understand, as a market participant, that this single issue was the biggest one. Again, I really credit the leadership, over many years, of having risk management systems that were quite thoughtful and rigorous -- for example, Goldman Sachs looked at liquidity VAR [value at risk] as well as VARfor many, many years to get a feel for what would happen in the case of a true liquidity crisis. But we've had events now that are at the tail [the unlikely extreme of a probability distribution]. If you had tried to probability weight -- how likely is it that we would have the kind of meltdown -- most people would have commented that it would have been a very, very low probability that you would have this kind of interconnected meltdown. Did certain commentators absolutely see it coming? No question. But I think the kind of depth and magnitude of it was hard for even the best minds, and the most rigorous risk management systems, to understand.
Useem: Arguably, one of the problems that we're all now working to overcome is a mindset that did not see the tails, that did not anticipate the once-in-a-century kind of event. Other factors, though, we need to be mindful of as well -- which include the relatively short-term thinking that seemed to dominate many financial decisions in the financial market. Picking up on all of the above, as you think about the culture of American business, not just financial but beyond -- do we need a change in mindset? Do we need a cultural shift? Is it a matter of tweaking, or should we really be rethinking our business model? And then, to add one last quick, final question to that long question, if a culture shift of some kind is required, who's going to make that happen? How difficult is it going to be to push through?
Johnson: I've actually thought a lot about this question because so many thoughtful people I know have said, "I'll never take a management position in a public company. I'll only do it in a private company." When they say that, I always ask them: "What is it that's motivating you?" And they generally come back with something that says, "I want to be able to do the right thing." Then I say, "Well, what does that mean?" And they say, "Well, I want to be able to balance the need to optimize shareholder equity with other constituencies, to do it somewhat under the radar screen."
And, again, I always look at the radar screen as a double edged sword. "Are you doing that because you don't want to be transparent? Or are you just doing it because you want to find a way to do some of the difficult decisions that might be challenging?" The other element of that which is relevant is that the U.S. and much of the Western world -- and much of Asia -- has a public company model that still is very short-term focused in terms of what institutional investors are rewarding. So, as I think about ways to change a culture, often it revolves around compensation structures. Again, I think compensation structures will likely be more transparent, rather than less, going forward. To the extent that those compensation structures are more long-term focused, that isn't necessarily always in line with what your shareholders -- particularly your more active shareholders -- are demanding. For example, I can see compensation structures making incentives multi-year. And I don't mean stock vesting. I literally mean that your revenue targets -- your earning targets -- are multiple years, not single years. I could see clawbacks. I could see looking at internal rates of equity -- meaning how much differentiation is there from the top to the bottom. All those things would have significant culture changes.
But to go back to the beginning -- of private company versus public company -- I think a lot of people sense that they would have a lot more flexibility in a private company setting to do some of those things, which means doing the right thing, making longer-term incentives, having ... clawbacks, having the kind of thing that helped justify a culture of "one for all," not "all for one."
Useem: As a non-executive director at Pfizer, AIG, Intuit and Visa, you're in kind of the hot seat on this very question right now.
Talk through a little bit what it means to move compensation towards more long-term. Are we talking three years out? Are we talking five years out? How would you structure it? Be as concrete as you can here -- to ensure that the top people, say at Pfizer, Visa, or you name the company -- are ready to look at what those companies need [in long-term executive compensation].
Johnson: I actually like seeing kind of multi-year timeframes. Clearly, you need to have some annual timeframes, because often budgets and investors are on that timeframe, at the very least. So you obviously have to have some annual metrics. But I think two, three, five-year metrics can be very, very healthy protocols to go through. It generally lets you live in and out of business cycles. It gives you a sense of who performs particularly well in adverse conditions. And hopefully there's a high correlation in the longer term of companies that do this with their shorter-term earnings, although, again, I think that's the billion dollar question. Can you make it somewhat consistent with those shorter-term expectations of public shareholder growth?
Useem: Suzanne, you joined the board of AIG, attended your first meeting, when AIG was really in the process at that very meeting of deciding it had to be, in effect, nationalized. What was it like to have joined the board of AIG at that particular moment?
Johnson: I would compare it to Ed Liddy's experience. Ed Liddy -- as people probably know -- is the CEO of AIG, who was brought in by the (U.S. Department of the] Treasury to replace the then-current CEO. Liddy had been the CEO of Allstate. When he was asked to take on the job, he was told, "This is really an act of public service. It's a very difficult, challenging situation." I think that's the way that you have to look at these situations -- it's critically important that we restore the financial quality, integrity and soundness of our system. Again, I view our whole economy -- both domestically and globally -- being very closely correlated to the strength of our financial institutions. I view it as, "Can you help make it right at this point," recognizing that you're having to balance public and private sector constituencies?
Useem: I'm going to change focus here. Thinking back on your own career -- you were trained as a lawyer, you clerked for a judge -- you've seen many law students as they have come out of law school over these years. You've seen many graduates of business programs as well. Do you think that the men and women coming out of law schools and business schools these days should have a different skill set, so to speak, a different orientation, than those who came out 20 or 30 years ago? And now, looking back at the schools themselves, are there some changes that law schools and business schools ought to be thinking about?
Johnson: Mike, it's a great question. I'll tell you, I've really seen the recruiting landscape change. When I joined Goldman Sachs over 20 years ago -- and I had practiced law for a number of years at that point -- most of the questions they asked were very broad, global, macro, thoughtful questions that would test my insight, my judgment, my common sense, my ability to deal with difficult questions. Over the last number of years, I have found that we gravitated much more toward asking people, "What was their experience in the business?" meaning at a summer job or as an analyst. "Why did they want to be an investment banker?" "Why did they want to be a trader?" "Why did they want to be an analyst?"
It's not that I don't think those questions are important, but I'm hoping we will get back to much broader gauged individuals who really do have extraordinary qualities of accomplishment, leadership and integrity -- that manifest themselves more broadly. Because I really do think people who understand the world -- no matter what situation they're in, whether that means globally or even in a domestic context -- are being more broadly gauged. It's not that I don't want people with quantitative aptitude who can do the rigors of a financial job. But I think those other qualities are more important at the end of the day [in terms of] how successful we will be and how successful your institution will be by having that cohort of people.
Useem: Suzanne, to put you on the spot here. If I'm a newly-minted graduate of a law school, a newly-graduated MBA holder -- I'm in your office, you're considering me for a position -- let's say at a Goldman Sachs or a Pfizer. What would be a question you might pose, now -- to get beyond the more particular issues that you said are more typical -- to gauge my ability to think broadly, to work effectively, longer-term, within the enterprise?
Johnson: Well, one very simple question I always ask is, "What's the most difficult situation you've had in your life, and how did you overcome it?" Just because I want to try to understand what level of adversity someone has actually really had, or how they think about adversity. Again, what was their game plan for changing it. And then I always ask people, too, to rank certain personal attributes, worst to best. If you can imagine all the very accomplished people I interview, they always answer it, first, best to worst. Then I force the other way around. And I find that by having them rank their worst to their best, in terms of core attributes, I get a lot more thoughtful answers in terms of how they think about those personal traits.
Useem: When you were still with Goldman Sachs, a couple of years back, the media often described you as one of the most influential women on The Street. Looking back on your own career -- think about the glass ceiling; you helped break it along the way -- talk a bit, if you would, about your own experience with the glass ceiling. Reference what it was like when you began, to what you think it is now, for women coming into investment banking.
Johnson: I think the single biggest change for women is that generationally, people think about differences more broadly [and] very differently. The cohort in business school today thinks about gender differences -- ethnicity, racial differences, global differences -- much differently. They're much more used to dealing in a very diverse world and understanding what the benefits of that are. That has changed in mindset. What hasn't changed -- and we have to still continue to push -- is you get very different cultural norms and very different value judgments, depending on how diverse a group you get. I find that whenever any one group tends to have a preponderance of influence, or concentration, that always skews the answer -- on questions or on modes of behavior. For part of my career at Goldman Sachs, I ran a group in investment banking with another partner -- who was an African American, but of African descent. His father actually was an African, from an African country. We had a group that was almost evenly balanced on any metric -- gender, ethnicity, race, nationality. I found that our group actually got the best and the brightest, in terms of questions being answered and addressed, problems being addressed, alternative methods of marketing, having insights. I really was still taken by that experience -- it clearly had a different cultural vibe than any other group I had worked with at Goldman Sachs.
Useem: [From your vantage point] as an independent, non-executive director on four major boards -- it's often said that for non-executive directors, the single most important decision is picking an executive successor as CEO. As of today, what would you look for when there is a succession event -- a CEO stepping down. Maybe you asked the person to step out or maybe that person has come to the end of their natural tenure. If you wouldn't mind walking us through the three or four criteria -- in light of the events of these past 12 months -- that you think would be vital to get the right strategic fit between the person you're looking at, and what one of these companies -- or maybe all four of them -- would be looking for, going forward.
Johnson: Again, not commenting on any individual company, but just as a general observation, I still find that companies that do the best are the ones where there is a very strong sense of succession planning, and there are multiple internal candidates who could assume the role. Because I do think understanding the culture, having been part of it, having paid your dues, having done the right thing, being rewarded, has incredibly powerful commercial impact -- and also has very powerful incentives inside, organizationally. That's not to say that, at times, you don't need to go outside and find the best, because there are circumstances where you need to do that. But on the margin, where you can go inside, I think it's very powerful. In terms of leadership attributes, first and probably most importantly, are they someone who has the kind of strategic vision and articulation -- literally, communication capability -- to motivate the troops to deliver to that common vision and understand that vision. And to external constituencies, can they make a very compelling enunciation of what the company is all about.
That, again, is reflected in their products, services and people -- but that is something that is true north, for both the inside and the outside.
It almost goes without saying that [it should be] someone of impeccable integrity. Related to that is their character. And do they have judgment? Do they have ability to take very tough topics, and, again, 99 out of 100 times, come out in the right place? I say 99 out of 100, because I assume there's always some gray areas where you could go either way. And then do they have courage? Can they do things that other people can't?
Useem: Let's assume you have three -- maybe even more -- great candidates in the ranks. A chief executive working for you as a non-executive director is about to step down. Or maybe you've got a six-to-12 month notice. People in the ranks at the senior level -- they're not there if they're not very good. But you want to find out who is the best. It's often a more difficult challenge than I think we sometimes appreciate. And let's assume that, as a non-executive director, you don't see them day to day -- could you offer up a couple of thoughts on how, as a non-executive director, you can cut through the images? Cut through reputations? Help identify, of three final candidates, which of those three best exemplifies the kinds of qualities you've identified?
Johnson: I'd say, first of all, the thing that I don't like that a lot of companies do is they set up horse races for internal candidates where they make it very clear that two, three or four people are in the running. And everybody knows it. I actually think that often causes more damage than it does good. You find that people are play acting for you more than anything else. But I do think [it's important to] find ways to make sure that your pool of potential candidates gets some face time, in a formal sense, presenting to boards, so that you see them over a period of time, [and can] interact in a formal setting. I've also found that, on some boards -- where if you make it a constant practice that every time you have a formal board meeting, you're having lunch or breakfast with a different member of the management team, getting to know them kind of one on one, or in a small group with a couple of board members -- you get a very different perspective than seeing them in a smaller setting. [You see] how they think about the world. Also, seeing their 360s -- and really understanding what the organization thinks about them, not just what the CEO thinks about them -- is critically important.
Useem: Suzanne, a final question. As the public looks in on, not just Wall Street, but large corporate compensation packages at the very top, there is a public revulsion -- maybe that's too strong a word -- but certainly a strong public criticism that for too many people at the top -- as their company is going south, their compensation is going north. Aside from that, aside from the poor correlation between pay and performance, many people think that the top people on The Street, the top people in industry in general, are, simply put, overpaid. What's your thinking on that one?
Johnson: That's interesting, Mike. I was with Lester Crown, at the Aspen Institute, maybe 10 or 12 years ago -- before executive compensation became a hot topic. He was saying how distressing he found it, as a board member, because clearly the way it was justified is you would look at employment comps of outsiders. And often when you would bring outsiders in, it would raise the whole comp level. He was very disturbed about this practice. I think you can use internal equity as a good touch point, and what I mean by internal equity is really looking at the differentials, from top to bottom, in an organization. I do think no matter how good somebody is at the top, if you see that stratification getting too significant, it is a warning signal to you. It is a red flag. And the other thing I have found -- and there's a fair amount of academic literature which absolutely supports this -- is that the more unequal you make your compensation structures, the more you pay, in total. Because often people are willing to take lower pay, if they think there is real equity, parity and fairness. The more they think there's unfairness in the system, the more they are chasing somebody who has a higher comp level who they are perceived to be a lot like. Again, I think we do this to ourselves sometimes.
Useem: I'm going to close with an extra question. The next 12 to 18 months are vital in the U.S., vital in Europe -- really, the world -- for getting through this enormous crisis that we've managed to walk ourselves into. It's sometimes said now that the private sector has helped create some of the problems, but many other forces are responsible, as well. But to dig out of this crisis, [some say] it is a time for government, for agencies, such as Treasury, for regulators, such as the SEC and their equivalentsaround the world, to not get the upper hand, but to take a strong hand in the months ahead. What's your cut on that one?
Johnson: It's clearly important for the government -- the public sector -- to provide a substrate for the conditions for reform and basically for rejuvenation of the system. But by providing a substrate, I think they need to make a very healthy, functioning private sector because that is where you still are going to have job creation over the longer term. You're going to have people build competitive advantage. And you'll have much healthier systems. So, again, they provide the substrate, but to think that they, alone, could solve this problem would be a mistake. There really does have to be a partnership with the other sectors of the economy.
Useem: Suzanne Nora Johnson, thank you for talking with us today.
Johnson: Mike, thanks. It was a pleasure.