A Discipline That Defines
What do we call it when a company reduces its mortgage portfolio well before the market crash, raises $10 billion in capital prior to TARP, avoids the CDO fallout, and reels in a $5 billion investment from Warren Buffett during the dark days of the Great Recession? At Directorship, we call it Goldman Sachs. We are pleased to announce the venerable financial firm is our choice for “Best Governed, Best Performing Company” in the Fortune 500, and its CEO, Lloyd Blankfein, is named CEO of The Year for 2009. Some say it is the trading floor, others say transactional prowess. But we believe thoughtfulness is the magic elixir behind Goldman Sachs’ success. For example, the firm outlined its global approach to risk management in a letter to the Financial Times written by CEO Lloyd Blankfein:
Lessons from the Financial Crisis
The first is that risk management should not be entirely predicated on historical data.
Second, too many financial institutions and investors simply outsourced their risk management.
Third, size matters. For example, whether you owned $5 billion or $50 billion of…a CDO, the likelihood of losses was, proportionally, the same. But the consequences of a miscalculation were obviously much bigger.
Fourth, many risk models incorrectly assumed that positions could be fully hedged.
Fifth, risk models failed to capture the risk inherent in off-balance sheet activities.
Sixth, complexity got the better of us…new instruments outstrip the operational capacity to manage them.
The last is that if more institutions had properly valued their positions and commitments at the outset, they would have been in a much better position to reduce their exposures.
For Goldman Sachs, the daily marking of positions to current market prices was a key contributor to our decision to reduce risk relatively early in markets. This process can be difficult, and sometimes painful, but I believe it is a discipline that should define financial institutions.
Without Peer
The rationale for a compensation peer group is simple: your quarterback gets paid like the other teams’ quarterbacks. But defining the actual components of a peer group can be a challenge, and some investors will criticize it as stacking the deck. So we looked at Proctor & Gamble’s peer group, largely because it is a company most of us are familiar with. You might be surprised by the company it keeps: AT&T, GE, Wal-Mart, Exxon, GM, in addition to Colgate. Is this fair? What does oil-reserve accounting have to do with marketing soap? Turns out, a goodly amount. Most compensation critics put too much weight on product mix as if P&G’s peer group should only be competitors who stock grocery store shelves. But the fact is that companies are systems, and like a computer they have front and back ends, as well as middleware. P&G may not look for oil in the ground, but you can be sure it thinks just as carefully about the environment. P&G is not an automation company, but GE’s Jeff Immelt would likely be impressed by how P&G manages manufacturing. A peer group is not always a pretty thing, and its usefulness will be questioned if arbitrary benchmarks like making the 75th percentile a pay barometer are used. But a healthy diversity among the peer group reflects the underlying trends in the system we call the modern global corporation.