It was recently reported that Goldman Sachs is taking measures to reduce the number of new partners for its 2020 class. The issue is that Godman’s profit pool, which was $400 million and divided among 220 partners in 2000, is now a little over $500 million and is divided among 550 partners. The consequence is that each partner at Goldman Sachs earns on average of $910,000 per year today compared to $1.80 million in 2000 (and the 2000 figures are in nominal dollars–not adjusted for inflation–so the difference is even more stark.
When the conservation about Goldman Sachs’ partnership structure comes up, many remark upon how even today’s lower figure remains extremely high compared to average executive profit-sharing in the United States and that no one wants to hear high-earners complain about how their profits “ain’t what it used to be.” True points, but low-hanging fruit.
A broader point that is rarely discussed is: How does Goldman Sachs have partners when it is a publicly traded corporation? Isn’t there an inherent conflict as to the division between profit-sharing that is attributable to a particular partner and the profits that should go to someone as a shareholder of the common stock?
The answer is that Goldman Sachs enters into a contract with a given partner (often called the “partner managing agreement”) that contains a base salary plus a certain percentage of profit for a particular project under the partner’s purview. These agreements are deemed confidential but Goldman Sachs did make its partnership agreement public in Exhibit 10.50 filed with the SEC as part of its IPO two decades ago.
For the most part, Goldman Sachs’ partnership agreement is indistinguishable from an incentive-performance plan that is in place at nearly every Fortune 500 company. If a partner’s assigned unit does well, compensation as high as 25% of profits can go to the individual partner with the remainder going to the Goldman Sachs shareholder.
Where it gets controversial is when a particular partner, believed to be so valuable to the firm, succeeds in negotiating a contract for a share of profits unrelated to an area under its purview. For the club of 550 managing partners at Goldman Sachs, there is a $500 million pool of profits split among the partners where only $350 million is attributable to business units under the partners receiving the profits. For the remaining $150 million, the profit sharing is coming from business operations that are wholly unrelated to the active management of the particular partner.
For this $150 million profit pool, it would be the equivalent to the managing director of Coca-Cola’s Mexico operations collecting a percentage fee from the Mexican operations as well as the Canadian operations. It raises the question: If this guy is doing nothing in Canada, why is he receiving an employment contract that entitles him to profits there? The corporation’s answer is that the added compensation is necessary to prevent the excellent manager from taking a job with PepsiCo.
In the case of Goldman Sachs, there are $6.8 billion in profits attributable to shareholders. If the managing partners only collected a base $910,000 salary without any profit sharing, the shareholders would be earning $7.3 billion in profits for an average of $21.28 profits per share instead of the $19.98 per share that is attributed to the shareholders now.
What is interesting about recent reporting is that, since the number of Goldman Sachs partners is higher than the historical average and profits are down due to COVID-19, the current partners are clambering to collect a 25% profit-sharing arrangement from a larger pool of investment sources for which they are not directly responsible from a management point of view. There are rumors that approximately $1 billion of Goldman’s current profits is requested to be added to the pool, which would mean that the 550 partners would collect an additional $250 million as part of their partnership sharing arrangement from a pool of funds that is currently to the benefit of the common stockholder.
Under Goldman Sachs’ Restated Articles of Incorporation, a director of the corporation is entitled under Paragraph 9 to enter into any agreement based upon (a) the interests of shareholders, (b) the interests of partners, or (c) any other additional factor that the director considers appropriate. This is significant from a fiduciary duty perspective because it means that a director of Goldman Sachs is not bound to follow the “shareholder primacy” view of the corporation where all decisions must be made for the benefit of the common stock shareholder, but rather, a director can make decisions based upon the interests of a partner or even any other factor that is deemed “appropriate.” Your guess is as good as mine regarding the future extent of Goldman Sachs’ profit pool, but it is important to note that management is expressly not legally bound to act for the benefit of stockholders alone when determining profit allocations.
Even aside from the peculiarities of present economic conditions, Goldman Sachs has not been able to grow its profits for common stockholders over the past decade. During this time, the universe of the firm’s profitable activities that are subject to a 25% collection from a partner (even outside the scope of the partner’s managing zone) has been increasing at a moderate rate. It is probably not surprising that Warren Buffett discarded with all of the Goldman Sachs stock that was sitting inside Berkshire Hathaway’s portfolio from the financial crisis. The profit override from insiders is unlike almost any other firm, and the directors are authorized to expand the share of the partnership profit stake without encountering the typical gamut of fiduciary duties as obstacles. Common shareholders, take heed.