PLSC 270: Capitalism: Success, Crisis, and Reform

Lecture 21

 - Guest Lecture by Paolo Zanonni, Part I


Guest speaker Paolo Zanonni, partner at Goldman Sachs, discusses the firm’s transition from a straight partnership to a hybrid partnership / joint stock corporation. The impetus for the transition was to obtain the advantages of the joint stock corporation, especially in raising permanent capital, while maintaining the beneficial incentive structure of a partnership. The partnership selection process, which fosters leadership, entrepreneurialism, and conformity to the firm’s corporate culture, has remained virtually unchanged since Goldman’s IPO. Mr. Zanonni describes the corporate culture and values of the firm as seen from the inside.

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Capitalism: Success, Crisis, and Reform

PLSC 270 - Lecture 21 - Guest Lecture by Paolo Zanonni, Part I

Chapter 1. Introduction and Course Agenda [00:00:00]

Professor Douglas W. Rae: We’re very privileged today and Wednwesday to have my dear and good friend of thirty-five years standing, Paulo Zanonni, who has for quite a long time been a partner at Goldman Sachs, and is indeed the second most senior member of the Goldman Sachs partnership, by age. Today we’re going to do a very informal class with facts on the slide sheet as background. We’re going to have Paolo talk about how Goldman actually works at seeing from the inside, which will be a rare opportunity to see the most remarkable American business firm from the interior. It’s truly a great opportunity for all of us. Then on Wednesday, Paolo will do a major European case managed by Goldman Sachs, and a case which was in progress when he was here a year ago, and it has now come to its fruition. The slide set for that is posted — that will be a little more formal than today, but still informal in style. Please help me welcome Paolo Zanonni.

Chapter 2. Paulo Zanonni before Goldman Sachs [00:01:44]

Paolo let’s talk about you to begin with. You are Northern rather than a Southern Italian?

Paolo Zanonni: Center-north, yeah.

Professor Douglas W. Rae: Yes, and is there any significance in North/South in Italy?

Paolo Zanonni: Yes, I think there’s significance.

Professor Douglas W. Rae: Are there — how many people of Southern Italian descent in the room? Sort of?

Student: Sicily.

Professor Douglas W. Rae: Okay. How do most Northern Italians look on that distinction?

Paolo Zanonni: They look at that distinction like the South was almost a colony, occupied or conquered in 1861, and never really — sort of conquered but that never really assimilated.

Professor Douglas W. Rae: Assimilated; the North is the industrial and business part of Italy, is that a fair statement?

Paolo Zanonni: The North is the most industrialized part, yes, but in the South you have — I don’t think you want to go into the Italian political economic system, but in the South you have certain areas that have a reasonably high level of industrialization.

Professor Douglas W. Rae: Paolo you came from — you first arrived in the states in what year?

Paolo Zanonni: 1973.

Professor Douglas W. Rae: 1973 and you came as a graduate student in the Yale Political Science Department. I remember it well.

Paolo Zanonni: Yeah.

Professor Douglas W. Rae: Paolo became an outstanding touch football player.

Paolo Zanonni: Too small for that.

Professor Douglas W. Rae: No, no you were really good at it. You even picked up the brawl language of the game.

Paolo Zanonni: That’s — size there is different.

Professor Douglas W. Rae: The — and you left Yale?

Paolo Zanonni: In 1978.

Professor Douglas W. Rae: In 1978 to go to work for Johnny at Fiat?

Paolo Zanonni: Yep.

Professor Douglas W. Rae: Tell us a little about that stint.

Paolo Zanonni: That’s the — I worked for the Chairman of the Board and also the owner of the controlling stake at Fiat for about five or six years —

Professor Douglas W. Rae: Right.

Paolo Zanonni: — and after, I became — I wanted to do some more operational experience and so I went to manage the international business development department at Fiat. In that capacity I spent about five years in Washington, here, because we had asked Chairman of Fiat U.S.A., because we had some issues with the then U.S. Government, and after, I spent two years in Moscow in 1990 and 1991.

Professor Douglas W. Rae: What were you looking at in Moscow?

Paolo Zanonni: In Moscow I was looking to acquire the largest Russian manufacturer of automobiles that the government — first the government of the Soviet Union, and second the government of the Russia Republic, when the Soviet Union was dismembered, or disappeared, I decided to buy [inaudible]. That company has been established by Fiat as a wholly owned company from — wholly owned by the Soviet state about fifteen years earlier, and so it was based on Fiat technology and both Gorbachev first and Yeltsin afterward wanted to privatize, and I was sent there to try to buy it, unsuccessfully.

Professor Douglas W. Rae: Ultimately — you ultimately walked away from the deal as I understand it?

Paolo Zanonni: Yeah. We walked away because there was no deal for the simple reason that the management and the region, some area region wanted to become owners of the factory and have ownership of the asset and 100% control on the profits, and on the cash flow, and so they were definitely — they were not willing to sell it to a foreigner.

Professor Douglas W. Rae: So that’s a non-starter. Then after the stint in Russia?

Chapter 3. Paulo Zanonni at Goldman Sachs [00:06:20]

Paolo Zanonni: I did a couple years more at Fiat, and after, I decided to join Goldman.

Professor Douglas W. Rae: Then you joined Goldman?

Paolo Zanonni: Yeah.

Professor Douglas W. Rae: And you joined them as — what was your title at that time?

Paolo Zanonni: At that time, Goldman did not have managing directors, as opposed to — so it only had vice president — sorry it had associate — analyst, associate, and vice president of various degrees of seniority and I joined them as a — the last degree of vice president, and after, I became managing director in 1997 and a partner in 2000.

Professor Douglas W. Rae: Let’s now turn to Goldman. I’m talking to these people now for a second. You’ll remember the stark contrast we’ve drawn between the ownership for — of joint stock corporations, publicly traded joint stock corporation on the one hand, and a partnership on the other. Can somebody help us out by naming the two or three variables on which those two are most importantly different? Okay I’ll settle for one variable.

Student: Liability.

Professor Douglas W. Rae: Okay limited liability in the case of the joint stock corporation; good. Another?

Student: Liquidity.

Professor Douglas W. Rae: Liquidity; huge difference. You can’t sell your partnership in Goldman. Another?

Student: Partnership income is not taxed separate from the [inaudible].

Professor Douglas W. Rae: The partnership is invisible in the tax codes so that the proceeds —

Paolo Zanonni: The individuals get taxed, the individual partners get taxed.

Professor Douglas W. Rae: The individuals get taxed, okay but it in effect saves one layer of taxation. Yes.

Student: The right or ability to make management decisions.

Professor Douglas W. Rae: Okay so that in the case of a partnership everyone has a management job, all the partners have management jobs. Whereas, with a corporation you have centralized management where the board appoints a chief executive and a chief executive, at least in theory, is responsible for appointing everyone else, and finally, how did the two do as media for raising capital? The mechanism for raising capital; back to Paolo.

Student: A joint stock corporation is much more scalable. It’s got greater scalability; you can raise a lot more capital than a partnership.

Professor Douglas W. Rae: Okay. The joint stock corporation was created as a mechanism for gathering up capital in very large quantities and it’s good at it. Now back to Paolo. Historically, Goldman was straight-forwardly a partnership?

Paolo Zanonni: It was a partnership up to 1999, but you have read the case study with the IPO of Goldman Sachs.

Professor Douglas W. Rae: And it was an extraordinary partnership with an extraordinary record of success in nearly all of its history. Is that a fair statement?

Paolo Zanonni: In 1999 with — it’s a fair statement. There are a couple of exceptions — 1929.

Professor Douglas W. Rae: Tough on a lot of people.

Paolo Zanonni: Yes, tough on a lot of people. Especially tough — almost killed the partnership. There is another exception which is interesting for your class because usually investment bank and securities firms tend to do badly, tend to be very cyclical, and to do badly on the downturn and well on the upturn. There was one exception, one exception, at least as far as Goldman is concerned, which is very interesting, everybody else was doing very well in 1994 but Goldman was doing very badly and it almost killed the partnership. As badly as — almost as badly in 1928, and as badly as the crisis or [inaudible] and the reason for that, and that again, mixed blessings, one of the facts of life.

The reason why Goldman was doing very badly was because Goldman has tried very aggressively to do proprietary trading, especially in fixed income, and that was not really part of the Goldman culture. The risk management and the trading organization of Goldman was very bad, and in 19 — toward the end of 1994, second half of 1994, Goldman started having losses at that time that were staggered, especially for a partnership. Almost the — the capital of the partnership was almost wiped out, and actually that’s where the firm had the remarkable ability of select — a group of leaders that knew — that came from trading, knew proprietary trading very well, even if some of them were not born in the same — in that same organization, and were able to restructure the trading philosophy and especially the risk management function of Goldman and probably one of the reasons why Goldman has done not so badly when the credit crunched, is because of that overhaul of the risk management and of the trading format style, and control of the autonomy of the traders. Actually the two people that did it, one was Corzine who was a managing partner when the firm went public, and the other was Lloyd Blankfein who is CEO today.

Professor Douglas W. Rae: Corazine may be available for —

Paolo Zanonni: If he could come back to Goldman.

Professor Douglas W. Rae: Kidding.

Paolo Zanonni: I think it he wants too.

Professor Douglas W. Rae: The mood — just notice the style of which Paolo just said something. He said Goldman has done fairly well in the current crisis. Now that’s a huge understatement; Goldman has blown the doors off the current crisis.

Paolo Zanonni: End of 2008 wasn’t a nice period.

Professor Douglas W. Rae: It was an ugly period, but compared with all its competitors, in this and in many other matters, Goldman has been absolutely tops, and part of the culture is not to — chest thumping is not the Goldman style. There’s a very understated style that emerges, and which Paolo, I think, embodies. Now the move to a corporation — corporate ownership form has an obvious upside in raising capital, but an apparent downside in changing the incentives for top management in a way that might, at first blush, seem likely to undermine the cultural strengths of the historical partnership.

Paolo Zanonni: Yeah.

Professor Douglas W. Rae: Why don’t I shut up for quite a while now and let’s get you talking about how that has been accomplished and how it works, and somewhere or another we ought to talk about how people are recruited to the partnership and to leadership roles in the firm, and how that might relate to the style of management that you get with Goldman.

Paolo Zanonni: I’m sure that you are — I’m sure that in Doug’s course you have gone through it and parties in the case that I have read. The two advantages of a partnership, especially in the investment banking world, and a securities firm how it might be is one that as opposed to the joint stock corporation in which Doug — that Doug discussed with you, in a partnership there is no split between management and ownership. The owners of the capital of the firm are also the managers of the company, and so that’s a — creates a set of incentives but by not distinguishing between provider of capital and the people that have the control of the operation of the firm.

In Goldman, every generation of partners and leaders have always been convinced that this was a great advantage. The other advantage that you have is that — and this is an advantage especially in investment banking and securities firm, which are people business, they have no — if you look at these companies they are remarkable in the amount of sales of revenues that they have, they have no fixed capital. They have no buildings, most of the buildings are leased, they have no plant and equipment, they have no patents, it’s just a people’s business and so when you are running a people’s business one of your core competencies has got to be the ability of coordinating the behavior to those people 3,000/4,000/20,000 and Goldman has only been convinced that the partnership structure, it’s ideal to coordinate the behavior of the top echelon of the firm.

So the real challenge that Goldman was facing when Goldman decided to go public was to try to combine the advantages of the joint stock corporation, especially in raising permanent capital, because the partnership capital is not permanent. It’s limited, but if you are very successful, the limitations are not so much on the size as they are on the availability on the capital for a long period of time, because of course you can put restrictions on the partners on taking away the capital when they become limited, but those restrictions will just prolong their ability to take capital out. If not, nobody would like to be a partner, if the capital cannot be taken out. Goldman tried to — the then leadership of Goldman tried to combine the advantages of the partnership as far as having the owner management — to get the owners managers to manage the company and the ability to coordinate behavior.

What Goldman tried to do and is a unique form of corporate governance, is the partnership that is also a joint stock company. For instance, a title of partner was not eliminated, and Goldman built a structure in which partners are rewarded and incentivized in a different way than the other stockholders. The other thing that Goldman decided to do was, which is unusual in a joint stock company, and you won’t find it in any other partnership that has become a joint stock company, was to maintain the structure of the selection of leadership; i.e., the selection of the partners almost as it was before it became a joint stock company.

Professor Douglas W. Rae: Maybe too —

Paolo Zanonni: So what you have — let me try to — what you have is that you have the legal form of a joint stock liability company imposed into an organization that, as organizational structure, and institutional government, except at the top, has maintained the same institution and the same type of leadership selection that you had in the partnership — let’s say partnership pre-IPO.

Chapter 4. Partnership Selection at Goldman Sachs [00:20:49]

Professor Douglas W. Rae: Okay, so let’s talk about this leadership selection process beginning with the entering classes of employees.

Paolo Zanonni: Usually when you enter Goldman you are given a class, like you are given a class when you went to Yale, you are the class of 2007/2008.

Professor Douglas W. Rae: We designate them by the year.

Paolo Zanonni: At the end that’s correct. We designate it by the year in which they start. There is some sort of courses in which you are generally considered for partnership once you have spent a fair amount of time in the firm, and once you have been — you have done a stint as a managing director. When your class is up for partnership there —

Professor Douglas W. Rae: How big are these classes, more or less?

Paolo Zanonni: It depends, but let’s say that they are a few hundred people.

Professor Douglas W. Rae: 500 maybe?

Paolo Zanonni: No, a little less because —

Professor Douglas W. Rae: 400?

Paolo Zanonni: Between 400 and 200 — it also depends because, you know, the partnership has been — it’s not — there is no erasure. When we went public the partnership — the partners were about 200 ten years ago. There were still less than 300 three years ago, or four years ago, now there are more than 400. There will be a lot less in 2010.

Professor Douglas W. Rae: Okay, so you’ve got these groups of a few hundred and at a certain point it comes time —

Paolo Zanonni: It comes time to be considered. For someone that has done — that they have had normal career, it comes time to be considered. The way the selection works is the partners of each division make two or three lists of all the candidates of their own division, an A list, a B list, and a C list. The A list is the best candidate, the B list is the candidate that are somewhere in between, and the C list is the candidates that are not — that do not have a lot of chances in that particular year. The partnership selection gets done every two years, even years, 2000/2002/2004/2006/2008/2010.

Once these selections — when the first selection has been done, what the firm does is takes a group of people and charge them with the task of asking the community of mostly of the professionals about the candidates, and so there are a group of people that conduct rigorous — reasonably rigorous interviews among everyone that has worked with everyone. A large number of the people — of the professionals that have worked with the partner’s candidate, be they more senior peers, or more junior, to try to gauge the quality of that individual, and even more, the quality of that individual vis-a-vis, the group that is being considered as partner. This is a process that sounds easy, but it’s a process that takes about two months.

Professor Douglas W. Rae: If I remember our conversation correctly, the firm insists on people making pair wise comparisons?

Paolo Zanonni: The first insists on people make — doing a qualitative analysis, and after making — make a ranking of everybody they know, first, second, third, fourth, and fifth; and in certain cases making pair wise. When there are two candidates that are in a similar position, making pair wise comparison, which is a nice — which is an old way to do leadership selection. Because my understanding — but it my — it’s an understanding is that it was reasonably well used in the Catholic Church orders on the twelfth — eleventh centuries. Actually there is someone that proposed that in electing the Pope, the Pope had to be elected doing pair wise comparison of the candidates.

Professor Douglas W. Rae: Well did the Roman Catholic Church is one of the few organizations with more distinguished administrative history than Goldman Sachs.

Paolo Zanonni: I don’t know one of the few, but definitely. I think that Goldman consciously or unconsciously copied some of the — at least some of the criteria used by the Catholic Church.

Professor Douglas W. Rae: As you listen to this, think about what this process would do to your thinking if you were a junior person at Goldman Sachs. This is all designed to shape and mold a certain kind of person — of persona and management style.

Paolo Zanonni: And behavior —

Professor Douglas W. Rae: Pardon?

Paolo Zanonni: And behavior in your daily business.

Professor Douglas W. Rae: So — and you mentioned in our conversation this morning an element of the process called cross roughing.

Paolo Zanonni: The cross roughing is the one you just mentioned.

Professor Douglas W. Rae: Is there a bridge player in the room? Cross roughing is a bridge term?

Paolo Zanonni: I’ll try to find out what it means exactly. I have no idea.

Professor Douglas W. Rae: Is there not one bridge player in this room? That’s an interesting fact. I think it —

Paolo Zanonni: Lots of poker players but very few bridge players.

Professor Douglas W. Rae: What’s cross roughing in this process?

Paolo Zanonni: It is a process of a group of people selected to search about the — it’s the one that I’ve just described. That search about the qualities of the various candidates.

Professor Douglas W. Rae: But it’s from — they’re not in the same —

Paolo Zanonni: They’re not in the same division.

Professor Douglas W. Rae: — their division.

Paolo Zanonni: They are not in the same division. They belong to another division. Of course when you look at an organization you have to think about the organization. I’m getting to theoretical, sorry too abstract, you have to think about the organization in two dimensions, vertical and horizontal. If you take the divisions they are like the business in your normal industrial organization and they cut vertically. If you take the partnership it cuts the organization horizontal. If you want to have a very effective organization you should have a good blend and a two mix of horizontal cleavages let’s say and vertical ones, so the way the selection to the partnership is done, because of course you cannot have a group of people that look at 500 candidates, or 200 candidates, you do it by division. The first selection is done by division. When you do the least, the least are done by the division, but afterward since you — since the people that will do the selection are the gatekeeper to a horizontal cleavage in a horizontal organization, they are not — that gate are not kept by people from the same division, but they are kept by people from another division because you are moved to a horizontal organization that should coordinate the top of the various vertical divisions.

Professor Douglas W. Rae: So this is a way — in part of checking the tendency of divisions of the —

Paolo Zanonni: Silos

Professor Douglas W. Rae: [inaudible]

Paolo Zanonni: Becoming silosis.

Professor Douglas W. Rae: Silos — I heard last week a great expression to this, for a frog at the bottom of the well, the sky is very small, and that’s certainly true in many organizations right, where people get into their little parts and they’re not seeing what other people are seeing across the other divisions.

Paolo Zanonni: Not only, and having gone through a fair amount of restructuring in my professional life, both in an industrial organization — in a partnership and in an investment bank that was a limited liability company, when you get to restructuring it is very difficult to make a rational decision if the organization is mostly based on vertical division, because the vertical logic limits to some extent — not to some extent, limits to a major extent, the horizontal movement of individuals. So you tend to consider them only on a vertical scale, and when on the contrary, you are trying to restructure the organization or change the organization, or reduce the number or develop new business units, you have to be able to cut across a vertical division, because if not, you utilize your manpower badly, and you give your people a limited set of choice. They can only move either up or down, but not sideways, or the move sideways becomes difficult, and if the move sideways becomes very difficult, it becomes very difficult for the organization to follow new business opportunities because those tend to be lateral. Its increase in scope, not the increase in depth. Sorry we tend to become too abstract, sorry. I’m sorry.

Professor Douglas W. Rae: What are the qualities that are most important to cultivate? Students, you’ve seen the fourteen commandments in the case?

Paolo Zanonni: Fourteen business principles.

Professor Douglas W. Rae: Business principles, seen from inside, commandments seen from outside — what are we trying to achieve here, the behavior of the partnership and those who aspire to be in the partnership? What would be the top two or three qualities?

Paolo Zanonni: A reasonable degree of autonomy and independence, but without getting too independent — without pushing the independent to some extreme that it gets disruptive for the organization, so if you want you try to strike a balance between independence, creativity, and conformity, and historically I think Goldman has a premium to some extent on conformity versus creativity. I think that there are a fair amount of innovations in which Goldman has come second or third and other firms have had — have been a lot more creative, or somewhat more creative, so you try to strike that balance and of course one of the characteristic of that balance is the adherence to a very reasonably straight belief system, or corporate culture.

Professor Douglas W. Rae: How about chest thumping and conspicuous display of wealth?

Paolo Zanonni: Chest thumping definitely is out. A conspicuous display of wealth I would say, consider the standard of the industry is not too bad, but consider the standard of the industry. If you look at it from the outside the industry, it’s hard to judge, but it seeing it from the inside, at least its frowned upon, it’s not considered — actually it’s sanctioned to some extent.

Professor Douglas W. Rae: Well, and —

Paolo Zanonni: Precisely.

Professor Douglas W. Rae: — and it can actually, if I’m not mistaken, damage a Goldman career if you are sort of wildly ostentatious and pick up $10,000 restaurant tabs and that sort of thing.

Paolo Zanonni: Yeah, it usually — you usually don’t do it twice.

Professor Douglas W. Rae: So Goldman —

Paolo Zanonni: What is the — let me think about, for a moment, about another characteristic. Within the limits of the adherence to a straight belief system, and I know the two things seem contradictory, it also pushes you to be an entrepreneurial because de facto partners run their own business unit. The levels of hierarchy are very, very, very short. The organization is very flat, and one of the reasons why it’s flat is it’s trying to foster entrepreneurship, especially in the partners, because, see, the business in which Goldman operates, the industry in which Goldman operates, and you will see it, I’ll to give some examples in the printout that you have, changes very, very quickly.

For instance if you take a picture — we don’t give those details for many, many reasons, one of which is they change too often. If you take the thirty-six — let’s say thirty major business lines of Goldman five years ago, they are not the same as what they are today, so — because the environment changes so fast that if you are — if you still try to operate and maximize, or be efficient in the business of yesterday, or of this morning, mostly you are — so if you are a good manager maybe you are a bad interpreter and you are missing new opportunities of the changes and the changes the environment creates. What the firm is trying to do is to have global leaders that more or less think along similar lines, but that are able to capture new opportunities and new business line.

Let’s take — let’s for instance — I’ll start to make some examples; we run the risk of being too abstract. Let’s take, for instance, I’m sure that some of you, most of you, are familiar with the crisis of the savings and loan association of the U.S. at the end of the 1980s. Before that crisis Goldman Sachs had never done a real estate principal investment, never. Didn’t even own the building where they were because they thought that there were no capabilities inside the firm for making investments. Actually when they — what was it National Trust, or whatever, what was the trust that the federal government —

Professor Douglas W. Rae: RTC.

Paolo Zanonni: Yeah. When they started — when the RTC, or at least the national struggle, the federal owner of all the real estate property, if you remember, most of the crisis originated from the loans that the savings and loan association had done, especially for real estate developers, so of course the federal authority that ran — the bureaucrats, in good sense, that ran that authority started selling a lot of real estate cheap all over the United States. It was obvious that there was a business opportunity there, but it was also obvious that Goldman didn’t know about how to do it, because I mean IPOs, rate defense, trading of stock — of loans, yes, but never real estate. An exceedingly smart person, who by the way happens to be a Yale graduate, saw the opportunity, saw the lack of capability, and decided to form a partnership with someone that knew a lot about real estate all over the United States and didn’t have any capital.

Goldman started buying real estate, and real estate loans, for themselves — or for ourselves and for investors, and they — the massive investment history of Goldman in real estate, both real estate asset and real estate loans, started then just because of the opportunity — because of the opportunity offered by this trust corporation that was selling a large amount of real estate, obviously very cheap and the ability of one of the partners to see that there was an opportunity, but that inside the firm there was no capability and understanding which one was cheap and which one was not cheap. It seemed cheap but maybe it’s too expensive, but it would have been a bad investment anyway. And at the end, the partner that we had got tired, he made too much money and — but he had transferred enough knowledge to the partners and we bought it out and made [inaudible].

The same is true with our huge private equity. We — when I joined the firm we didn’t do much private equity. We did it on behalf of clients, we advised them when they are buying or selling companies, but we didn’t do it on our own. On the contrary, immediately after the crisis of 2000, the dot com crisis, we started seeing an opportunity and started seeing an opportunity that you were going to make a lot more money if you did it on your own than if you are advised by Blackstone. A lot of banks saw it, however, this is a very interesting — I forgot when — a lot of banks saw it, but they decided not to do it for one very basic and valid reason. The fact that if you do private equity you start competing with your clients, and that is supposed to be the sin number one in a service organization. However, the hubris of Goldman was such that Goldman believed that they were smart enough and good enough to be able to manage the companies. It was a conscious decision, there was a debate, I remember it because I was part of the debate, I was not part unfortunately of the debate of going public, but I was — I was on the outside. Actually I was — can we joke? I was actually cheated because I thought I was going to be in the next partnership, and so the partnership was going public in 1999 and I was up for election in 2000, the big prize was postpone or snatched to a limited, so actually —

Professor Douglas W. Rae: Pretty good prize as we all know.

Paolo Zanonni: Yeah it was a very good prize, but I was part of the private equity one.

Chapter 5. Goldman Sachs, Government and Society [00:41:58]

Professor Douglas W. Rae: Can I get you to talk for a minute about how Goldman manages its relationships with power in government and other branches of society, not just in the states but worldwide.

Paolo Zanonni: As me and you have discussed, I think that investment banking is a business where culture is very important and in all of you that are going to be here on Wednesday, you’ll see that when I speak about Enel/Endesa take over, the financial variables are important, but I will say that the variables that determine winning or losing sometime, what we call soft variables, but have little to do with prize and finance. For a global firm that operates in this business it is very, very difficult, if not impossible, to be able to understand the complexities of the business culture in which it operates. Your best way to understand those complexities and to avoid the landmines that are in different business cultures is to get someone that knows the business culture of that particular culture very well, so you end up selecting a group of advisors, in any nation in which you operate, that have a very deep understanding of that particular business culture and can guide you and your client through that particular culture.

I want to give you an example that is so — if not we have too abstract. I want to give you an example that it’s — actually it’s personal to some extent. Goldman was very late compared to the other firms in moving overseas. Goldman started a small operation in London in 1987, when JPMorgan was big, when Lehman was big, when Meryl was big — no Meryl started a little later, but definitely when Morgan Stanley was big, and at one point the problem that the Goldman people sent overseas faced was how do we get — how do we enlarge in Europe without making too many mistakes? The usual traditional way of American firms to do that was to send investment bankers from the U.S. and waited until they learned the various cultures.

A very smart banker, Goldman, who, by the way, is one of the first graduates of these SOM; when he had the responsibility of Europe he said — the reason why I know it and I say it’s personal because that’s the way in which I wasn’t counted. He said, “Wait a second, here we have to do something totally different. We have to select for every nation where we operate, someone that maybe is not a banker, who cares, but that knows that business culture very well,” and so we had a generation of lateral hires. Me, my colleague in France, one in Spain, one in Germany, one in England, one in Holland, one in Sweden, none of them came from investment banking; very few of them came from banking.

My French colleague came from the States, and when I did my interview with John Soren before the selection I said — he said what would you like to do, I said, “How can I think about going into investment banking, I can’t even count. I can’t count now. I can’t balance a checkbook.” He said, “Don’t worry, we have hundreds of people that can do that, and we will give you a smart VP that knows everything about investment banking, but you can operate an Italian business in [inaudible].” I said, “I think so.” He said, “Do you under — we want to have twenty clients, no more in Italy, or fifteen clients. Do you know which client we want and which we don’t?” I said, “I think so.” He said, “Do you know the way the client we want to operate inside?” I said, “I think so,” and he said, “Okay, who cares if you can’t balance a checkbook?” Goldman became the first investment bank in Europe from 1994 to 1997 in three years, when in 1993 it was well below everybody else, and it is due to that particular creativity of John [inaudible] who saw it clearly, at least at this cultural business. How can I send an American or British in Italy? They don’t even speak the language. Or in France they — I mean how can you? You ever try to do a deal in France, or in Spain, even for someone that has a — some sort of exposure to different business culture like myself. I would never be able to do it. Like someone else would like to try to do it in Italy, try to understand how Fiat works, or Enel thinks, or only [inaudible] operates.

Professor Douglas W. Rae: So when — in the context of the states you sent a beaten up, Dartmouth linebacker to Washington?

Paolo Zanonni: Hank was — now the story about Hank is he has always been a Republican.

Professor Douglas W. Rae: Do you want to give your little imitation of his voice style?

Paolo Zanonni: Paolo — his real voice style was, the real imitation, “Paolo go and get the business,” at 3:00 in the morning. Hank has always been a Republican. He — if you talk to him, he ascribed his success at Goldman with the fact that he didn’t know what to do when he got out of The Harvard Business School and he went to work for The Nixon Whitehouse in the domestic affair division, and he finds himself at 24/25 immediately after Watergate, and everybody about him is either in jail or had to resign, so he becomes the most senior person in that department and he has to deal with the CEO. He has to deal for a year and a half with the CEOs of large corporations, and he learns, and at the end he decided he doesn’t like the government and he tries to get a job at Goldman and he gets hired, and what he was always telling me he would say, see the real skill that I had was not what they taught me, The Harvard Business School, but the fact that I spent a year and a half in interacting with CEOs and CFOs from the largest corporation because I was at The White House and there was — nobody was more senior than me. So he had been — Bush tried to get him to be the Secretary of the Treasury, to my knowledge which is limited, at least twice before he accepted. At one point he decided that it was time to let Glen Klein be the chairman and that was a perfect exit.

Professor Douglas W. Rae: Last question for today, a simple observation would be that Goldman has essentially bet its life on the quality of the people. Just meaning all the things you’re talking about, plus something to do with just sheer mental horse power, smart people.

Paolo Zanonni: There is a reasonable amount of smart of people. Wait —

Professor Douglas W. Rae: Don’t overstate here Paolo.

Paolo Zanonni: No, there is a reasonable amount of smart people, but do you know what the characteristic — you know it. I mean everybody who goes to an Ivy League school would know it. Determination, it’s almost as important as brain power, and definitely Goldman — definitely you will not get a chance, not even of becoming a VP, not a partner, if you are not determined. The associate and the analyst work 100 hours per week, for years, for five years, seven years, and ten years. The partners work 70 or 80 hours per week until they retire; unless you are ready to do that, no way.

Professor Douglas W. Rae: And if the phone rings —

Paolo Zanonni: If the phone rings — I told you, Hank was used too — when he was the chairman, Hank was used to listening to voicemail, because now we communicate via email, then we communicated only via voicemail. In a firm that was — that had $25 billion in revenues, you could leave a voicemail to Hank Paulson, and unless he was on a plane, you got an answer in less than five hours, and if he was on a plane, it depends how long the flight was, but fifteen hours you got your answer after fifteen hours.

Professor Douglas W. Rae: Terrific, so please review the slides for Wednesday, and let’s thank Paolo for this very interesting conversation

Paolo Zanonni: Thank you.

[end of transcript]

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