Pining for those old partnerships
A return to partnerships in the financial sector is unlikely, so publically listed behemoths need to find a way to mimic the balanced incentive system of that largely bygone business model.
Romantics searching for a business model to lead the financial sector out of post-crisis limbo keep flirting with the idea of partnership.
That is no surprise, since banks’ flight from partnerships to public markets is partly responsible for the fix they are now in. William Cohan, author of books about Goldman Sachs and Lazard Frres, says he is "more convinced than ever that an important turning point in Wall Street history was 1970, when Donaldson Lufkin & Jenrette (another investment bank) went public”. He means a wrong turning – one that was all too obvious to those banks’ customers.
Former General Electric lawyer Peter Solmssen, now Siemens’s general counsel, recalls, for example, how GE "felt a difference when the great banks went from being partnerships to being publicly traded companies ... It changed behaviour”.
So my ears pricked up when Andy Haldane, the Bank of England’s financial stability director – a radical thinker on reform – called for banks to defer bonus payments for 10 years or more. Such an approach would help recover "the old partnership, unlimited liability model, where you are on the hook until you walk out of the door”, he told a British parliamentary committee last week.
The interesting point was not that Haldane mentioned partnerships, but that he implicitly acknowledged that squeezing vast multinational banks back into such a straitjacket was impossible. What is required, instead, is a structure that replicates the incentives and, critically, disincentives that used to govern partners’ behaviour.
Corporate form alone – be it mutual, co-operative, partnership, or listed company – may nudge businesses towards particular behaviour, but it is no proof against mismanagement or strategic foul-ups. Dewey & Leboeuf, which last year became the largest law firm failure in history, was a partnership. So, more strikingly, was Monitor, the US-based consultancy that, in failing to heed the strategic insights of its co-founder Michael Porter, slid into bankruptcy last year and has just been bought, for a song, by Deloitte.
Partnerships are arguably harder to run, because, as Tim Morris of Oxford’s Sad Business School observes, managers have to rely heavily on persuasion to influence highly autonomous partners. As they grow bigger, partnerships face the difficulty of raising new capital, while peer pressure – their great advantage over arm’s length management models – dissipates. The problem with Wall Street banks’ initial public offerings, Cohan points out, was "not that each of the partners got rich ... but rather that the partnership culture – where people were encouraged to take prudent risks with their own money – was replaced with a bonus culture, where people were encouraged to take asynchronous risks with other people’s money”. Solmssen’s great-grandfather was "personally responsible to the depositors” of the bank he ran: "His behaviour was different from those who merely manage a publicly traded institution.”
Newer and smaller financial institutions may still consider partnership. In some countries, including France, publicly traded partnerships offer a way round capital-raising restrictions. But there are more practical solutions available to large listed banks.
Consider, for instance, HSBC’s post-crisis remuneration policy – favoured by Haldane – according to which the bank’s senior executives have to hold share awards until retirement or resignation. Or UBS’s pioneering "malus” (as opposed to bonus) – or clawback – now a feature of many banks’ approach to incentive pay. Addressing the stick, rather than the carrot, some, including Cohan and University of Minnesota law professors Claire Hill and Richard Painter, believe regulators should make the highest paid bank executives personally liable for institutional failures.
Such approaches have flaws. A bank interested in poaching a risk-hungry trader could promise to offset clawback by his former employer, for instance. But they offer the hope that listed companies might at least mimic the elegant form, the balanced incentive system and even some of the mutual responsibility of banking partnerships. The big snag, of course, is that no amount of tinkering with bonus timetables, clawbacks and corporate statutes will ensure good management – let alone restore partnerships’ lost ethos.
Copyright the Financial Times 2013.