Job insecurity at Goldman Sachs

By Felix Salmon
June 4, 2012

Mitt Romney likes to think of himself as a businessman, but in reality he’s not a businessman, he’s a financier, and there’s a big difference between the vast majority of employers, on the one hand, and financiers like bankers and private-equity executives, on the other. It’s a difference which makes it all to easy to read a bit too much into things like Goldman Sachs headcount cuts:

Goldman Sachs last week laid off roughly 50 people, according to people briefed on the matter but not authorized to speak on the record. The cutbacks have rattled some people in the firm, in part because a number of the employees were managing directors and on the higher end of Goldman’s pay scale.

The thing to realize here is that when firms like Goldman (and Morgan Stanley, and Credit Suisse) fire people, we often think that they’ve made a really tough decision — because in our firms, when people get fired, that’s a big and fateful day.

But banks aren’t like our firms.

Here’s Tim Noah, in his new book, explaining how the real world works:

One of the ways that the real-world economy differs from theoretical models is that bosses tend not to think about employee salaries as they relate to the labor market. Or rather, the boss doesn’t typically compare an individual employee’s salary to the labor market after he hires him. Instead, the boss thinks about how good a job the employee is doing, how much cash the company has on hand this year (or doesn’t have) for raises and bonuses, what the company’s internal (perhaps union-negotiated) compensation policies are, and so on. The moment when the boss does compare an employee’s salary to the labor market typically occurs when he makes the hire. I need a guy to do X, the boss thinks. How much do guys like that get paid? After that, the employee ceases to be an economic abstraction and is judged based on his own performance.

The point here is that banks behave much more like theoretical models than most companies do. In some dystopian capitalist universe, employers would constantly be alive to the nuances of the labor market. Never mind that you were hired at $60,000 a year: if someone just as good as you can be found to do the job for $50,000 a year, then you’ll either have to accept a pay cut or get fired.

Employers don’t act that way, because they generally have better things to do than be concentrating on the nuances of the labor market all the time, and also because it’s really expensive and time-consuming and unpleasant to hire and fire people. And, because they’re not evil profit-maximizing automatons. But banks are different.

If you’re Goldman Sachs, it’s actually really easy to hire people. And the cost of firing people, relative to how much they get paid, is actually pretty low. Moreover, at Goldman, the value of any given employee is far more quantifiable than it is at most other firms. The employees know it, which is one reason they get paid so much. And the firm knows it, too. That’s why banks have variable compensation: if you were worth $2 million last year and $1 million this year, your pay will go down this year.

All businesses are cyclical, which makes it hard to hire effectively. Do you hire lots of people when times are booming, only to find yourself overstaffed when times are less great? Or do you underhire in the booms, depriving yourself of growth? Places like Goldman solve that problem the capitalist way: they simply staff to the cycle. When profits are going up, they hire; when profits are going down, they fire.

Private-equity companies generally behave that kind of way once, when they first come in to a company. They’ll fire a lot of people, or make them reapply for their jobs, or otherwise reset the firm to the labor market at the time. But even they don’t then continue to hire and fire people continually across cycles: it doesn’t make sense to do that, when the cost of keeping someone on, even if they’re earning a few thousand dollars more than the prevailing wage, is so much greater than the cost of firing them and then re-hiring for the job.

But at investment banks, it’s different. If you’re not pulling your weight, you’re out. And when dealflow dries up, jobs get lost. It’s brutal, but it has a lot of internal logic. Which means that the real surprise here, as the global recovery sputters, is not that investment banks are firing. Rather, it’s that such activity is newsworthy at all, or that Goldman employees ever thought that managing directors had any kind of job security in the first place.

Partners, on the other hand…

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