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Corporate Governance

Prof. Matthias Finger

McKinsey & Company

How Has The McKinseys Decentralized Partnership


Model Contributed To Its Success?

By

Ali Gharaei
Mahdi Tamizifar

12th June 2017


Abstract

This study concerns an analysis within the scope of the governance of McKinsey & Company
regarding the course Corporate Governance. McKinsey & Company is the largest private
partnership firm in world, is widely known as the most prestigious management consulting
firm with a portfolio of clients believed to be covering 70 percent of Fortunes Most Admired
Companies list. Such admiring success put next to the unorthodox governance structure of
McKinsey, the decentralized partnership, raises questions about the impact of such structure
on the success of the firm as well as the level of sustainability it yields. Considering the wide
and important roles that the partners have at McKinsey, the purpose of this study to dig
deeper into this decentralized partnership approach and the path that one needs to take in the
up-or-out atmosphere of the corporation to reach such position. To achieve this, after
explaining the history of McKinsey and its evolution to the current structure as a
decentralized partnership, we analyze the problems involved in this structure. This goal is
achieved by asking three main questions regarding the importance, costs, and net benefits of
decentralizing the consulting business at McKinsey & Company. Afterwards, we refer to the
scandal of 2009 as a qualification test for the robustness and sustainability of such
decentralized and partner-dependent system. Finally, the summary of the main events and
main concept followed by a brief conclusion is presented.

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Table of Contents Page

Problem Statement...... 3

Presentation of The Case........ 7

McKinsey & Companys Birth


The Role of Marvin Bower
History-1940s
History-1950-1956
History 1956-1970
History 1970s-2000s
Questions To Be Raised
McKinsey & Company, As of Today

Requirement of Decentralization 17
Importance of Decentralization
Cost of Decentralization
Comparison Between the Costs and Benefits of Decentralization

Conclusion........... 24

References........... 25

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Problem Statement

In this section, first, we are going to introduce the company chosen for the study, McKinsey
& Company. Then, we elaborate why do we consider it as interesting and clarify the topic.
Afterwards, specifically, what questions we are intending to find answers for.

How has the McKinseys decentralized partnership


model contributed to its success?

Mckinsey & Company (established in 1939) is widely known as the worlds most prestigious
management consulting firm with a portfolio of clients believed to be covering 70 percent of
Fortunes Most Admired Companies list. According what was published in Fortune Magazine
in 19931, McKinsey & Company is the most well-known, most secretive, most high-priced,
most prestigious, most consistently successful, most envied, most trusted, most disliked
management consulting firm on earth. According to Forbes2, McKinsey & Company is
ranked 39th among Americas Largest Private Companies and 66th among Americas
Best Midsize Employers. Having all these notes regarding McKinsey & Company, we found
it very intriguing to do a deeper analysis to find out more about the drivers for McKinseys
success. Unfortunately, although there are zillions of articles published by McKinsey on
many governance issues, articles on the McKinseys governance itself can hardly be found.

McKinsey & Company has brought new ideas and quite noticeable organizational
innovations into the businesses. Not only can you find these eccentric features in McKinseys
organizational structures, McKinseys influence on firms and industries is conspicuous
especially in 1960s as it had a rapid global growth. One of its distinct organizational
characteristics, for instance, is its promotional system of hierarchies known as the up-or-out
policy.

Up or out policy, also known as tenure or partnership system, would be adopted by an


organization as a hierarchal system to push employees to achieve a certain rank within a
predefined expected period of time implying that if they fail, they have to leave the
organization. Concerning McKinsey, for instance, an Associate (who works on a client
project on a daily basis) might have about 2 years to promote to the next rank, Engagement
Manager (who is responsible for coaching teams and leading projects). Adopting such a
policy would affect the culture of the organization in a large extent. Figure below illustrates
the up-or-out pyramid. There are seven layers of hierarchies; Worldwide Managing Director,
Director/Senior Partner, Principal/Partner, Associate Principals, Engagement Manager,
Associate, Business Analyst. As a consequence of the application of such a policy,
approximately, one-fifth of members leave the company each year.

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Figure 1: Up-or-out McKinseys pyramid (Simplified Model). The levels from bottom are
Business Analysts, Associate, Engagement Manager, Associate Principal, Partner ,Senior
Partner ,Worldwide Managing Director (MD)

As a second example, we may refer to its decentralized governance structure. By


decentralization of partnership and ownership - adapted to its goals, strategies, and culture-
McKinsey could gain huge reputation and acceptance among prestigious firms and
organization. Such admiring success and reputation brings about questions on McKinsey's
own corporate governance and management style which has made it such an iconic
management consulting firm. Furthermore, as their governance style is in fact very
unorthodox in the corporate world, the answer to these questions become of higher
importance.

As an example, having no headquarters in the traditional sense, their global managing partner
who is elected by the other partners inside the company chooses his or her home office. In
addition to that, their Shareholders Council or Board also comprises partners elected by their
peers. Considering such wide and important roles that the so-called partners have at
McKinsey, the purpose of this study is to dig deeper into this decentralized partnership
approach and the path that one needs to take in the up-or-out atmosphere of the corporation
to reach such position. In Fact, we intend to analyze this structure and evaluate how much the
McKinseys decentralized partnership has contributed to the extraordinary success of the firm
over the past century. These require also to go through the history, find links between the
policys structure and its consequences brought into the system within the context of the
firms unique culture - knowing that a well cultural establishment within an organization
would lead to long-term benefits (gain in productivity, reducing costs, sustainable growth,
and success in general terms) and the opposite holds as well.

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More specifically, in this research, we will cover the History of McKinsey and its main
organizational transformations with an emphasis on the introduction of decentralized
partnership to the governance structure. After explaining the history of McKinsey and its
evolution to the current structure, we analyze the problems involved in this method of
corporate governance, especially due to the potential principal-principal conflicts arising
from the role of approximately 1,400 owners including 1000 partners and about 400 senior
partners in the firm. To elaborate this, three main questions will be raised regarding the
importance, costs, and the net benefits of decentralizing the consulting business at McKinsey
& Company. The questions are as the following:

How important are the potential benefits of decentralizing


Can potential costs of decentralizing be compensated
Are the costs of decentralization outweighed by the benefits

This systematic approach for analyzing this unique corporate structure at McKinsey enables
us to better evaluate the impacts that decentralized partnership has had on the performance of
the firm through its history. As the next step, we debrief the scandal of 2009 in which Rajat
Gupta, the former managing director of McKinsey, was convicted of insider trading. We will
analyze this scandal and its consequences as a qualification test for the robustness and
sustainability of such decentralized and partner-dependent system.

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Table 1: Historical Overview

1939 (inception)
Goals, values and objectives were defined
Building a prestigious firm to be successful and long living
Focusing only on top management problems
Promoting professionalism (formal code preparation by 1974)
Promoting decision-making upon general consensus
Providing employees more financial incentives compared with the industry
Responsibility to dissent formal adoption in 1968
Active members (partners) owned the company

1944
National Expansion inauguration with opening the first office in the UK
Introduction of One firm policy

Early 1950s
New profit-sharing system based on partners performance lead to higher
variance in compensations

1954
Introduction of a new recruitment policy: hiring business school graduates by
focusing on their intellectual abilities
Up-Or-Out policy was adopted though it was modified later on

1956
McKinsey incorporated: stocks could be traded at their book value among
partners
Further emphasis on decentralization by introducing individual ownership
restrictions (individual ownership limited to 25% and then 5%)

1959
International expansion started quite rapidly

1970
Substantial investments on developing expertise were agreed on to secure their
growth (due to pressure of economic recession and saturation of organizational
transformation, emerging new competitors such as BCG)

1980
Introduction of centralized knowledge management initiatives

2009
Rajat Guptas insider trading scandal

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Presentation Of The Case

McKinsey & Companys Birth

James Oscar McKinsey (born in June 4th 1889), a professor of accounting at University of
Chicago, founded his accounting and management company in 1926 with the objective of
giving consultation on accounting principles and as a tool within the scope of management.
The companys growth happened quite quickly in a way that McKinsey asked Tom Kearney
(1929) and Marvin Bower (1933) to join and become a partner on the business.3

After Mr. McKinseys demise in 1937, Bower and Kearney s disagreements on the
governance of the company, separated their way which lead to the split of McKinsey,
Wellington & Company (previously merged with Scovell Wellington & Company) into two
divisions named as McKinsey & Company and Kearney & Company focusing on
management engineering practices rather than accounting though in separate offices; Kearney
& Company remained in Chicago while Bower with other two co-founders decided to run
their business in New York.3

The Role of Marvin Bower

Bower (1903-2003) started to work at Jones, Day, one of the most prestigious companies
located in Cleveland, after his graduation from Harvard Business School with an MBA
though he was graduated from Brown University (1925) and Harvard Law School (1928)
prior to that. Later, Bower acknowledged that working at Jones, Day was an opportunity for
him to learn the root causes of successful practices as he brought those experience to
McKinsey years later. He was inspired by the companys recruiting standards as well as the
respect to the notion of professionalism. In fact, McKinsey & Companys culture, as many
believe, is well structured and shaped by Marvin Bowers thoughts.3

Bowers business studies was on potential earning power of distressed companies and
proposed recapitalization structures. Therefore, when McKinsey asked him to join his firm,
he accepted the offer believing that he could help McKinsey by put his knowledge and ideas
into practice. In 1937 before the division of the firm, Bower proposed that McKinsey,
Wellington & Company should focus on solving major management problems, learning
processes and training employees, continual improvements regarding the firms influence,
and respect the highest levels of integrity, professional ethics, and technical excellence. After
the separation of the firms, in 1939, fundamental goals clearly specified within the firm by
Bower and his colleagues. They decided to put the firms emphasis on consulting to top
managers, training and professional approaches, development of the firms clients, and the
culture of welcoming decision-making based on general consensus. Bower deeply believed to
these principles; so, he spent a year (starting in 1940) to provide a booklet called
Supplementing Successful Management as a reference to firms practices supposed to be
respected by the three founders.3

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History-1940s

Within the last decade, McKinsey was trying to find its own path and identity by drawing
fundamental organizational principles though the gradual implementation of those decisions
was postponed to the next decade. Within the next decade (1940s), Mckinsey focused on
economic strengths, fame and building its culture from the base. We can say that 1940s is the
decade when the culture of McKinsey is almost shaped as a result of establishing and
promoting the spirit of professionalism and partnership. In parallel, setting clear economic
objectives (raising its services fees, for instance) and defining its client strategies to gain
geographical and economic growth towards its future were what the company achieved
during the period.3

In 1939, McKinsey made a noticeable profit which this continued for the year ahead. As a
consequence, Mckinsey increased the compensation to its partners and principles and agreed
on growing economically and open new offices nationwide. As the first step, their San
Francisco office was opened in 1944 and made a profit by 1946. On that time, Bower was
thinking about opening a new office in chicago and merging the company again with Kearney
though this never happened since during the recent years they had been using different
strategies which this made the reconsolidation unfavorable for each them.1 As a result,
McKinsey alone opened an office in Chicago in 1947 and another office in Los Angeles two
years later.3

Having many offices required a clear stance against the degree of freedom to be defined for
each local office. Therefore, McKinsey decided to introduce and apply the policy of one
firm. According to this policy, each office had its own operating responsibility and the right
for decision-making but they had to comply with the McKinseys principles as a unified firm.
The recruitment and training, for instance, had to be done by the firm rather than by the office
alone. In addition, an offices client had to be considered as the firms client. Specifically, all
the offices had to put profits of the firm prior to their offices. Consequently, the firm could
make its customers sure of providing the standard level of quality of services. Application of
this policy also required an increase in the mobility of members to boost sharing knowledge
and establish the desired firms culture across all offices in order to provide the opportunity
of opening new offices/ businesses.3

According to the objectives defined by Bower in the last decade, McKinsey was determined
to give services to large, prestigious companies to solve only major problems which are
concerned by the top management though this was not pragmatic at the beginning; they
needed companies of any size with relatively good fame to work with in order to grow their
reputation and expand their number of client. Moreover, McKinsey believed that every
customers case they accept has to bring something more than income to the firm; could it be
experience, fame, or prestige; an approach that was supported by several studies previously
done by mid-1940s.3

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Kearney used to recruit highly experienced individuals from business field though Bower
believed in recruiting brilliant young graduates and train them since they are more prone to
adapt themselves to the distinctive culture of McKinsey compared to experienced business
executives. In addition, McKinsey had raised its fees and had been paying higher
remunerations to its staff which all these were considered as risks to Kearney if it wanted to
agree with the merge.3
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McKinsey did not believe in advertisement. However, to boost firms fame, as Bower
believed, McKinsey had to convince its customers to act based on McKinseys final
recommendations since otherwise the impact of the consulting by McKinsey might remain
invisible to others or to the firm itself. Thus, McKinsey decided to include the factor of
clients willingness to act as one of the parameters to accept assignment/ projects requested
from their clients. In addition, McKinsey used to organize seminars and clinic dinners2 and
also started to distribute newsletter to its clients in order to promote professional relationships
among its clients, McKinsey and its consultants.3

One of Bowers objective was to establish the spirit of professionalism to be adopted by all
McKinseys member. By mentioning professionalism, Bower meant that consultants should
adopt self-imposed standards of competence, respect ethical principles, accept their
responsibilities, preserve their interdependencies and confidence on their opinions, avoid
accepting tasks that there is no benefit in performing them, and accept only the tasks
McKinsey is capable to do. Moreover, members were expected to assign priorities to the
customers interest rather than the firms income.3

History-1950-1956

In 1950, Bower was promoted to be the Managing Director since Guy Crockett, the
co-founder of McKinsey, left the firm at the age of 60. Consequently, he had more power to
bring changes regarding the governance, recruitment and advancement policies and
ownership structure as he had envisioned previously. At the same year, we can see that
McKinsey began to have a closer look at its internal matters such as the system of profit
sharing, promotion and partner election policies.3

In 1951, McKinsey narrowed down recruiting members with executive work experience to
hire young graduates instead. In the same year, three committees were nominated to
strengthen the spirit of general consensus for the sake of improving internal matters;
profit-sharing committee (responsible for the allocation of profits), executive committee as a
representative of all partners, and the planning committee (including Bower) to tackle
noticeable management issues by providing solutions for all partners. As a consequence, for
instance, the planning committee changed the system of allocating shares among partners.
The old system was based on the level of contribution of each partner according to some
specific criteria while the new system was based on a rating system whereby each partner had
to rate all the others except himself.3

In 1953, eventually, the new recruitment policy raised by Bower was accepted by other
partners. According to the new policy, graduates from business schools had to be hired rather
than potential nominees with executive profiles arguing that young graduate are more prone
to adapt themselves to a new culture as of McKinseys. In fact, Bower cared more about
strong intellectual abilities rather than professional experience. After World War II, the
application of such a policy was quite problematic since McKinsey lacked such a reputation
among its clients to hire outstanding talented graduates and make them responsible for

2
a reunion of about 20 to 25 executives and the firms' members and a guest of honor to have a
dinner together
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consulting them. Bower also believed that young graduates of business school are potentially
better candidates, having more of the expected admission requirements, and it is quite more
difficult to find such qualified graduates elsewhere. 3

In 1954, up-or-out policy for associates was officially implemented though Bower had been
negotiating since 1950 to convince the majority of partners to adopt such a policy. In
1952,for example, one-sixth of total professionals (16 members) left the firm which most of
them (12 members) left McKinsey voluntarily due to the pressure that McKinsey was trying
to impose on them claiming that they did not have sufficient competency. The difficulties of
holding such a policy forced McKinsey to do a revision two years later though it completely
survived.3

The the logic behind adopting such a policy was that up-or-out is a complement to the
recruiting policy. McKinsey argued that it recruits highly qualified candidates with
outstanding characteristics; if they could not grow and be promoted they should go to another
organization so that their qualifications and traits perhaps become more beneficial to that
organization. They expected outstanding consultants who can perform exceptionally for the
firm as well. In fact, McKinsey did not want to provide job security for its members but
create an atmosphere which the firm's long-term growth could be underpinned. On the other
side, there were enough motivation for members and candidates to make them interested to
work for McKinsey. They could work for a company whose turnover was very high and they
could receive a high financial return in a very relatively short term if they could succeed to
climb the ladder promotion constructed by the up-or-out notion shaped in the pyramid shown
earlier.3

In 1956, after several years of research and investigation, Mckinsey changed its partnership
to a private corporation. Prior to that, McKinseys ownership could be considered as business
partnership. There were individuals working as partners together who they used to bring their
own asset to invest in the frim. In return, McKinseys all earning used to be shared among
them at the end of their fiscal year. Then, partners could bring their asset or profits again for
the next year after paying their income taxes to the government. The firm was disadvantaged
by this model to some extent. In fact, the assets could not be retained as the firms asset. In
addition, according to the firms regulation- inherited by their previous regulation in 1935-
McKinsey had to pay a predetermined portion of the firms earning to a member for 3
consecutive years after his death or retirement which this was a growing concern for
McKinsey and could be considered as a pressure on the firm to change its partnership model
since many partners were approaching to their retirement age.3

By incorporation, the firm could make the transfer of ownership from partners who were
about to leave to the incoming ones in order to retain its earnings, increase the value of its
stocks, and pay dividends to its partners. The firms income, however, could be reduced by a
two-level taxation according to the ongoing USs corporate regulations were enacted by the
congress. Taxes could be levied once at the corporation level and once after the firm pays
dividend to its investors, at the personal level. After several years of hesitation-hoping the US
congress would amend the associated law in favor of companies like McKinsey- they finally
decided to incorporate holding that more hesitation would hamper the organizations growth.
3

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Thanks to the incorporation, McKinsey was not liable anymore to the financial claims of
partners on their retirement or death. However, it agreed to pay an equal fixed sum to its
existing partners in installments being paid in 10 years to compensate their gains upon their
retirement as it was included in their previous contract. Besides, any active member could
own some of the firms company. Any partner who was about to leave could sell his stocks to
the partner who was going to be replaced. As it was noted in their new regulation, partners
had to trade stock based on their book price claiming that otherwise the incoming partner
might not be willing to buy the stocks with a price offered by the leaving partner. They also
put, first, a 25% ceiling to the percentage of ownership to be bought by partners as stocks and
later they decreased it to only 5 percent stating that no partner has to own more than 5 % of
all the firms stock value. The argument behind it was that this is the effort of all partners
that is making McKinsey to grow so their ownership has to remain decentralized as well.3

History 1956-1970

McKinsey's internal focus on its internal matter, between 1950 and 1956, helped it to remove
barriers for a further expansion though, this time, more internationally. That was a unique
opportunity for McKinsey to explore immense lucrative business areas though it could be
considered as a risk as well since they were doing very good in the US; why should they
endanger their short-term national reap of profit after gaining such a reputation and
organizational stability?! However international regulations were also about to change; trade
barriers for EU countries supposed to be abolished very soon (as it happened in 1958).
Therefore, Bower and the other proponents convinced the majority of partners to agree on
international expansions to be able to serve american companies division located in Europe.
They argued that after removing trade barriers many US firms will expand their commercial
activities to enter Europe and compete with their European counterparts which this situation
open up new opportunities for McKinsey.3

McKinsey opened new offices in United Kingdom (London 1959), Switzerland (Geneva
1961), The Netherlands (Amsterdam 1964), France (Paris 1964), Germany (Dsseldorf
1964) and Australia (Melbourne 1962) quite rapidly. That was because, unexpectedly, the
situation became even more in favor of McKinsey. In fact, Many European firms were
interested to hire McKinsey, an american consulting firm, to learn more about american
organizational method to be able to compete with them (this can be concluded by the fact
that, McKinsey as it had envisioned, wanted to focus on consulting European division of
american companies whereas approximately 3 out of 4 of the assignments in early 1960s,
turned to be for European-based companies). On the other hand, a relatively rapid
international growth could deviate McKinseys concentration on further growth of US
offices to international growth. Therefore, they decided to continue their international growth
slower than before and try not to choose long-lasting assignments and ones which required
high number of employees to work on.3

The story of their first office in London started in early 1956, the time that McKinsey started
an assignment for the largest operative company of its new client, Royal Dutch Shell. Being
familiar with the organizations structure and becoming successful in the operation of those
assignments, McKinsey was convinced to opened an office in London in April 1959. Some
years later, in 1962, McKinsey started another assignment for Chemical Industries Limited,

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the largest industrial business in the United Kingdom. By that time, McKinsey gained high
recognition in the UK in a way that Cambridge and Oxford graduates, as McKinsey were
interested in them, knew McKinsey and were more willing to work for it.3

Almost all offices in Europe became profitable from the beginning, specially the London
office contributed to the McKinseys reputation and revenue considerably. Number of
McKinseys employees, only in London office, reached to 37 by 1966 making it the second
largest office after the New Yorks (with 96 consultants). Other offices could not attract
clients as quickly as the London office, though their growth were quite rapid. Early clients of
McKinsey in the UK were Royal Dutch Shell, Chemical Industries Limited, Heinz, Massey
Ferguson, Hoover, Dunlop Rubber, and ICI. In June 1961, McKinsey opened its first office in
Geneva whereby they attracted big clients such as Nestle, Sandoz, and Union Bank. In the
Netherlands, they took assignments from KLM airlines, United Fruit, and the Ministry of
Education . Early well-known clients of its office in France were Pechiney, Rhone Poulenc,
and Air France and in Germany they worked for Volkswagen, Deutsche Bank, and BASF.
Actually, McKinsey gained reputation in Europe very soon since it performed very well for
very well-known companies as just mentioned which those companies played a role of a
bridge for McKinsey to make connections with others. Finally, McKinseys revenue
increased to $ 20 million by 1967. According to another study, as it3 holds, McKinseys profit
used to increase on average by 69 % each year in years between 1962 till 1969. 3

Disregarding McKinseys own decentralized organization, it persuaded many large


corporations also to decentralize (compatible with their own way) by creating
divisions/departments responsible for doing autonomous decision-making processes. In fact,
in 1960s, decentralization could help many companies (that had been growing in 1950s) to
perform more efficiently and increase their productivity. Ciba-Geigy, a Swiss chemical and
pharmaceutical company, for instance, accepted McKinseys advice to divide its
organizational structure into groups based on its customer segment for its various consumer
product. As a consequence, five business categories were specified such as dyestuffs,
chemicals, pharmaceuticals, agricultural chemicals, and consumer products. In addition,
functional groups were also introduced such as research, production, finance, legal,
personnel, and advertising associated to the product divisions. McKinsey reorganized other
leading chemical manufacturers like DuPont, Monsanto, ICI, Rhone-Poulenc, and BASF with
the same approach. 3

In 1960s, the deep penetration of McKinsey had a considerable impact on the reorganization
of many well-known and large companies in Europe. In Britain, for instance, 72 out of 100
largest businesses positively responded to the decentralization advice from McKinsey by the
end of 1970. The trend noticeably caught the public attention in a way that McKinsey became
famous for reorganizing firms by doing Xerox, a word used to imply to copy. Others
used the phrase being Mckinseyed or to McKinsey to refer such a trend.3

History 1970s-2000s

The next decade, 1970s, the situation became challenging for McKinsey; its growth slowed
down considerably. The main reason was that Oil crisis and economic recession in 1970s

3
The American Challenge McKinsey & Company Role in the Transfer of Decentralization to Europe
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restrained European companies growth rate. Another explanation for that could be the
advent of other accounting or consulting companies like BCG as the competitors. In addition,
many analysts argued that McKinsey reached to a saturation level where large firms were not
interested anymore in further organizational changes as McKinsey had been trying to advice
within that domain. After mcKinseys own investigation about the root causes, they came to
the result that they need to focus on their relationships with their clients which the approach
was not their focus in the last decade (1960s) since they were more preoccupied with the
global expansion. Therefore, McKinsey highly invested in developing expertise and strategies
in response to the evolutions. McKinsey, afterwards, tried to give advices on strategic
planning, profitability of businesses, and merging possibilities.4

Mckinseys global expansions continued more steadily in 1980s and 1990s especially when
globalization became a trend in 1990s. In 1993, McKinsey had 58 offices worldwide. By
2000, its revenue hit $ 3 billion. McKinsey served famous clients such as HP9, General
Motors, Johnson & Johnson, Siemens, and Home Depot by id 2000s. As of 2007, McKinsey
had over 6000 consultants including more than 1000 partners working in more than 45
countries.4

Questions To Be Raised

1960s is the brightest decade for McKinsey to gain reputation, influence and profit though it
had started decades ago to build such a unique identity enabling it to flourish in decades.
Having the descriptive history of McKinsey we might take a closer look by raising some
interesting questions.

McKinsey gives a high degree of autonomy and promote the sense of having
responsibility to dissent. Why McKinsey chose this policy and how this could not
end up in a situation where personal interest comes in prior to the firms benefits and
prevent the firm from growing in perpetuity?

To answer this questions we should mention that McKinsey, as it had imagined, wanted a
situation where professionalism become well-structured and they found autonomy and the
ability to dissent complying with professional practices. This also underpins the spirit of
partnership among partners. Moreover, the viewpoint was well-correlated with the notion of
decentralization of partnership that also required high degree of autonomy and letting each
member have a voice on the firms matters that these were necessary for exploring new
business areas.3

On the other hand, they had to provide counter forces to neutralize the degree of autonomy
and that was the reason that they raised the notion of general consensus and one firm
Law. In fact, the decision at each level had to be done based on the general consensus. A
drawback was that it imposed delays to the process of decision making though when It was
accepted by everyone the implementations happens more effectively. Moreover, by adopting
the notion of being one firm, members were encouraged to seek benefits for the firm as an
entity who tries to have a long term healthy life span. 3

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To establish such a culture, they also aligned their strategies at various levels to their goals
and objectives. Recruiting policy, for example, was adapted to help the establishment of the
culture in a way they prefered to hire young graduates claiming that they are more prone to
adapt to the culture (though it was not the only the reason for adopting such a policy as
elaborated previously). Moreover, considering candidate's motivation for elections and doing
peer reviews as criteria to be met in addition to other outstanding analytical competencies
was another example of such an adaptation to promote the spirit of a decentralized
partnership and working for one firm and following the same strategies defined by
McKinsey.3

How could the firm attract exceptional candidates (as it intended to) while its
up-or-out policy and high expected level of qualification and contribution could easily
turn them away from the position? The answer lies in the mechanism whereby
McKinsey used to provide or is providing incentives to its members; could it be high
financial compensations or promising opportunities.

Members in McKinsey were relatively well-paid. This is also true as of today. Their salary
might change each year and it also depends on the location of their office as well.
Nevertheless, providing some numbers might clear the situation or give a clue. It is
estimated5 that a newly hired undergraduate as a Business Analysts might receive about
$75,000 in US as his salary. He might receive $5,000 signing bonus and another $5,000 for
relocation allowance. Associates (fresh MBA hire) might receive a $125,000 salary +
$20,000 signing bonus + performance bonus of up to $40,000 + 12% of bonus/salary
contributed to retirement fund. An Engagement Manager might earn about $250,000. The
amount for Associate Principals might goes up to $800,000. And Partners often earn over
$1,000,000. In addition, the variance in the compensation rate increases as we go upstream
along with the hierarchy since their earnings are to be more dependant on their performance
and the portion of shares they own.5

The incentives, however, are not limited to the financial kind. Coming candidates knows that
they have a definite time to be promoted compared to the situation where they have to wait
more years to be promoted and be paid higher as it is true in many firms. In fact, if they
remain qualified in McKinsey, they grow with a much more pace both to have higher
financial benefits or to keep up with a very steep learning process; though the latter could be
part of the members complaint as well knowing that it has been said6, for example, that 60
hours of work per week is considered as standard. Last but not least, many of candidates look
at this job as an opportunity to be a distinct person. Working in McKinsey brings prestige as
you consult well-known firms regarding their top managerial issues, bring the sense of being
a professional and it enables you to make connections and relationships which they have a
key role on running businesses.

In 1950s, partners prefered to make the McKinsey grow more internationally rather
focusing on the national expansion. Actually, they chose investment and higher
returns by exploring international opportunities over a conservative move, keep on
finding new business cases in the US. why?

It is all about incentives and how members are incentivised and how much cultural norms are
legitimate and respected. By opening new offices in other countries they could explore new

14
opportunities to make business and improve McKinseys reputation especially when the trade
barriers were about to be removed. That could lead to a noticeable financial return as it
happened so. In fact, having shares of the firm was a big incentive for the partners to make
the risk of international expansion in order to receive huge financial return. Moreover, their
decision were also compatible with the cultural norms that they had to put the firms long
term benefit ahead of its short-terms to make McKinsey live for perpetuity.

In a similar situation, In the mid 1960s, McKinsey was offered to make its shares open to
public with even for a two or three times higher than the book value. McKinsey declined such
a proposition claiming that it would jeopardize McKinseys long-term health. By letting
shares to be traded at a higher price, young candidates would be discouraged to join
McKinsey and existing members would be encouraged to leave which they considered this as
a threat to the McKinseys long-term health. In addition, according to the norms, members
were about to seek long term interest to benefit McKinsey as a one firm.

McKinsey & Company, As of Today

After having a short description of McKinseys history, lets briefly study McKinseys goals,
values, and organizational structure within its current state. McKinsey in its official website
introduce its mission and values as the following.

Mission7 :

Our mission is to help our clients make distinctive, lasting and substantial improvements in
their performance and to build a great firm that attracts, develops, excites, and retains
exceptional people.

Values7 :

Adhere to the highest professional standards


Put client interests ahead of the firms
Observe high ethical standards
Preserve client confidences
Maintain an independent perspective
Manage client and firm resources cost-effectively

Improve our clients performance significantly


Follow the top management approach
Use our global network to deliver the best of the firm to all clients
Bring innovations to management practice to clients
Bend enduring relationships based on trust

Create and unrivaled environment for exceptional people


Be nonhierarchical and inclusive
Sustain a caring meritocracy

15
Develope one another through apprenticeship and mentoring
Uphold the obligation to dissent
Govern as a one firm partnership

By scrutinizing the McKinseys mission and its values, we realize that their mission is tried to
be well-correlated with its presented values. It can be implies that McKinsey believes that by
promoting professional standards, making noticeable improvements in their clients
performance, and providing an efficient organizational structure capable of attracting
exceptional employees will achieve its mission. Looking at the values, we found them very
familiar to what we already read about its history. In fact, we can see that the majority of
sub-values (refers to the sentences in red color) are identical to what they are mentioned
directly in the history, as they were trying to abide by those values from the beginning. Still
the rest of the values are what McKinsey experiencing itself. For instance, to be
nonhierarchical and inclusive is what exactly what McKinsey tried to establish in itself and
advised many other firms in 1960s. All these make the McKinseys cultural heritage during
its evolution conspicuous.

Figure 2: Organizational Structure of McKinsey

Now, Lets have a look at McKinseys organizational structure as of today, as Figure 2


illustrates. In the figure below, each office is represented by an up-or-out pyramid schematic
(employee pyramids inside blue circles) representing the hierarchies exists. Today, there are
more that 110 offices worldwide which each office are supervised by a number of senior
partners. All senior partner (around 400 people), as they are shown inside the green box, are
considered in the same level of hierarchy-representing the McKinseys decentralized
structure- elect the global managing director (M.D.) shown in red. Finally, we can evaluate
McKinseys structure as a hybrid one; hierarchical at the low levels of the organization where
it concerns offices, and decentralized at the top level as the ownership is diversified among
them as well.

16
Requirements of Decentralization
Having gone through the history of McKinsey, the evolution of its decentralized partnership
governance structure and its current organizational model, it is important to evaluate whether
deciding to go this way has been a right decision for McKinsey and what have been the
implications of such decision. In Table 2, the four basic types of decision-making structures
are shown, in which the cons and pros of centralized hierarchies alongside the three major
forms of decentralization being the loose hierarchies, democracies, and markets, can be
compared with each other 8 .

Table 2: Relative advantages and disadvantages of different decision-making structures 9 .

Decision-Mak Relative Cost of Individualization Ability to Autonomy,


ing Structure Communication & Ability to Use Resolve Motivation
Many Minds Conflicts &
Simultaneously Creativity

Centralized Low Low High Low


Hierarchy

Loose Medium Medium Medium Medium


Hierarchy

Democracy High High Medium Medium

Market High High Low High

It can be observed that each of these structures has its own advantages and disadvantages.
The above table indicates the presence of a trade-off between creating a motivating
atmosphere for the employees versus the potential anarchy that might arise inside the firm. In
this regard, centralized hierarchies can be the best choice when a company intends to cut
down the costs of communication, or when it is trying to solve challenging conflicts of
interest. On the other hand, markets are particularly appealing when a company plans to
exploit creativity and motivation of employees to its maximum, or to bring as many minds as
possible simultaneously into the game. As can be inferred, when features of all of the four
aspects are critical, the loose hierarchies and democracies which are the two intermediary
. In practice, what is happening in the case of
structures may be the most suitable structures 8,9
high-level governance at McKinsey, is the utilization of the democracy structure in which the
managing director of the company who sits at top of the hierarchy, is chosen by his peer
partners through a democratic voting process, and the partners do in fact represent their
employees in their respective office. Thus, while directly or indirectly, everyone has his own
opinion expressed in the selection of the top managerial position, the remaining hierarchical
structure maintains the possibility of resolving potential conflicts between offices10.

17
However, in order to indicate the most appropriate structure for the governance of a
company, one should have a comprehensive understanding of the current situation and aims
of the firm. Thomas W. Malone, who is a professor at MIT Sloan School of Management,
proposes a systematic way for the managers to think about this problem. In his book The
Future of Work, he advises companies willing to do decentralization to ask themselves the
following three questions: (1) How important are the potential benefits of decentralization (2)
Can the potential costs of decentralizing be compensated (3) Are the costs of decentralization
outweighed by the benefits8,9. Thus, in this section we have tried to utilize this systematic
approach for analyzing the decision of McKinsey regarding its decentralization, in order to
evaluate whether it is an appropriate fit for this method of governance or not.

1) How important are the potential benefits of decentralizing for McKinsey?

In order to answer this question, we should have a look at the types of the business McKinsey
runs. A management consulting firm such as McKinsey runs a service business and is
generally defined and represented by its consultants. Having offices in more than 60 countries
and conducting projects in approximately all over the world, makes it nearly impossible for
McKinsey to have a centralized business practice to address all the clients worldwide
effectively. Furthermore, knowledge and creativity are the cornerstones of this business and
an essential ingredient to creativity is the freedom provided to the partners running each
office. As a result, management consulting is considered a highly local business which can be
done successfully only if the well-trained and knowledgeable consultants understand the
characteristics of the local market. For this purpose, the most important potential benefit for
McKinsey in decentralizing the governance is to enable each office to be as dynamic and
adaptive as possible to the local market and demands. Alongside with that, this creates an
incredible leadership opportunity that gives the partners the possibility to choose which
practice they want to build and which industry and clients they want to serve in their
respective office10.

2) Can potential costs of decentralizing be compensated?

As believed to be one of the most important missions of a company, profitability should be


pushed to be maximized. Profit, being the surplus of the deduction of costs from the revenue,
is directly affected by the change in each of these two elements. As said before, the main
advantage of decentralization is the higher degree of autonomy, motivation and creativity
provided to the employees, which will directly influence the performance of the consultants
and the success of the company in the long run, thus enhancing the overall performance and
revenue of the firm. However, this increase in productivity comes at the cost of added
communication expenditures as well as the difficulties in resolving the conflicts especially
when general consensus is to be respected10. In order to evaluate the potential means of
compensating the aforementioned costs in McKinsey, the following three questions should be
asked additionally9:

a) How can a decentralized firm make decisions quickly and efficiently when no
one is in control?

18
The flatter the governance structure of a company gets, the more difficult it becomes to
resolve the conflicts and involve everyone in the decision-making process. Although
McKinsey has a democratic decision-making structure, it has two main mechanisms that help
the firm to be as effective as possible when it is time to make final decisions. The first
mechanism is the presence of a Managing Director (MD), who has a role significantly
different from the CEO of other large corporations. Every 3 years, the 400 senior partners
elect the MD among themselves, who will serve as first among equals. The maximum
allowed period is 3 full terms and when the term finishes, the MD will become a senior
partner again. The managing director at McKinsey, is in charge of setting the main themes,
establishing connections and pushing for the initiatives that ensure the development of the
people and strengthening of the firm. The second mechanism is the Shareholders Council
which is the board of directors composed of 30 partners from several different offices
worldwide representing more than a dozen different nationalities10. The MD reports directly
to the shareholders council and more indirectly to other partners.

Nonetheless, the coordination of these two mechanisms and the mutual connections between
the stakeholders in this context would theoretically impose high costs on the firm. It should
be noted that the decentralization rate reached to its summit in the early 1960s and the
decentralization itself has been continued until today. The high communication costs in those
early days were well offset by the extraordinary values which were unlocked by entering new
markets, especially in Europe, and consequently rationalizing such initiatives. However,
thanks to the astonishing advances in the information technologies over the past decades
-emails, instant messaging, web conferencing, etc.- the costs of communication have been
significantly reduced compared to those early days. As a result, this drawback of the
decentralization is ever-diminishing, enabling McKinsey to decentralize more than ever
before, while maintaining the efficiency and timeliness in decision-making.

b) How can a decentralized company guarantee quality or protect against


catastrophic losses if no one is in control?

Even though the structure of the top management of McKinsey is highly flat, it is noteworthy
that within each local office, the reporting and decision-making processes are conducted most
similar to a loose-hierarchy structure with the characteristics presented in Table 2. Inside each
office, the managing partner does not force decisions quite often, unless decisions are taking
too long or there are internal conflicts between the team 8 . This means that on one hand, the
senior partner managing each local office is directly benefiting from the democratic
decision-making structure at the corporate level and has full autonomy in establishing his or
her own business practices, as well as choosing the type of industry and client to be served.

On the other hand, within each office, the loose-hierarchy structure reduces the potential of
heterogeneity in the quality of the services offered to the clients by the consultants working in
the respective office. However, cultural differences and the access to the same quality of
talents, will definitely result in providing higher quality of services in certain offices.
Although the cycling of consultants among offices is an already implemented practice, the
quality of the services can vary considerably between the offices. In conclusion, it can be
seen that McKinsey has chosen a hybrid structure for its governance, trying to benefit from
the merits of two decision-making methods being the democracy for the top-level
management of the firm and the loose hierarchy for managing the offices11.

19
c) How can a decentralized company take advantage of economies of scale and
knowledge sharing?

The most important asset that McKinsey depends on for its functioning and growth is the
knowledge and experience that it has been able to accumulate over the past decades. In other
words, after serving each client, regardless of the result being either a success or a failure,
there will be an incredible amount of information gathered about that specific client, its
respective industry and the recommendation and practices that have either worked for them
or not. Theoretically, this knowledge can extremely reduce the costs for future projects with
the similar themes. Moreover, knowledge sharing and correct management of this knowledge
is what enables these economies of scale to be achieved. However, according to what was
mentioned before, not only the up-or-out policy reduces the time that many consultants stay
with the firm, but also the decentralization and the widely-spread offices can potentially
reduce the possibility of sharing the accumulated knowledge in each office with the rest of
the firm over years. In order to address this crucial need for unlocking the economies of scale
and accessing the real value of knowledge inside the firm, the knowledge should be
systematically managed internally. Even though the initial classification of the intellectual
resources at McKinsey goes back to 1950s, it was not before 1980s that the Knowledge
Management project was launched. This project for systematic knowledge building had three
pillars:

efficient classification of the intellectual resources based on the experiences of


McKinseys consultants with each client
renewal and development of intellectual resources inside the firm through
establishment of 15 centers of competence
distribution of knowledge among other offices and the next generations of consultants
through seminars, workshops, and training sessions across the world.

In fact, the development of intellectual resources have become the cornerstone of the
McKinseys business since 1980s and it reached a point during late 1990s that the recurring
claim inside the firm was We do more research on business issues than the business schools
at Harvard, Stanford, and Wharton combined.10,11 In addition to this project, several other
measures such as the McKinsey Quarterly (a journal of management ideas), hundreds of
pamphlets, articles and dozens of books written by its consultants have also contributed to the
accumulation of vast amounts of knowledge inside the firm.

3) Are the costs of decentralization outweighed by the benefits?

Now that the costs and benefits of decentralization have been discussed, these two categories
should be compared with each other in order to answer this question. As mentioned before,
the main direct cost for decentralization is due to the increased expenditure for the
communications. Furthermore, the indirect costs arising from the lost economies of scale that
could be grasped by reprocessing the accumulated knowledge inside the firm should be taken
into account as well.

20
By analyzing the growth of the company after the beginning of its decentralized expansion in
early 1960s, it can be clearly demonstrated that the costs have been well outweighed by the
benefits as during the following years until 1970, the company enjoys an average of 69%
growth per year for 8 years. This rapid expansion of decentralization, however, was stagnated
by reaching the economic recession in the middle of 1970s and emergence of competitors
such as Boston Consulting Group (BCG) which were offering a new intellectual product
.
known as the Growth Share Matrix 4,11

On one hand, having opened many new offices had imposed high fixed costs on the company
while there were not enough clients for a few years due to the recession. On the other hand, it
was an opportunity for McKinsey to invest in the expertise of its consultants as well as its
relationships with the clients to guarantee its market share despite the emergence of new
competitors. Afterwards, the coincidence of the economic expansion, with the internal
knowledge development and building of the centers of competence and central databases for
intellectual resources in the firm, lead to another high-growth rate for the firm. By looking at
the financial figures of the company during this period, it can be seen that the total revenue of
McKinsey grew from $45 million in 1972, up to $500 million in 1987, which was again
doubled to $1 billion in 1991 over 4 years. Therefore, the growth rate and profitability of the
firm show that despite many concerns that were raised internally during the years of recession
on the decentralized expansion of the firm, the coherency of this structure with other
measures for development of the internal knowledge and networks made this strategy a total
success11.

Rajat Guptas scandal and the sustainability of McKinseys decentralized partnership:

On Friday October 16, 2009, the FBI arrested Raj Rajaratnam a Sri Lankan-American
billionaire and the founder of the Galleon Group, a New York-based hedge fund which
managed over $7 billion at that time. Rajaratnam was accused of insider trading in a number
of publicly traded corporations such as Goldman Sachs Group, eBay and Google. U.S.
Attorney Preet Bharara announced this hedge fund insider trading as the largest in the history
of the United States, with profits of more than $60 million in favor of the defendants. The
heaviest accusation was due to a conspiracy done at the midst of the great recession of 2008,
for obtaining confidential information on the purchase of preferred stocks of Goldman Sachs
by Warren Buffets Berkshire Hathaway before the official announcement of the transaction
.
in the September 2008 12,13

Coverage of this scandal showed that two senior executives at McKinsey, Rajat Gupta and
Anil Kumar, were also involved in this high-profile insider trading with the billionaire Raj
Rajaratnam. Rajat Gupta, the former managing director of McKinsey who was the first
non-American born MD at the firm, had joined the McKinsey in 1973 and had served at the
highest level of the firm for 3 full terms from 1994 to 2003. Gupta became senior partner
again in 2003 and senior partner emeritus in 2007. He was in fact the mentor of the other
accused McKinsey executive, Anil Kumar, and a close friend of him. They first met when
they were both raising fund for the Indian School of Business in 1999. Furthermore, they
both had both graduated from the Indian Institute of Technology and Wharton business
school and had also co-founded the Indian School of Business in New Delhi in 1997. Anil
Kumar was a highly reputed senior partner at McKinsey and was pleaded guilty in the same

21
case with Rajat Gupta 5 . Kumar was also a classmate of Rajartnam in Wharton business
school. After the allegations, McKinsey cut all the professional partnership ties with Gupta
and Kumar. Furthermore, in order to reduce further tensions and public coverage, Gupta
resigned or refused to run again for the board of several companies and foundations such as
Goldman Sachs, Procter and Gamble, AMR Inc., Harman International and Genpact Ltd 5,12 .

Rajaratnam, Gupta and Kumar were all close friends and business partners, having founded
the New Silk Route, a private equity firm valued at $1.4-billion. Gupta became the chairman
while Kumar and Rajaratnam left the firm before beginning of its operations. However, New
Silk Route maintained close relationships with Goldman Sachs and the Galleon group and
even invested $600 million of its initially raised $2 billion fund into Galleon group managed
.
by Rajaratnam 12,13

On March 1, 2011, the Securities and Exchange Commission (SEC) filed an administrative
proceeding against Gupta for insider trading. He was alleged of illegally passing the
confidential information about Goldman Sachs and Procter and Gamble (P&G) to the hedge
fund manager Rajaratnam while serving on the boards of these two companies. He had in fact
betrayed the trust of these companies who were providing their confidential information to
him seeking counsel and advice. The accusations were made upon wiretappings done by the
FBI and the conversations were widely discussed in the public. It was made clear that by
trading based on these insider information on the activities of Goldman Sachs and P&G,
Rajaratnam made a personal illicit profit of $17 million and $570,000 by buying and selling
shares of these companies respectively. Although Gupta had not officially received anything
in exchange of the information, Gupta was still considered as a potential beneficiary to the
illicit profits as he was a friend of Rajaratnam, the potential chairman of Galleon
International, and the a co-founder of New Silk Route.

Finally, Raj Rajaratnam was charged with conspiracy and securities fraud and was sentenced
to 11 years in prison and fined with a penalty of over $150 million. Gupta was sentenced to 2
years of prison and Kumar received 2 years probation, forfeited $2.26 million and was fined
. During this case, 7 other senior executives or board members of high-tech
$25,000 12,13
companies such as IBM, Intel and Google were convicted of trading insider information with
Raj Rajaratnam.

After this scandal, McKinsey became under unprecedented criticism because of having two
of its highly reputed and longtime senior partners involved in insider trading. The focus of the
critiques was the structure of business that has allowed such wrongdoing of senior partners.
However, while the clear outcome of such scandal should have been the loss of many clients.
In contrary, this did not happen and many of those clients whose information was illicitly
exchanged with Rajaratnam stayed with McKinsey. This was mainly due to the tough stance
McKinsey had upon Gupta and Kumar at early stages of the scandal and also because of the
close relationship that offices had established with the clients.

Nevertheless, McKinseys own psyche bore the biggest effects of the Guptas scandal which
is basically due to the fact that the self-image of McKinsey and its consultants are highly
interwoven and dependent on each other. The fact that two longtime leaders at McKinsey
have not abided by the basic principles set by the firm for all the employees, was similar to a

22
. The decentralized structure of McKinsey was kept
loss of identity for the employees 5,14
together as The One Firm through the shared values and principles set in the company
during the past decades. In order to stop the collapsing of the firm in the shadow of losing
such integrating elements, the shared culture and values, McKinsey started strong initiatives
for hindering the recurrence of such wrongdoings in the future.

As an example, Dominic Barton who was elected as the MD in 2009, pushed for a new policy
on personal investments in 2010, right after the hype of the scandal. The rules clearly
mentioned that the employees shall not tip any family member on insider information of the
clients. Although in the United States this was rapidly put into place, in Europe it was
considered impractical and futile as for privacy issues the firm cannot force the relatives of an
employee to submit their investment data.

23
Conclusion
In this research, the characteristics of the governance method of McKinsey which is a
decentralized partnership has been analyzed in an attempt to evaluate the contribution of such
structure to the success of the firm. For this purpose, the history of McKinsey and its
evolution to the current state, the main challenges faced in this path and the future of this
structure in terms of its sustainability are analyzed. It was shown that during the
transformation of McKinsey from a small company owned by three partners, into the largest
private partnership in the world owned by 1,400 partners, it has gone through several
transformations and has implemented multiple supplementary initiatives in parallel to the
decentralized structure to compensate for the shortcomings of such method of governance.

By systematically analyzing the decentralized partnership, it was shown that in general,


McKinsey has been successful in meeting the requirements of decentralization, although in
certain areas such as knowledge management, some relatively long time gaps could be
observed. Not only the firm is owned by the partners, but also it is governed by the partners
and a managing director chosen by senior partners. While benefitting from the merits of a
democratic decentralized structure for the high-level governance of the firm, McKinsey has
maintained a loose hierarchy inside the offices to guarantee the quality and avoid catastrophic
mistakes.

However, without the implementation of other initiatives in the firm, it would most probably
be impossible for McKinsey to reach such success only through the decentralized partnership.
In order to keep the decentralized structure still as a unified entity, not only financial
outcomes of the firm were chosen to be shared, but also the same cultures and values with
high-standard principles were strongly promoted. These set of principles have been designed
to shape the vision of the employees into the nature of the business as a single integrated
firm, despite the decentralization and autonomy of the partners managing each office.

Nevertheless, the Scandal of 2009 was a considerable question mark on the structure of
McKinsey. It showed that the main downside of this structure is the lack of control over a
systematic corruption among the equally leveled partners who do not feel much supervision
from an independent body. The potential principal-principal conflicts of this kind indicate
that corporate governance of McKinsey is so dependent on the assumption that everyone
abides by its sets of principle that it basically does not have sufficient means to hinder such
wrongdoings. Thus, it is anticipated that in the future, the rules and principles of the firm be
further modified and the supervision on the managing director from the shareholders council
be intensified.

As the final remark, since this research is solely done on the effects of decentralized
partnership on McKinsey, there has been no benchmark for comparing its success with other
firms. Therefore, it is suggested that for continuation of this research, a comparison of the
growth of McKinseys main competitors such as Bain and Company and the Boston
Consulting Group be done, vis--vis their corporate governance structures and the
supplementary initiatives that they have utilized for their businesses.

24
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