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Management’s Discussion and Analysis
46 GOLDMAN SACHS 2003 ANNUAL REPORT
primarily related to exit costs associated with reductions
in our global office space. These expense increases were
partially offset by lower market development and com-
munications and technology expenses, reflecting the
impact of reduced employment levels, lower levels of
business activity and continued cost-containment disci-
pline. Pre-tax earnings of $207 million in 2003 decreased
45% compared with 2002.
2002 versus 2001 – Net revenues in Investment Banking
of $2.83 billion for 2002 decreased 26% compared with
2001. Net revenues in Financial Advisory of $1.50 billion
decreased 28% from 2001, reflecting a decline in indus-
try-wide completed mergers and acquisitions. Net rev-
enues in our Underwriting business of $1.33 billion
decreased 25%, primarily reflecting a decline in industry-
wide total equity underwriting volume, including initial
public offerings, as well as a decline in Goldman Sachs’
market share in global debt underwriting. The reduction
in Investment Banking net revenues was primarily due to
lower levels of activity across all sectors, particularly
technology, media and telecommunications, natural
resources and healthcare. Our investment banking back-
log at the end of 2002 was significantly lower than at the
end of 2001.(1)
Operating expenses were $2.45 billion in 2002, 21%
lower than 2001, primarily due to decreased compensa-
tion and benefits expenses, reflecting lower discretionary
compensation and lower employment levels. Market
development and communications and technology
expenses also decreased, reflecting the continued impact
of expense-reduction initiatives first implemented in
2001, reduced employment levels and lower levels of
business activity. Pre-tax earnings of $376 million in
2002 decreased 48% compared with 2001.
trading and principal investments
Our Trading and Principal Investments segment is
divided into three components:
•ficc – We make markets in and trade interest rate
and credit products, mortgage-backed securities
and loans, currencies and commodities, structure
and enter into a wide variety of derivative trans-
actions, and engage in proprietary trading.
•equities – We make markets in, act as a specialist
for, and trade equities and equity-related products,
structure and enter into equity derivative transac-
tions, and engage in proprietary trading. We also
execute and clear customer transactions on major
stock, options and futures exchanges worldwide.
•principal investments – Principal Investments
primarily represents net revenues from our mer-
chant banking investments, including the increased
share of the income and gains derived from our
merchant banking funds when the return on a
fund’s investments exceeds certain threshold
returns (merchant banking overrides), as well as
unrealized gains or losses on our investment in the
convertible preferred stock of SMFG.
Substantially all of our inventory is marked-to-market
daily and, therefore, its value and our net revenues are
subject to fluctuations based on market movements. In
addition, net revenues derived from our principal invest-
ments in privately held concerns and in real estate may
fluctuate significantly depending on the revaluation or
sale of these investments in any given period. We also reg-
ularly enter into large transactions as part of our trading
businesses. The number and size of such transactions may
affect our results of operations in a given period.
In January 2002, we began to implement a new fee-based
pricing structure in our Nasdaq trading business.
Previously we did not charge explicit fees in this business
but rather earned market-making revenues based gener-
ally on the difference between bid and ask prices. Such
market-making net revenues are reported in our Equities
Trading results. As a result of the change to the fee-based
pricing structure, a substantial portion of our Nasdaq net
revenues is reported in Equities Commissions. Both mar-
ket-making revenues and explicit fees from our Nasdaq
business are reported in “Trading and principal invest-
ments” in the consolidated statements of earnings.
Net revenues from Principal Investments do not include
management fees generated from our merchant banking
funds. These management fees are included in the net
revenues of the Asset Management and Securities
Services segment.
(1) Our investment banking backlog represents an estimate of our future
net revenues from investment banking transactions where we
believe that future revenue realization is more likely than not.