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Emulating rivals is best way for Goldman to beat them

The return to perceived exceptionalism at Goldman Sachs remains elusive. The bank handily beat Wall Street forecasts for the third quarter with $1.5-billion (U.S.) of profit, which enabled a small dividend hike. But at just 8.6 per cent, Goldman's return on equity still isn't enough to cover its cost of capital.

That's not unusual on Wall Street or in the City of London these days. Only JPMorgan is on track to earn more than the 10 per cent accepted as the broad target for justifying taking money from shareholders. But that's sort of the point. Goldman used to be the firm to beat, posting equity returns of 30 per cent or more during the boom. On that all-important metric, chief executive officer Lloyd Blankfein finds himself running a firm relegated to the pack.

It's not a comfortable position. Investors have already expressed displeasure by valuing the shares of many financial institutions below their book value. Goldman's are discounted by 11 per cent. Boards also may be losing patience. Citi's is reported to have clashed with CEO Vikram Pandit on strategy and operating performance, which may have contributed to his resignation.

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Mr. Blankfein has more options. For starters, the U.S. Federal Reserve has been more willing to let him return capital to shareholders. The four-cent dividend declared on Tuesday might only yield an extra $76-million a year, but it's a symbolic step in the right direction and when added to the April increase, Goldman owners are pocketing 43 per cent extra.

Cost cuts also can have a bigger effect on Goldman's bottom line. Slashing pay to 30 per cent of revenue from an expected 42 per cent for the year, for example, would elevate Goldman's return on equity above 12 per cent. According to a Breakingviews calculator, Citi can't achieve as much by paying less.

Goldman doesn't show any sign of trimming compensation to such an extent, even if the industry is moving in that direction. Deutsche Bank's Anshu Jain and Morgan Stanley's James Gorman are among the latest bank bosses to signal the trend. Unless he can find another way to juice returns, Mr. Blankfein may find the best way to rise above his peers is, in fact, to follow them.

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