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The Goodman was founded in 1925 as a tribute to the Chicago playwright Kenneth Sawyer Goodman, who had died of pneumonia in 1918. The theater was funded by Goodman's parents, Mr. and Mrs. William O. Goodman, who donated USD$350,000 to the Art Institute of Chicago to establish a professional repertory company and a school of drama at the Institute. The theater was designed by the architect Howard Van Doren Shaw, although its design was severely hampered by location restrictions resulting in a lack of space for scenery and effects and poor acoustics.
The opening ceremony on October 20, 1925, featured three of Kenneth Sawyer Goodman's plays: Back of the Yards, The Green Scarf, and The Game of Chess. The theater presented its first public performance on October 22, 1925, with John Galsworthy's The Forest.
The theater struggled for many years with financial problems and resignations of directors. In 2000, the company moved into its new building at 170 N. Dearborn (just north of Randolph Street) in Chicago's theater district. It has two fully-modern auditoriums, named the 'Albert' and the 'Owen' after two further members of the Goodman family, who continue to be major donors.
After his death in 1999, comedian Del Close purportedly donated his skull to the Goodman Theatre for use in Hamlet productions on the condition that he should receive credit in the program as Yorick. The skull resides in the office of Goodman artistic director Robert Falls. In October 2006, it was revealed by Charna Halpern, the executrix of Del Close's will, that the skull donated to the Goodman was not actually Close's. Due to pressures from the morgue, Halpern wound up purchasing a replacement skull. The information was uncovered by the Chicago Tribune.