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CEOs prove eager to strike up friendships with chiefs of rival firms

August 1, 2004

For more information, contact: Benjamin Haimowitz, HHaimowitz@aol.com

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. It is impossible indeed to prevent such meetings by any law which either could be executed or would be consistent with liberty and justice.   --Adam Smith, The Wealth of Nations

The chief executive of a prominent corporation is a friend of the CEO of a competitor who resigns under pressure from the company's board of directors. How does the first CEO respond?

Quite likely by striking up a friendship with the friend's successor. And, the more competitive the industry, the more likely that would be to happen.

This startling finding emerges from a study, presented on August 9 at the annual meeting of the Academy of Management in New Orleans, that focuses on friendships among chief executives and what happens when one or another of the chiefs leaves or is removed.

"The greater the competitive uncertainty (as determined by the level of industry concentration), the greater the likelihood that a broken friendship tie between the CEOs of competitor firms will be reconstituted, where the broken tie results from turnover of either CEO," conclude the study's authors, James D. Westphal, Steven Boivie, and Daniel Chng of the University of Texas, Austin.

A favorite theme of Prof. Westphal, one of the country's leading young scholars on corporate management, is how CEOs and other corporate elite manage to find their way around the increasing number of statutes, rules, and sanctions designed to check their power.

Friendships between chiefs, Westphal and colleagues observe in their new study, may enable the CEOs to skirt laws and constraints against formal ties between executives of competing firms. As they note, "Direct interlock ties between competitors, where the manager of one firm sits on the board of a competitor, are prohibited by antitrust regulations." And even though "nondirectional interlock ties between competitors, where the same person serves as outside director on the board of competitors, are not prohibited by law, they may still contribute to the perception of collusive behavior among stakeholders, thus inviting closer scrutiny from regulators and ultimately increasing the likelihood of other forms of antitrust regulation."

In contrast to such official ties, friendships between CEOs of rival firms "are not formally regulated; they are less visible to stakeholders, and thus do not give the appearance of collusive behavior; and they do not compromise organizational autonomy by giving the CEO of a competitor formal authority over the affairs of the firm. At the same time, such ties promise benefits to firms with respect to the reduction of competitive uncertainty that are analogous to the putative benefits of board interlocks."

Thus, mutual knowledge gained from such friendships, the study continues, "facilitates tacit coordination between firms. If a CEO can predict with confidence that a competitor will raise prices in a certain time frame...then the focal executive will be more willing and able to make necessary preparations to match the increase. Conversely, a CEO will be more willing to lead a price increase if he or she can trust the CEO of a competitor to follow."

If the advantages of such friendships are clear enough, what is the evidence that CEOs initiate and maintain them with such benefits in mind? "It is one thing to suspect such things and something quite different to be able to document them," acknowledges Prof. Westphal.

To do so, the researchers focused on a pattern of behavior that gives the game away -- namely, whether a CEO will seek out the friendship of the new chief of a rival firm after a friend leaves that position. Will the likelihood of reconstituting that tie correlate with the competitiveness of the industry in which the rival firms operate? In other words, will the likelihood be less in lower-competitive industries and greater in more highly competitive industries?

To find out, the researchers carried out a two-stage survey of CEOs and other top executives of large U.S. companies about the friendships the chiefs maintained with bosses of three types of firms -- direct competitors, buyer or supplier firms, and financial firms. Stage one of the survey was in 1999. Three years later, top executives of companies that had responded to that first questionnaire were surveyed again. In all, the investigators received repeat responses from knowledgeable insiders at 293 companies, 152 of whom were the CEOs themselves.

The researchers found that, when a tie between CEOs had been disrupted by a change in leadership, the likelihood of reconstituted friendship increased significantly with the competitiveness of the industry. Similarly, they found it to increase based on the importance to a given company of a buyer or supplier or of a financial firm.

In view of the fact that the study probed personal relationships motivated by business considerations, is it accurate to describe them as real friendships as opposed to acquaintanceships of convenience? To ascertain that they were actual friendships, the researchers asked executives to choose among four descriptions: Was the CEO in question, 1) "among your closest friends"; 2) "a friend, but not among your closest friends"; 3) "less than a friend but more than an acquaintance"; and 4) "an acquaintance?" In addition, they asked about such key features of friendship as trust ("to what extent do you feel you can trust this person?"); disclosure of personal information ("to what extent do you feel comfortable disclosing personal information to this person?") and personal loyalty and commitment ("to what extent do you believe this person is committed to continuing a personal relationship with you regardless of what firm you work for?").

Further confirming the genuine nature of the friendships: in more than 90% of the cases where a CEO reported a friendship with a chief who subsequently left his or her position, the friendship was still alive at the time of the follow-up survey.

Unlike Adam Smith, Prof. Westphal and his colleagues do not pass judgment about the propriety of the friendships uncovered among competitors. "Collusion does not require friendship," Westphal observes. "The willingness of executives to reveal these relationships suggests that they view them as proper."

But he adds: "It is also true that the friendships among competitors documented in this study do provide a way around laws and ethical strictures. It may not be far-fetched to compare what is going on here to flying under the public's radar."

In that sense, the new study bears comparison with earlier research by Prof. Westphal. At last year's annual meeting of the Academy of Management, for example, he presented research to the effect that corporate directors who participate in reforms at one company are ostracized by fellow directors of other companies where they are board members. In other words, a subtle form of ostracism is used to forestall reform.

In essence, the new research sounds a similar theme -- namely, how a powerful elite, faced with legal, ethical, or simply managerial constraints, advances its interests through relationships that are under the radar -- unlikely to be revealed in any newspaper or to attract the attention of any regulator.

The Academy of Management, founded in 1936, is the largest organization in the world devoted to management research and teaching. It has about 15,000 members in more than 90 countries, including some 10,000 in the United States. The academy's 2004 annual meeting, August 6-11, drew about 7,000 scholars and practitioners to New Orleans for over 1,000 sessions on a host of issues relating to corporate organization, the workplace, technology development, and other management-related subjects.

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