“That’s what friends are for….” – Nepotism in business

The first funding for a company often comes from the notorious “triple F”….Friends, Fools, and Family. 

For early-stage, high-risk, small-ticket investments, this is the right audience. Personal trust (often somewhat biased), and long-lasting shared legacy, give a reason for investments beyond a sound commercial due diligence.

Young companies grow through creativity, thriving in an environment of trust, open debate, low formal restrictions, high engagement, a common goal, and mutual inspiration….among friends.

Not a surprise, the founding teams including the first hirings of start-up companies are often friends from university or early career stations. Or they become new friends over long days with splendid ideas, in bootstrapped offices, with shared pizzas, to substitute for work-life balance outside their start-up bubble.

The same is true for family-owned SMEs. Co-working family members may not be befriended in the conventional understanding of the term, yet family members also act on a platform of personal trust and relationships, untypical for the professional context of a “normal” firm.

Friends in business?

To get this right, there is nothing wrong, to create a friendly and open atmosphere with co-workers. Trust, and feeling safe in the workplace are crucial, to thrive, independent of company size or industry sector. Problems are created if personal relationships overrule the principles of sound governance, checks and balances, and individual accountability.

The red line is crossed, when colleagues, that are friends turn into friends that are colleagues.

A stunning example was given by the failed crypto exchange FTX, known for being run by a group of 10 close, nerdy friends, who knew each other from college or first jobs, earlier in their careers. Sharing a posh penthouse apartment in the Bahamas, occasional psychedelic substances, and each others’ intimacy.

FTX is an example of an extremely dysfunctional relationship in the professional environment, yet by far not the only case. Elizabeth Holmes and Theranos may not be as theatric as “SBF and his crew”, but just as dysfunctional. Beyond these good portrait cases, the (e.g.) “owner’s nephew joining a managerial role, without recognizable qualification“, might be a more common case and fits the same criteria.

Corporate evolution overtakes personal relationships 

The transformation of corporate culture as a function of corporate growth and maturity is well described in the Greiner Curve. The Greiner curve was presented in 1972 by Larry Greiner and described six stages of corporate development and the requirements of corporate leadership. 

Whereas the environment of creativity is crucial for the early stage of a firm, the growth of the company requires more formal structures and frameworks at later stages. This includes degrees of bureaucracy that may be well-hated by employees, yet, are a necessity for growth. Keeping the balance between formalization and empowerment of employees is a challenge for management.

Friendship is prey to success

Friendships end due to the loss of commonalities, mismatched expectations, and betrayal.

Whereas start-up cultures (as well as family-owned SMEs) are based on multiple levels of alignment, growing and mature organizations require inconvenient leadership decisions. Easily these can offend the basis of a friendship if segregation between professional environment and personal relationships gets ignored. 

This sounds like trivia, as it is easily agreed, expectations in the workplace must be limited to the work context. Yet, long hours in start-up companies and family-owned firms are exceeding the agreed conditions of labor contracts and can be a sign of solidarity among the founding team. 

The same holds for companies of any size in a situation of crisis. Working long hours to mitigate whatever crisis is hitting the firm, can be committed to the common cause of saving the company, but also a social contract among the executives, not to let down each other. Law firms and consulting teams are additional examples of environments, that expand the employees’ commitment far beyond the mandatory. Whereas these two examples often operate in “project management mode”, hence, in something, similar to a crisis condition, the self-declaration of “elite” teams can also contribute to the willingness of team members, to extend their working hours.

So, if the company expands its expectations beyond the contractually agreed terms of the functional role, isn’t it fair for the employee to expect room for growth and degrees of protection?

And Elon Musk? Asking Twitter employees to “commit to extreme hardcover “ after his $44 billion take-over of cash-draining Twitter.

This is asking for work performance exceeding the work agreement out of a commitment to his vision of Twitter 2.0 under turnaround conditions; a cause, that was not that common after all. The request was not welcomed by at least 500 employees, answering with farewell messages. The best guess would be, these were employees with better chances on the job market, hence, the better part of Twitter’s workforce. 

Misusing the terms of friendship to leverage employee performance is one form of misunderstanding corporate evolution relative to interpersonal relationships.

It’s lonely at the top – from friendship to Nepotism 

Emotional abuse can also come from confusion.

The CEO’s job, being in the sandwich between shareholders, management, and workforce, is lonely. 

It is understandable, yet a sign of a weak leader, if personal friendship is an element of their leadership culture. “Friendship” can be a wish for a friendly company or an acronym for a request for ill-fated loyalty.

Either can easily turn into forms of nepotism, systematically bypassing the delegation of authorities (DOA) and checks and balances of corporate governance that can be observed in:

  • Building functions around people
  • Lack of transparency and accountability 
  • employing, rewarding, and promoting people for other than skill, performance, and talent

There is a give and take to be observed: Whilst “the favorable few” are given extra authority, resources, and inappropriate weight in decisions, this is creating what can be described as an “inner circle” within the management of the firm. Unquestioned loyalty is required in exchange for protection and low degrees of accountability. Easily this shifts the focus within an organization away from task conflicts towards relationship conflicts. Once relationship conflicts prevail, it’s more important “who is in favor” than “how to get it (together) done”. This undermines trust and leads to a toxic atmosphere in the workplace.

This is causing multiple inefficiencies throughout the organization, starting with the ineffective allocation of resources, frustration of other employees, difficulties to retain talent, lack of foresight and lack of leadership engagement, etc., hence, ultimately increasing risk and deteriorating efficiency, harming shareholder interests.

In economic theory, the effects of nepotism are rather weakly reflected, whereas conflicts of interest between the management and shareholders are traditionally considered under the assumption of principal-agent conflicts. Thus a principal-agent conflict considers misaligned economic interests, hence underlying different, yet rationale, motivations, among the parties, whilst nepotism is triggered by irrational drivers.

Asymmetric evolution of corporate culture and corporate growth are dysfunctional 

Strong personal relationships are natural for early-stage companies, yet mature firms suffer from weak leadership practices, building rather on personal loyalties than formal governance. Shortcomings of the leadership foster dysfunctional processes within the firm and increase economic risks for the shareholders. 

This can be attributed to the asymmetric development of organizational demands and leadership skills.

Leadership patterns, eligible for early-stage companies are dysfunctional for mature firms. 

For shareholders and non-executives, observation of the evolution of the leadership culture in relation to the growth of the firm is crucial. Adjusting and improving management practices must be aligned with the evolving demands of the organization over time.

Six steps, to prevent nepotism include:

  • Limit tenure of senior executives
  • Enforce formalized decision processes
  • Minute decisions and follow-up on execution
  • Establish transparency and accountability throughout the leadership team
  • Foster diversity
  • Apply sound governance and management oversight

kolja rafferty headshot

Kolja A. Rafferty, MBA, IDP-C, CTP

Follow me on LinkedIn and Twitter

Leave a Reply

Your email address will not be published. Required fields are marked *

Proudly powered by WordPress | Theme: Baskerville 2 by Anders Noren.

Up ↑