No ethical issue here. Your friend should reveal the other school. It cannot hurt.
The schools are just trying to determine what the competition is, and to figure out what they need to do to recruit your friend to their school. They will likely compare/contrast the strengths/weaknesses of the two schools in an effort to "sell" their school to him.
Riverripper is right in that it could lead to a scholarship. (In fact, if you're trying to negotiate a larger scholarship award, a school may ask you to verify other scholarships by sending you a copy of the other award letters. Don't be shy about doing that.)
When I was the Director of MBA Admissions at a top-30 school, I asked this question all the time. It's interesting to explore the judgement a candidate uses in their choice set of schools, and it enabled me to more closely align my program's strengths with the candidates goals.
Did candidates always tell me the truth? Of course not. However, I valued a candidate's trust in me when they were willing to reveal their other schools.