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Abstract. The purpose of this study is to define on the enterprise level how informal institutions
directly and indirectly could affect innovative entrepreneurial behaviour. The study of the impact of
institutions on the entrepreneurial behaviour is not widespread in the literature because of the
difficulties in defining the proxies for entrepreneurial innovative behaviour at the county level or
the difficulties in selecting the proxies for informal institutions on the enterprise level. In addressing
these issues the Business environment and enterprise performance panel dataset 2002-2009 have
been used in this study for defining the proxies of the informal institutions on the enterprise level.
As one the proxies for informal institutions on the firm level a component of firms loses due to
others’ unfair behaviour unexplained by the perceptions of these unfair behaviour as an obstacle in
the regression has been selected. The goodness of this proxy is shown by its high correlation at the
country-level with Corruption Perception Index and moderately with cultural values. The main
findings are that informal institutions have a statistically significant impact on the entrepreneurs
innovative behaviour. This is the first paper devoted to defining the effects of institutions at the
entrepreneurial innovativeness at the firm-level.
Keywords: innovation, entrepreneurship, informal institutions, culture, corruption
Introduction. It is well known that entrepreneurship sector is important for the economic
growth and development of the national economy because it could reduce negative consequences of
economic recession by creating working places and also by implementing innovations into the
economy (Martin et al., 2010; Kreft and Sobel, 2005; etc.). By the Schumpeter’s (1934, 1950) view
entrepreneurs should provide innovations intro national economy and, therefore, stimulate
economic growth. But in the fact it is seen that entrepreneurs are often don’t implement any
innovations and don’t even contribute enough to the national budget. This could be explained by the
Baumol’s (1990) statement that the entrepreneurial individuals have a choice to devote their labour
effort toward productive (innovation) or unproductive (rent-seeking) way. This decision is
influenced by the corresponding rates of return to the activities, which in turn is shaped by the
quality of existing political and legal institutions.
In institutional terms enterprise behaviour is understood as a reaction to inadequate formal
and informal institutions, leaving little scope to explain emergent behaviour (Hare, 2001; Krueger et
al. 2000, Peng, 2000; Stenholm et al. 2013). Institutions create constraints and incentives that
encourage entrepreneurs to move from unproductive to productive activities and ultimately improve
the overall economic well-being of society (Baumol, 1990; North, 1990) and understanding the
influence of informal institutions on the entrepreneurship sector is of considerable theoretical and
practical value, more so when taken alongside formal institutions (Hayton et al., 2002). The
institutional configuration perspective recognizes that human behaviour is jointly shaped by formal
and informal institutions, which is often discussed but rarely empirically tested (Stephan et al.,
2015). To fill this gap the purpose of this research is to define empirically the effect of the informal
institutions on entrepreneurial behaviour towards innovations. But to do that the informal
institutions’ effect should be analysed together with the formal institutions (as suggested by Stephan
et al., 2015).
To be able to do this the Business environment and enterprise performance panel dataset
2002-2009 have been selected as a main data source for the study. The logit regression has been
used therefore for computing the effect of formal and informal institutions on the different measures
of enterprise innovativeness. As the proxy for informal institutions on the firm level a component of
firms loses due to others’ unfair behaviour unexplained by the perceptions of these unfair behaviour
as an obstacle in the regression has been selected. The main findings reflect that informal
institutions have a significant effect on the enterprise’s innovativeness, as well as formal institutions
do.
The rest of the paper is organized as follows: in section 2 the literature review is presented,
section 3 describes the methodology of research, section 4 presents the empirical results, section 5
setups discussion and, finally, in section 6 conclusions are presented.
Literature review. Entrepreneurial activity has been established as one of the key drivers of
macroeconomic outcomes. Entrepreneurs may contribute to growth through a diverse range of
behaviours, including innovation, combination of resources and increased competitive pressures
(Valliere and Peterson 2009). According to Schumpeter (1934, 1950), an entrepreneur is someone
who finds new combinations of resources and creates products that did not previously exist. He is a
disruptive force in an economy, because the introduction of these new combinations leads to the
obsolescence of others. Thus, entrepreneurship is the main factor in promoting economic growth
and its instrument is innovation.
Entrepreneurial activity is fundamentally influenced by economic and socio-cultural
influences in the environment in which it is formed and executed (e.g. Krueger et al. 2000,
Stenholm et al. 2013). According to Baumol (1990) institutional environment could drive
entrepreneurial behaviour into productive or unproductive way.
The main informal norm studied in the scientific literature is a national culture. As noted by
North (1990), culture provides a language-based conceptual framework for encoding and
interpreting the information that the senses are presenting to the brain, thereby shaping human
actors’ perceptions of the external world and influencing their decisions and behaviour. Culture also
influences how individuals process information and shapes their subjective mental constructs used
to interpret problems faced in life, which in turn affects their decision-making (North, 1990).
The culture influences economic activities through two mechanisms. First, based on the
model of Williamson (2000), culture conditions formal institutions and hence indirectly affects
economic outcomes as suggested by Licht et al. (2005). Second, culture exerts a direct impact on
economic activities through its role as an informal constraint on opportunistic behaviour and
through its influence on human actors’ actions and decision-making by shaping their incentives and
subjective perceptions of the external world (Akerlof and Kranton, 2000; Rabin, 1993). The direct
impact of culture on expectations and preferences was reflected in the works Henrich et al. (2001)
and Bornhorst et al. (2005).
A lot of studies have concluded that “supportive” national culture increases the
entrepreneurial potential of the country (Hechavarria and Reynolds, 2009; Mueller and Thomas,
2001; Pinillos and Reyes, 2011; Zhao et al., 2012). In the paper of Estrin and Mickiewicz (2010)
established a clear impact of informal institutions on entrepreneurial activity in transition
economies. Engle et al. (2011) concluded that informal institutional factors have a greater impact
than do formal institutional factors on entrepreneurial intent and beliefs have been found to result in
intentions to behave in a particular manner. Some of the existing literature on cultural differences in
entrepreneurship suggests that entrepreneurs from different countries are more alike than non-
entrepreneurs from the same country (McGrath and MacMillan, 1992). Yet, other studies suggest
the attributes of entrepreneurs differ drastically across cultures and countries (Thomas and Mueller,
2000).
Stephan et al. (2015) suggested that cross-cultural psychologists should consider formal
institutions when exploring the effects of culture as well as differentiate between cultural values and
norms. Similarly, Williamson (2000) state that the effects of the informal institutions are
transmitted to the institutional environment and governance structures. Autio et al. (2014) stated
that formal institutions mostly influence economic outcomes and opportunity costs when informal
institutions tend to operate through established social norms and perceptions of legitimacy and
social desirability. In the work of Stephan et al. (2015) joint effects of formal regulatory
(government activism), informal cognitive (postmaterialist cultural values), and informal normative
(socially supportive cultural norms, or weak-tie social capital) institutions on social
entrepreneurship have been found out.
From the formal institutions impact on the entrepreneurship Kreft and Sobel (2005) of
multiple regression analysis within 50 US states show that an area’s degree of economic freedom
significantly positively impacts the underlying level of entrepreneurial activity. Sobel (2008)
examined cross-sectional data from the continental 48 US States and found a significant impact of
institutional quality on the productive (positive) and unproductive (negative) entrepreneurship and
confirm the hypothesis that institutional quality creates wealth primarily because it promotes
productive entrepreneurship, which in turn creates wealth and income.
One more approach to study the development of the small business from a position of the
institutional theory is based on studies of coherence of formal and informal institutions (Roxas et
al., 2008). For example, participation of entrepreneurs in the informal economy and tax evasion
(unproductive entrepreneurship) has been asserted to result from the lack of alignment of formal
institutions (i.e., the codified laws and regulations) with informal institutions, namely the norms,
values and beliefs of entrepreneurs (De Castro et al., 2014; De Mel et al., 2012; Webb et al., 2014;
Williams and Horodnic, 2015; Williams et al., 2015). The proposition has been that when the
norms, values and beliefs of entrepreneurs align with the codified laws and regulations, there will
be little or no participation of entrepreneurs in the informal economy. As these formal and informal
institutions become more unaligned, however, the propensity to engage in illegitimate
entrepreneurial behaviour increases. This is the institutional asymmetry thesis (Ostapenko and
Williams, 2016; Williams and Vorley, 2015).
From the above analysis, it could be concluded that scientists investigated mainly direct and
separate impact of formal and informal institutions on entrepreneurship by conducting multi-level
regressions (Autio et al., 2013; Davidsson and Wiklund, 1997; Estrin and Mickiewicz, 2010; Guiso
et al., 2006; Klyver al., 2007; Levie and Autio, 2007; Stephan et al., 2015; Wennberg et al., 2013;
Zhao et al., 2012) or by cross-section analysis (Pinillos and Reyes, 2011; Kreft and Sobel. 2005;
Sobel, 2008). But at the same time combining different levels could be disadvantageous because the
perceptions of different categories of the population may be different and as well the representation
of formal institutions in peoples’ minds (Decety and Sommerville, 2003; Kasperson, 1992;
Rohrmann, 1994; Tversky and Kahneman, 1981). The other point is that in the most researchers
have been examining the impact of the institution on the entrepreneurial entry rates, not on the
behaviour of existing entrepreneurs.
Problem Definition. Meanwhile, the way of informal institutions’ influence on
entrepreneurs’ behaviour hasn’t been studied to the full extent yet. This is a gap in the literature
because the effect of these influences could lead to biases in the evaluation of the impact of formal
institutions on the business productiveness, which could lead to a problem of simultainity and
endogeneity in the research results.
Methodology. Since in previous researches on macro and multi levels endogeneity is a
concern, particularly since past research emphasizes the link between institutions and economic
growth (Stephan et al., 2015), here firm-level analysis will be implemented. To do this Business
environment and enterprise performance panel dataset 2002-2009 is used (European Bank for
Reconstruction and Development, 2016).
As the proxy for the entrepreneurial innovativeness the following variables have been used:
if enterprise have introduced new products or services by the in the last three years;
if a company spent on research and development activities in 2007;
if a company upgraded an existing product line or service by this in the last three years.
All these proxies for the firms’ innovativeness were also used in the Transition Report of
European bank for Reconstruction and Development (European bank for Reconstruction and
Development, 2014). In that report as proxies for innovation were used new products and
production processes, R&D firms spendings, novel approaches to marketing and improved
management techniques. The connections between selected proxies of entrepreneurial
innovativeness are presented in Table 1.
The push factors of the entrepreneurial innovativeness have been selected to define the
factors which forced business to implement innovations for their survival. By the allocation of push
factors, it would be possible to separate the effect of these factors from the effect of institutions. So
following variables have been selected as the proxies for the push factors:
Importance of pressure from domestic competitors in developing new products;
Importance of pressure from customers in developing new products;
Importance of pressure from foreign competitors in developing new products.
While conducting the analysis on the impact of the institutions on the enterprise level, we
have an advantage of using the variable of perceptions of formal institutions by entrepreneurs
instead of evaluating the effect of formal institutions per se. That is advantageous because
perceptions of formal institutions predetermine the impact of informal institutions on the
entrepreneurial behaviour. If entrepreneurs don’t see the rules as effective and transparent, even if
these rules are recognized as effective and transparent by government officials and experts they still
will not have so positive impact on the enterprises as if they would be perceived by entrepreneurs as
effective. Therefore, as the proxies of perceptions of formal institutions the following ones were
used:
The court system is fair, impartial and uncorrupted;
Corruption is an obstacle to current operations;
Government contract secured (or attempted) in the last 12 months;
Courts is an obstacle to current operations;
The court system is able to enforce its decisions.
In the analysis also informal practices were included, which is an informal “norms” in the
society, which could also impact the behaviour of entrepreneurs. As the proxies for informal
practices the following variables have been used:
In order to obtain any of the compulsory certificates was a gift or informal payment
expected or requested;
In reference to any of applications for permits, was an informal gift or payment expected or
requested;
In any of inspections or meetings was a gift or informal payment expected or requested.
In addition, we are controlling for the effect of formal institutions and, since all the variables
in the BEEPS data set are subjective, as the proxy for the formal institutions could serve the
country, because the institutions are country specific and it is impossible to have the same
institutions between countries. The full list of used variables from Business environment and
enterprise performance is presented in Appendix 1.
The deriving the proxy for the informal institutions is somewhat difficult because the
existing variables for capturing it are endogenous, i.e. the informal institutions are unobservable
variables which could lead to biased estimates. As the proxy for the informal institutions the
unexplained component of the regression analysis with the dependent variable of losses due to theft
from the perception of the theft as an obstacle to current operations has been used. If the unfair
behaviour isn’t perceived as an obstacle it means that it is rooted as the norm for the society.
As BEEPS 2002-2009 presents the panel data, for the estimation of dependence of enterprise
losses due to theft, robbery, vandalism or arson experienced in the last fiscal year from the personal
evaluation of crime, theft and disorder to enterprise as an obstacle with the fixed or random effects
estimators could be used:
Where Los – losses due to theft, robbery, vandalism or arson experienced in the last fiscal
year;
Accept - how much of an obstacle are crime, theft and disorder to this establishment?, No
obstacle =0, very obstracle=4.
From this model we will eliminate the enterprise specific fixed effects Ui.
The second estimator is a random effect estimator:
Losit Losi ( Accept it Accept i ) (1 )Ui (it i ) (2)
From here the composite error term (1 )Ui (it i ) was taken out for the proxy of
informal institutions.
To define the proxy foe embedded informality the corresponding regression has been
calculated (in Table 2) and the fixed effects and errors from this analysis have been used later as the
proxies for informal institutions.
Table 2. Regression for the losses due to theft, robbery, vandalism or arson experienced in the
last fiscal year
I II
How much of an obstacle are crime, theft and 0.033*** 0.053***
disorder to this establishment? (0.005) (0.002)
Constant 0.20*** 0.179***
(0.005) (0.003)
N 26178 26178
Prob > F = 0.0000 0.0000
The difference between these proxies lies in the method of estimation of the regressions.
Informal institutions’ proxy no. 1 have been predicted from the fixed effects regression in Table 2
(model I), and the second proxy for informal institutions from the random effect panel regression
with using the overall error component (Table 2 model II). However, it should be noted that F-test
for fixed effect model rejected the hypothesis about zero values of all Ui and Hausmann test
suggested fixed effect model. At the same time the implementation of the random effect model
could be also useful as Breusch and Pagan LM test for random effects suggested that there are
random effects in the model.
The country-level means of obtained proxies have been examined for the connection with
the indicators of culture and informal institutions. The proxy for the informal institutions from the
fixed effect model for the fifteen countries (Albania, Bulgaria, Croatia, Czech Republic, Estonia,
Hungary, Latvia, Lithuania, Poland, Romania, Russia, Serbia, Slovakia, Slovenia, Ukraine)
moderately correlates with Hofstede’s power distance (-0.55), individualism (0.71), and uncertainty
avoidance (-0.55) and Inglehart’s Traditional-Rational values (0.5). The informal institution's proxy
from the error term moderately correlates with Inglehart’s Survival-Self-expression values (0.55)
Other correlations with indicators of culture are weak. At the same time for twenty five countries
(Albania, Armenia, Azerbaijan, Belarus, Bosnia, Bulgaria, Croatia, Czech Republic, Estonia,
Georgia, Hungary, Kyrgyz Republic, Latvia, Lithuania, Moldova, Montenegro, Poland, Romania,
Russia, Serbia, Slovakia, Slovenia, Tajikistan, Ukraine, Uzbekistan) the correlation between proxies
for informal institutions and the Corruption perception index is moderate - 0.63 with proxy from the
fixed effects model and 0.66 with the proxy from the random effect model correspondingly.
The descriptive statistic of the selected variables is presented in Appendix 2. The cross-
correlation analysis also has been implemented and presented in Table 3. One could see the
moderate correlations between the ability of the court system to enforce its decisions and
perceptions of the court system as uncorrupted, between the perceptions of the courts as an obstacle
to current operations and the perceptions of the corruption as an obstacle to current operations, and
between the requirements of informal gifts and payments during inspections or meetings and
requests of informal gifts and payments during applications for permits (correlation coefficients are
0.50, 0.62 and correspondingly). The correlation between the different proxies for informal
institutions is 0.9. ll other correlations between variables are weak (Table 3).
The estimation technique for the entrepreneurial innovativeness uses random effect logit
models, from where we are using odds ratios:
P( Innovi 1)
Ln t a Push 1 Perc _ Form 2 Inform _ norm 3 Forma 4 Informal 5
P( Innovi 0)
(3)
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15)
(1) Importance of pressure from domestic
competitors in developing new products 1.00
(2) Importance of pressure from customers
in developing new products 0.42* 1.00
(3) Importance of pressure from foreign
competitors in developing new products 0.26* 0.3* 1.00
(4) The court system is fair, impartial and
uncorrupted 0.02 0.05* 0.03* 1.00
(5) Corruption is an obstacle to current
operations 0.11* 0.07* 0.13* -0.24* 1.00
(6) Government contract secured (or
attempted) in the last 12 months 0.06* 0.05* 0.05* -0.05* 0.16* 1.00
(7) Courts is an obstacle to current
operations 0.11* 0.11* 0.16* -0.24* 0.62* 0.10* 1.00
(8) In order to obtain any of the compulsory
certificates was a gift or informal payment
expected or requested -0.00 -0.02* 0.00 -0.10* 0.13* 0.03* 0.08* 1.00
(9) In reference to any of applications for
permits, was an informal gift or payment
expected or requested? 0.05* 0.05* 0.02* -0.02 0.15* 0.24* 0.10* 0.06* 1.00
(10) In any of inspections or meetings was a
gift or informal payment expected or
requested? 0.03* 0.03* 0.01 0.01 0.13* 0.23* 0.06* 0.03* 0.50* 1.00
(11) The court system is able to enforce its
decisions -0.01 -0.00 -0.01 0.50* -0.17* -0.03* -0.22* -0.05* -0.02 -0.00 1.00
(12) Country 0.07* 0.11* 0.10* 0.03* -0.10* -0.02* -0.05* -0.05* -0.07* -0.12* -0.01 1.00
(13) Size of the enterprise -0.04* -0.00 0.14* 0.05* 0.02* 0.02* 0.06* 0.05* -0.06* -0.06* 0.04* -0.02 1.00
(14) Informal institutions1 0.06* 0.07* 0.03* -0.00 0.03* 0.07* 0.07* -0.02* 0.05* 0.01 -0.02* 0.11 0.14* 1.00
(15) Informal institutions 2 0.05* 0.06* 0.03* 0.01 0.00 0.07* 0.04* 0.02 0.05 0.02 0.02 0.10 0.13* 0.91* 1.00
Empirical results. Empirical evaluations of the impact of institutions on the decisions about
developing new products and services are presented in Table 4. The results show seven models with
different ways of informal institutions’ impacts – directly or through the interaction with formal
institutions. All models present the odds ratios of the coefficients from the panel random effects
logit regressions. The Hypothesis that all random effects are equal to zero has been rejected at 0.01
level.
As could be seen from the models’ evaluations in Table 4, from the push factors for
innovativeness in developing new products and services the pressure from customers and foreign
competitors have a positive and significant impact in specifications. So these factors could “push”
enterprises to starting develop new products and services.
The indicators of the perceptions of formal rules are statistically significant in all models as
well, except the perceptions of the courts as an obstacle to current operations. It should be
mentioned however that perception of the corruption as an obstacle and the fairness of the court
system influence the decisions about developing new products in the unpredicted way. That could
be explained by the bypass of these obstacles in the business operations by innovations. According
to the strength of the impacts the greatest influence from the perceptions of formal institutions have
the perception of the secureness of government contracts and it has a positive effect on the firms’
innovations in developing new products.
From the informal practices’ indicators the informal payments for the compulsory
certificates highly positively associated with the decision to develop new products, whereas
informal gifts’ requests during the inspections negatively associated. That could confirm our
previous thesis that entrepreneurs could use innovations to overcome the institutional barriers.
Table 4. Odds ratios of the panel logit regression with the dependent variable “In the last three years, has this establishment introduced new
products or services?” Random effects models
and
of the company on
introduction of new
development activities
three years
research
in 2007
if
As could be seen from Table 7, the formal institutions have more effect on business
innovativeness in the developing countries compared to developed countries. The formal
institutions are statistically significant and positively associated for all entrepreneurial innovation
proxies in Belarus, Bosnia, Croatia, Lithuania, Moldova, Russia, Tajikistan and Ukraine.
Discussion. This firm-level study contributes to understanding the factors influencing
innovative behaviour of entrepreneurs. Beyond the specific results which enhance better
understanding of productive entrepreneurship activity, this study contributes to institutional theory
by advancing the understanding of the way of informal institutions’ influence on the innovation.
This research empirically extends the institutional context for entrepreneurial innovation.
The scholars usually examine the impact of informal institutions on the entrepreneurship entry rates
(Puumalainen et al., 2015; Stephan et al., 2015; Zhao et al., 2012) and this research adds the
previous ones in the field by approving another object of the influence of institutions on
entrepreneurship development – institutions could impact not just the entrepreneurship entry rates,
but also on the current behaviour of entrepreneurs. The most interesting question of institutions and
entrepreneurial behaviour is how they could affect innovative behaviour (the question has been
stated up to now by Baumol, 1990).
This study also contributes in the outlining the ways of possible influence of informal
institutions on the entrepreneurship (direct and indirect), and empirically complements the existing
theoretical analyses (Henrekson and Sanandaji, 2010; Williams and Vorley, 2015). The findings
supplement the findings of Stephan et al. (2015), who by conducting multilevel analysis confirmed
joint effects on social entrepreneurship of formal regulatory, informal cognitive and informal
normative institutional pillars.
The methodology of the research also complements the existing approaches in examining
the impact of coherence between formal and informal institutions – namely Williams’ and Vorley’s
(2015) evaluation of the institutional asymmetry’s influence by drawing on in-depth interviews with
Bulgarian entrepreneurs.They have found out, similarly to this research, that ‘institutional
asymmetry’ between formal and informal institutions hampers the development of economically
and socially productive entrepreneurship.
Conclusions. From the above analysis, it could be concluded that informal institutions have
as much important effect on the decisions of entrepreneurs to implement innovations as the formal
institutions does. The informal institutions have a positive statistically significant and robust
association with innovative entrepreneurial behaviour in all regressions. The less the practice of
unfair behaviour roots in the society the more innovative entrepreneurs are.
From the analysis, it is shown that informal institutions could directly affect entrepreneurial
behaviour as well as indirectly. Coherence between formal and informal institutions could be that
mechanism through which formal and informal institutions impact the behaviour. Informal
institutions could impact through the security of government contracts, perceptions of the courts as
an obstacle to current operations and the ability of the court system to enforce its decisions.
From the perceptions of institutions the security of government contracts has the highest
positive effect on business innovativeness.
The size of the enterprise was found to have a positive and robust effect on the
entrepreneurial innovativeness, which means that the bigger the enterprise the more innovative it is,
which is contrary to the Schumpeter’s (1934, 1950) view of entrepreneur as an innovator.
The countries’ dummies also were found to have statistically significant association with the
firms’ innovations. They were used in this study as an objective proxies for the formal institutions.
Practical implication. The importance for policy lies in the fact that politicians cannot
design optimal institutions once and for all; if there are special informal institutions rooted in
peoples’ minds the entrepreneurial responses to these new institutions could be not as predicted and
there is no guarantee that opportunities created by new reforms will be used solely for the
productive entrepreneurship (also was stated by Henrekson and Sanandaji, 2010).
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Appendix.
Appendix 1. Selected variables from Business environment and enterprise performance
survey 2002-2009