Abstract
Small firms, especially those in developing countries, face several serious problems: (1) costs of regulation, including corruption, (2) contract enforcement, and (3) idiosyncratic risks that leave their owners with high costs of finance. To deal with these problems, it is recognized that firms exercise choice over their degree of formality. Little attention, however, has been given to the alternative strategies that firms may choose in gaining formality and dealing with these problems. This article examines the choice between two different strategies: (1) registering with official entities, and (2) participating in private associations. We develop hypotheses concerning factors that would favor one such choice over the other and then test these hypotheses with data taken from a large sample survey of Mexican microenterprises. The results provide support, in some cases strong support, for most of the hypotheses.
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Notes
de Soto did pay attention to private associations in his more recent book (de Soto 2000). In general, existing literature on these private associations tends to be limited to the following issues: (1) the capture of such associations by governments largely for political purposes (e.g., in Mexico, Shadlen (2002)), (2) interfirm networking and cooperation in the success of associations in certain regions, e.g., the industrial districts of Northeastern Italy or less frequently in Mexico and other Latin American countries (Rabellotti 1993; Woodruff 1998), and (3) identifying other factors affecting the success of such associations (Cronin (2004), including their role in promoting technological change or exports (Levy et al. 1998).
La Porta et al. (1998) provide an empirical analysis of the degree and quality of law enforcement, investor protection, and ownership concentration using data from 49 countries around the world. They show that countries with poor investor protection indeed have significantly smaller debt and equity markets and higher levels of ownership concentration. Such protection allows firms to attract outside investors and thereby reduce idiosyncratic risk. The environment of microenterprises in Mexico, however, is one where such protections do not apply and entrepreneurs typically have no one with whom to share their idiosyncratic risks. (See also Himmelberg et al. (2002)).
Likewise, in the case of firms with large suppliers or customers and/or fixed locations, the rationale would be that in such cases one party or the other would be vulnerable to holdup problems associated with investment in product specificity and would view registration with the authorities and memberships in associations as means of lowering their vulnerability to these problems.
Shadlen (2002), moreover, shows that the attempts of the major political parties to organize the numerous small microentrepreneurs into their party organizations failed because the interests of such entrepreneurs were not congruent with those of other popular groups like workers or consumers.
Laeven and Woodruff (2003) have also made use of these same indicators, among others, in relating the quality of the legal system to firm size and ownership in 1998.
Having a fixed or semi-fixed location here is viewed as pre-determined to the choice of registration inasmuch as the location type can be viewed as part of a detailed definition of the industry or activity type.
Since both registration types are binary, while both y *1 and y *2 are estimated continuous response variables, they are defined as follows: \(\left\{{\begin{array}{lll} {y_i =1} & {\hbox{if}} & {y_i^\ast > 0} \\ {y_i =0} & {\hbox{if}} & {\hbox{otherwise}} \\ \end{array}}\right.,\) i = 1,2, where the y 1(y 2) dummy variable is one if registered with the official entity (any private association) and zero otherwise.
The latter’s computational algorithm is based on the Geweke, Hajivassiliou, and Keane (GHK) recursive simulator (Geweke 1989). For further reference on multivariate probit estimation, see Heckman (1978) and Greene (2003, p. 714). Our application of the method is almost identical to the example illustrated by Greene (2003, 715–719)
In the second specification of the reduced form, where we use only two of the four instruments, the test results do not reject the validity of the instruments for the equation when the dependent variable is the registration with informal organizations. But, once again they fail to support their validity for the equation when the dependent variable is the registration with the authorities.
The other official entities are omitted since they would be relevant primarily to firms in a single sector (such as health) rather than to all firms.
To account for possible heteroscedasticity of the residuals due to the possible variation of the data at the state level, all the specifications in Tables 3 and 4 are estimated using the robust variance-covariance matrix of the estimators. We also use Veal and Zimmermann (1992) to calculate the pseudo-R 2 measure for estimations with binary dependent variables. This is essentially the normalized Aldrich and Nelson (1984) measure of pseudo-R 2, estimated using the following formula: \(\hbox{Pseudo}\_R^{2}=-\frac{2(l_{\rm M} -l_0 )}{2(l_{\rm M} -l_0 )+N}\frac{N-2l_0}{2l_0},\) where N is the number of observations, l M is the maximized likelihood value of the model, and l 0 is the maximized likelihood value when the non-intercept coefficients are restricted to zero.
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Sukiassyan, G., Nugent, J.B. Associations versus registration as alternative strategies of small firms. Small Bus Econ 31, 147–161 (2008). https://doi.org/10.1007/s11187-007-9085-7
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DOI: https://doi.org/10.1007/s11187-007-9085-7
Keywords
- Regulation costs
- Contract enforcement
- Efficiency of the legal system
- Microenterprise
- Business associations
- Mexico