Informal
Entrepreneurship in
Developing Economies:
The Impacts of Starting
Up Unregistered on
Firm Performance
Colin C. Williams
Alvaro Martinez-Perez
Abbi M. Kedir
To advance understanding of the entrepreneurship process in developing economies, this
article evaluates whether registered enterprises that initially avoid the cost of registration,
and focus their resources on overcoming other liabilities of newness, lay a stronger foun-
dation for subsequent growth. Analyzing World Bank Enterprise Survey data across 127
countries, and controlling for other firm performance determinants, registered enterprises
that started up unregistered and spent longer operating unregistered are revealed to have
significantly higher subsequent annual sales, employment, and productivity growth rates
compared with those that registered from the outset. The theoretical and policy implica-
tions are then discussed.
Introduction
In recent years, a small but burgeoning body of entrepreneurship scholarship has
begun to focus upon entrepreneurship in the informal sector, by which is here meant
starting up and/or owning and managing a business venture which does not register with
and/or declare some or all of its production and/or sales to the authorities for tax, benefit,
and/or labor law purposes when it should do so (Ketchen, Ireland, & Webb, 2014;
Siqueira, Webb, & Bruton, 2016; Williams & Martinez-Perez, 2014). This is an important
development in entrepreneurship scholarship. With two-thirds of enterprises in the
Please send correspondence to: Colin C. Williams, tel.: 144 (0)114 222 3476; e-mail: C.C.Williams@
sheffield.ac.uk.
This is an open access article under the terms of the Creative Commons Attribution-NonCommercial-
NoDerivs License, which permits use and distribution in any medium, provided the original work is
properly cited, the use is non-commercial and no modifications or adaptations are made.
August, 2016 1
DOI: 10.1111/etap.12238
1042-2587
V
C
2016 The Authors. Entrepreneurship Theory and Practice published
by Wiley Periodicals, Inc. on behalf of SAGE Publications Inc.
developing world estimated to start up unregistered (Autio & Fu, 2015), advancing com-
prehension of the reasons for, and impacts of, nonregistration is crucial if the entrepre-
neurship process in developing economies is to be more fully understood.
Conventionally, nonregistration has been viewed as deleterious to firm performance.
In the long-standing liabilities of newness approach, registration provides new ventures
with some level of legitimacy, and reduces their probability of failure (Stinchcombe,
1965). Here, however, we question the transferability of this widely accepted (developed
world) view of the reasons for, and impacts of, registration to the developing world. The
aim of this article is to analyze whether formal enterprises in developing countries that
initially avoid the cost of registration, and instead concentrate their scarce resources on
overcoming other liabilities of newness, subsequently outperform those which registered
from the outset.
By analyzing the relationship between starting up unregistered and future firm per-
forma nce, knowledge is advanced in thr ee importa nt ways . First, this article advances
theory on no t only venture creation and growth in developing countries but also develops
a more contextualized understanding of liabilities of newness. Reading venture creation
and liabilities of newness in the impoverished setting of the devel oping world through
the lens of institutional theory, it will be asserted not only that unregistered enterprises
may lack formal legality but possess a le vel of social legitimacy (Godfrey, 2015; Webb,
Tihanyi, Ireland, & Sirmon, 2009) but also that the considerable formal market imper-
fections in the developing world result in registration having limited benefits but rela-
tively substantial costs. Hence, ra ther than address their l iabilities of newness by
investing resources in seeking legality through registration, which in many developing
economies is a significant cost but with few benefits, enterprises in the developing world
that delay registration a nd its associated costs, and instead focus their scarce resources
on overcoming other liabilitie s of newness (e.g., establishing stronger routines, relat ion-
ships with suppliers and customers), are propounde d to lay the foundations for stronger
subsequent firm performance than those that register from the outset. The original empi r-
ical contribution of this article, using World Bank Enterprise Survey (WBES) data on
127 developing countries, is to reveal that registered enterprises that start up unregi stered
and spend longer operating unregistered do indeed outper form tho se registering from the
outset. This is the case for econometric estimations using imputed and nonimp uted data,
with and without ou tlying observations , and with correction for potential sample selec-
tion bias, given that registration at start up is an endogeno us choice . Finally, and from a
policy perspective, we demo nstrate the need for governments in developing countries
when tackling informal entrepreneurship to put less emphasis on pursuing a puniti ve
approach that does not deal with the caus es of nonregistration, and to place more empha-
sis on the institutional conditions tha t signi ficantly disa dvantage enterprises registering
from the outset relative to those delaying registration, due to the costs of registration out-
weighing the benefi ts.
To advance understanding of the entrepreneurship process in developing countries,
therefore, the first section frames the contributions of this article by reviewing how insti-
tutional theory explains nonregistration in developing countries. This will reveal that
despite institutional scholars recognizing that unregistered enterprises often possess
social legitimacy in the developing world, and that they prevail due to formal institutional
imperfections and institutional incongruence, little attention has been given to evaluating
the impacts of starting up unregistered on subsequent firm performance. Consequently, to
develop theory and hypotheses, the second section reviews the conventional (developed
world) liabilities of newness approach that views registration as providing some level of
legality and as positively affecting firm performance, followed by the need for a
2 ENTREPRENEURSHIP THEORY and PRACTICE
rethinking of nonregistration in developing world contexts along with the rationales for
viewing enterprises in developing countries that initially avoid the cost of firm registra-
tion as achieving higher subsequent firm performance than those that register from the
outset. To evaluate the resultant propositions, the third section introduces the data and
methods, namely World Bank Enterprise Survey (WBES) harmonized data on 95,522
enterprises in 127 developing countries and multilevel modeling techniques (random con-
stant and random slope models). In the fourth section, we present the results to explore
the main impacts of starting up unregistered and the duration of nonregistration. To con-
trol for sample selection bias, we use a Heckman two-step estimator, while robustness
checks on the results are conducted by removing outliers from both ends of the distribu-
tion of suspected variables. Finding that registered enterprises that started up unregistered
and spent longer unregistered have significantly higher subsequent annual sales, employ-
ment and productivity growth rates than enterprises registered from the outset, the fifth
and final section discusses the resultant theoretical and policy advances along with the
limitations of the research and future research required.
Informal Entrepreneurship in Developing Countries: An Institutional
Perspective
For much of the twentieth century, the informal sector in developing countries was
largely deemed unimportant and unworthy of scholarly attention. A modernization theory
prevailed that depicted the informal sector as some minor and declining remnant of an
earlier mode of production, and its continuing persistence in countries as signaling their
“underdevelopment” and “backwardness” (Geertz, 1963; Gilbert, 1998; Lewis, 1959).
The widespread belief was that such endeavor would naturally and inevitably disappear
with economic advancement and modernization. Over the past few decades however, the
informal sector has been recognized as an extensive and persistent feature of the develop-
ing world, equivalent to some 40–60% of GDP (Schneider & Williams, 2013), with 60%
of the workforce having their main employment in the informal economy (J
€
utting &
Laiglesia, 2009), of which 70% are self-employed (ILO, 2013). Indeed, although there is
a lack of robust comprehensive data on the number of unregistered businesses, a conser-
vative lower-bound estimate is that at least half of all enterprises are unregistered (Acs,
Desai, Stenholm, & Wuebker, 2013), and that some two-thirds of all enterprises are
unregistered at start up (Autio & Fu, 2015).
Recently, significant advances have been made in understanding the prevalence of
informal entrepreneurship in developing countries by scholars adopting an institutional
perspective. Entrepreneurship is viewed as a socially constructed behavior (Sine & David,
2010; Webb & Ireland, 2015), and institutions as “the rules of the game” which prescribe,
monitor, enforce, and support what is socially acceptable (Baumol & Blinder, 2008; Den-
zau & North 1994; Mathias, Lux, Crook, Autry, & Zaretzki, 2014; North, 1990; Webb
et al., 2009). All societies have both formal institutions (i.e., codified laws and regula-
tions) that set out the legal rules of the game, as well as informal institutions which are the
“socially shared rules, usually unwritten, that are created, communicated and enforced
outside of officially sanctioned channels” (Helmke & Levitsky, 2004, p. 727). Informal
entrepreneurship is viewed as an endeavor occurring outside of formal institutional pre-
scriptions but within the norms, values, and beliefs of informal institutions (Godfrey,
2011; Kistruck, Webb, Sutter, & Bailey, 2015; Siqueira et al., 2016; Webb et al.; Welter,
Smallbone, & Pobol, 2015). For example, although avoiding registration laws is formally
illegal, in many developing economies registration requirements are seen as overly
August, 2016 3
burdensome, due to the formal institutional imperfections, and their circumvention thus
deemed socially legitimate (De Soto, 1989; Webb, Bruton, Tihanyi, & Ireland, 2013).
This institutional perspective, therefore, has explained informal entrepreneurship in
developing countries as resulting from either formal institutional imperfections and/or the
incongruence between formal and informal institutions. As Webb and Ireland (2015) out-
line, these formal institutional imperfections are of four types. First, there are formal insti-
tutional voids, including the lack of, or poorly defined, property rights, lack of basic
utilities, and poor social protection which forces citizens into necessity-driven informal
entrepreneurship as a survival strategy (Kistruck, Webb, Sutter, & Ireland, 2011; Webb,
Kistruck, Ireland, & Ketchen, 2010). Second, there are formal institutional inefficiencies,
or resource misallocations by formal institutions (Qian & Strahan, 2007), such as when
formal institutions seek to protect or maximize economic rents for elites (Acemoglu &
Robinson, 2012), manifested in overly burdensome taxes, and registration and licensing
regulations and costs, which act as an entry barrier to formality for new entrepreneurs (De
Soto, 1989; Siqueira et al., 2016; Williams, Shahid, & Martinez, 2016). Third, there is for-
mal institutional uncertainty when technology and sociocultural changes outpace changes
in the ability of formal institutions to accommodate new domains of activity and fourth,
there is formal institutional weakness and instability, manifested in a lack of capacity to
enforce policies (Webb et al., 2009) and continuous changes in laws and regulations (Lev-
itsky & Murillo, 2009; Williams & Vorley, 2015).
When explaining informal entrepreneurship, however, focusing upon solely formal
institutional imperfections ignores the role played by cognitive and normative institutions,
which can be joined within the broad category of informal institutions (Godfrey, 2015;
North, 1990; Scott, 2008). Indeed, informal entrepreneurship has been increasingly
viewed as arising “because of the incongruence between what is defined as legitimate by
formal and informal institutions” (Webb et al., 2009, p. 495). Given that developing econ-
omies are so defined precisely because they have under-developed formal institutions,
entrepreneurs draw upon existing norms, values, and beliefs to facilitate, govern, and
structure their economic activities instead of relying on formal codified laws and regula-
tions (London, Esper, Grogan-Kaylor, & Kistruck, 2014; Mair, Marti, & Ventresca,
2012). When these formal and informal institutions do not align, as is common in many
developing countries, the result is informal entrepreneurship which, although formally
illegal, is deemed socially legitimate (De Castro, Khavul, & Bruton, 2014; Kistruck et al.,
2015; Siqueira et al., 2016; Webb et al., 2013; Webb, Ireland, & Ketchen, 2014). Indeed,
the greater the degree of incongruence (i.e., nonalignment) between formal and informal
institutions, the higher the level of informal entrepreneurship (Williams & Shahid, 2016).
Informal entrepreneurship is therefore more extensive in developing than developed econ-
omies due to not only the greater formal institutional imperfections, but also the greater
incongruence between formal and informal institutions, resulting in the use of informal
institutions as an alternative guiding framework (Mair et al., 2012; Godfrey, 2015).
Turning to the impacts of entrepreneurs deciding to operate informally, the wide-
spread finding has been that enterprises operating under the guiding framework of the
informal institutional environment are less efficient and poorer performing than those
operating in formal institutional environments (Benjamin & Mbaye, 2012; La Porta &
Schleifer, 2008, 2014). Indeed, not only do new ventures operating legitimately show
higher levels of revenue and profits, use more workers, and are more capital intensive
than their informal counterparts (Fajnzylber, Maloney, & Montes-Rojas, 2011; McKenzie
& Sakho, 2010) but there is also evidence that registration by informal firms leads to
higher firm performance than if they remained unregistered (Demenet, Razafindrakoto, &
Roubaud, 2015; Fajnzylber et al.; Rand & Torm, 2012). What has been seldom evaluated,
4 ENTREPRENEURSHIP THEORY and PRACTICE
however, is whether enterprises that start up unregistered and register later, not least to
avoid the cost of registration during their start up phase, subsequently witness higher firm
performance than those registered from the outset. This empirical focus, as will now be
shown, is important because it enables new theoretical insights to be generated regarding
the longstanding liabilities of newness approach.
Starting Up Unregistered and Firm Performance
Impacts of Delaying Registration on Future Firm Performance
The concept of liabilities of newness (Stinchcombe, 1965) has been a key element in
scholars’ understanding of the emergence and growth of new ventures for the past half
century. Recognizing that new ventures have higher mortality rates than older more estab-
lished ventures (Barron, West, & Hannan, 1994; Wiklund, Baker, & Shepherd, 2010),
new ventures are asserted to lack a track record of past performance on which to base
claims of legitimacy, reliability, and accountability (Choi & Shepherd, 2005; Delmar &
Shane, 2004) and to be perceived as competent, effective, and worthy (Zimmerman &
Zeitz, 2002). Registering is, thus, a way of enhancing legitimacy because registering sug-
gests that a business complies with other laws and regulations, such as paying taxes and
has the appropriate licenses and certifications, and thereby generally contributes to the
overall societal good (Kistruck et al., 2015; Webb et al., 2009), signaling stability, quality,
and/or prestige (Bitektine, 2011; Suchman, 1995) and reducing liabilities of newness.
Nonregistration, conversely, is seen to lead to a lack of legitimacy which negatively
affects nascent firm performance (Fajnzylber, Maloney, & Montes Rojas, 2009; Farrell,
2004; ILO, 2007; La Porta & Schleifer, 2008; Palmer, 2007).
Ventures starting up unregistered should therefore have worse subsequent perfor-
mance levels than those registered from the outset, all other things being equal. However,
although a positive relationship has been identified between newness and mortality rates
(Dobrev & Gotsopoulos, 2010; Le Mens, Hannan, & P
olos, 2011), with the exception of
Henderson (1999) who examines sales growth, the impact of newness has not been evalu-
ated using other firm performance measures, and neither has there been any evaluation of
whether formal enterprises delaying registration suffer worse future firm performance
than those registered from the outset. Although studies by McKenzie and Sakho (2010) in
Bolivia and McCulloch, Schulze, and Voss (2010) in rural Indonesia evaluate the benefits
of registration, they do not consider the benefits of nonregistration. Neither has there been
any comparison of the firm performance of registered firms delaying registration at start
up with those registered from the outset. The exception is a study by Perry et al. (2007).
Analyzing World Bank survey data on 355 formal enterprises that delayed registration
across seven Latin American countries (104 in Colombia, 72 in Argentina, 72 in Bolivia,
66 in Mexico, 20 in Peru, 12 in Uruguay, and 9 in Panama), the finding is that they “at
least initially, exhibit on average, much lower levels of output per worker, after control-
ling for firm size, time in business, sector and region” (Perry et al., p. 173). However, this
is a small sample, the productivity gap is statistically significant in only four of the seven
countries, and the average national figure of 29% lower productivity for those delaying
registration is skewed by the Peru figure where the productivity gap is over 50%, which is
not statistically significant, and only 20 unregistered start ups were surveyed.
It is not only the weak evidence base that intimates a need to analyze this relationship
between delaying registration and firm performance. There are strong theoretical ration-
ales for doing so. For entrepreneurs to survive and grow, they must gain legitimacy (Scott,
August, 2016 5