Shades of Grey: How do Informal Firms Navigate Between Macro and Meso Institutional Environments?

SHADES OF GREY: HOW DO INFORMAL FIRMSNAVIGATE BETWEEN MACRO AND MESOINSTITUTIONAL ENVIRONMENTS?

JULIO O. DE CASTRO1*, SUSANNA KHAVUL2, and GARRY D. BRUTON3

1IE Business School, Madrid, Spain2Department of Management, College of Business, University of Texas atArlington, Arlington, Texas, U.S.A.3Neeley School of Business, Texas Christian University, Fort Worth, Texas, U.S.A.

Our qualitative research shows that when making decisions about informality, entrepreneurs inemerging economies purposefully navigate between the enabling and constraining rules of themacro institutional environment and the norms of the meso institutional environment. We showthat: (1) informality is a multidimensional continuum along which path to formalizationunfolds; (2) as entrepreneurs grow more successful they become simultaneously more attunedto the countervailing constraints of both the macro and meso institutional environments; and(3) informal firms and formal firms weave together an exchange system that legitimizes thepersistence of informality. In the context of informality, meso institutions serve as the connec-tive tissue which cross-link levels of the environment and shape the context in which entrepre-neurs make decisions. Copyright © 2014 Strategic Management Society.

INTRODUCTION

Firms that fail to legally register and pay taxes rep-resent one common form of firm activity that fallswithin the boundaries of the informal economy. Suchfirms make up the informal economy and represent40 to 60 percent of the GDP in emerging economies(Schneider, 2005; Portes and Schauffler, 1993; deSoto, 1989). A prominent view of informality sug-gests that firms start and remain informal becausethe economic costs, in both money and time, to for-mally register with the government are too high (deSoto, 2000; Webb et al., 2013). By implication, ifgovernments lower costs or reduce the time andcomplexity required to complete registration, thenentrepreneurs would react by converting their infor-mal ventures into formal ones (de Soto, 2000). Pro-

ponents of this ground their argument in the nexus ofbehavioral responses of individuals to changes inmacro institutional regimes. An alternative argumentsuggests that by staying informal, entrepreneurs aremaking rational decisions based on cost-benefitanalysis (de Mel, McKenzie, and Woodruff, 2013;Perry et al., 2007). That is, the cost of being formalis too high relative to the benefit. Whether initialregistration costs or ongoing costs impede formal-ization remains a hotly contested academic questionthat also confounds policy makers as they designinterventions to stem the tide of informality.

In this article, we argue that informality is anuanced phenomenon best examined at the intersec-tion of institutional environments that entrepreneursface. Using qualitative field data, we show that inmaking decisions about informality, entrepreneurs inemerging economies purposefully navigate betweenthe enabling and constraining powers of the macroand meso institutional environments they face. Attheir core, institutions consist of rules and norms,both formal and informal, which structure social

Keywords: informality; entrepreneurship; emerging market;institutional environments*Correspondence to: Julio O. De Castro, IE Business School,Maria de Molina 6, E, 28006 Madrid, Spain. E-mail:[email protected]

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Strategic Entrepreneurship JournalStrat. Entrepreneurship J., 8: 75–94 (2014)

Published online in Wiley Online Library (wileyonlinelibrary.com). DOI: 10.1002/sej.1172

Copyright © 2014 Strategic Management Society

interaction by constraining and enabling actors’behaviors (Helmke and Levitsky, 2004). Institutionsexist at the macro, meso, and micro levels that, inthe context of our work, broadly correspond to thenational (federal or common union), local (includingcommunities of practice), and individual levels,respectively. Prior research has focused on the top-down effects of macro regulatory environment oninformality. We believe it is time to drill deeper(Bruton, Ireland, and Ketchen, 2012) and unpackhow informal entrepreneurs navigate among levelsof institutional environments. To motivate ourresearch we ask three questions:

Research Question 1: How do the macro andmeso institutional environments affect entrepre-neurs’ decisions to formalize their businesses?

Research Question 2: As their firms become moresuccessful, how do the countervailing demands ofthe macro and meso institutional environmentsinfluence the informal entrepreneurs’ cost-benefitconsiderations related to formalizing?

Research Question 3: How does the interactionbetween informal firms and formal organiza-tions affect the cost-benefit decisions thatinformal entrepreneurs make with respect toformalization?

We examine these research questions in theDominican Republic, where informality is central tothe local economy (42% of GDP, Vuletin, 2008) anda key source of economic growth. Despite its sig-nificant role in countries such as the DominicanRepublic, informality remains understudied, espe-cially from an entrepreneurship perspective (Bruton,Khavul, and Chavez, 2011; Khavul, 2010; Bruton,Ahlstrom, and Obloj, 2008; de Soto, 1989).

Our study makes several contributions to the lit-erature. First, we show that entrepreneurs seeformalization of their firms in terms of multiple stra-tegic choices that unfold over time and are notsimply excluded from formalization by the cost orcomplexity of registration. We suggest that thebinary classification of formal versus informal firms,into which the management literature has tended topigeonhole this decision, needs to evolve into a mul-tidimensional continuum that is responsive to insti-tutional differences and cross-country variation.Second, we demonstrate that when successful entre-preneurs face the challenges of institutional plural-

ism, they become simultaneously more attuned tothe countervailing constraints of both the macro andmeso institutional environments. Finally, we showthat informal and formal firms weave together anexchange system that legitimizes the persistence ofinformality.

Informal firms and institutional environments

Informal firms

Informal firms are organizations that conduct market-based activities with legal goods produced and dis-tributed without regard for taxation or regulation(Portes and Castells, 1989; de Soto, 1989; Portes andHaller, 2005; Schneider, 2005; Webb et al., 2009).The distinction between legal and illegal activity isimportant because many informal businesses supplyillegal goods (i.e., pirated media and software) and donot register with their governments. By contrast, ourresearch focuses on the vast majority of unregisteredbusinesses that provide legal goods and services (deSoto, 1989), and we leave aside questions of illegalgoods that notionally fall within the boundaries of theinformal economy. Albeit at different rates, informalfirms are prevalent in both mature and emergingeconomies. As a defining characteristic of entrepre-neurial life in emerging economies (Khavul, Bruton,and Wood, 2009; Khavul, 2010; Kodithuwakku andRosa, 2002), the effect of informality on firm produc-tivity and growth is much debated (LaPorta andShleifer, 2008). Scholars have long accepted thatinstitutional context influences entrepreneurial activ-ity (Estrin, Korosteleva, and Mickiewicz, 2013), sothe face of entrepreneurship differs between emerg-ing and mature economies (Peng, 2000; Bruton et al.,2008). Similarly, the causes and consequences ofinformality in emerging and mature economies likelydiffer. Indeed, research that distinguishes the con-tours of informality in emerging and mature econo-mies is gaining momentum (Estrin and Mickiewicz,2012). The spotlight on the role of institutions in firmentry and growth is particularly intense (Estrin et al.,2013).

Institutions

Institutions and their governance play an importantrole in the rise and fall of nations (Acemoglu andRobinson, 2012), the evolution of organizationalforms (Khavul, Chavez, and Bruton, 2013), and poli-cies to promote economic inclusion (Banerjee and

76 J. O. De Castro, S. Khavul, and G. D. Bruton

Copyright © 2014 Strategic Management Society Strat. Entrepreneurship J., 8: 75–94 (2014)DOI: 10.1002/sej

Duflo, 2011. Formal and informal institutions shapeentrepreneurial behaviors in subtle but pervasiveways (Scott, 1995; Bruton, Ahlstrom, and Li, 2010;Estrin et al., 2013). To date, almost all of the analysisof how institutions affect informality has looked atthe macro (national or regulatory) level, yet institu-tions also help direct actions of individuals and com-munities at the meso level (Roelants, 2000; Elsner,2010).1 The meso level institutions are a bridge builton community values that accrete over time into acoherent and predictable set of well-known rulesand taken-for-granted norms. Institutions at thislevel come closest to ‘more-or-less taken-for-grantedsocial behavior that is underpinned by normativesystems and cognitive understandings that givemeaning to social exchange and thus enable self-reproducing social order’ (Greenwood et al., 2008:4). Meso institutions could be identified in local geo-graphically defined communities, but they can alsorefer to communities of practice and communitiesbound together by ethnic, economic, and politicalties. Meso institutions can be formal, with codifiedrules, or informal, with rules that members know andfollow but that no one explicitly states (Helmke andLevitsky, 2004).

The boundaries of meso institutional environ-ments are porous and responsive to the reach andinfluence of macro institutions. Porous boundariesallow meso institutional environments to captureinformation about changes in the macro institutionalenvironment as they diffuse across the institutionallandscape. As it crosses meso institutional boundar-ies, such new information can trigger communitiesto engage in sensemaking processes that may requirethe augmentation of existing taken-for-grantednorms. The responsiveness of meso institutionalenvironments can be seen when the taken-for-granted norms or values coalesce over time andeither complement or substitute the formal rules inthe macro environment. Thus, complementary mesoinstitutions bridge the gap between the demands ofthe macro environment and the needs of the indi-vidual. However, in emerging economies, we oftenobserve that meso institutions can also be substitutesfor weak macro institutions, the symptoms of which

are limited enforcement of legal requirements andtacit complicity at multiple levels of government tocircumvent legal institutional frameworks. In thissetting, meso institutions provide the locus for anentrepreneur’s identity and solidarity with a commu-nity, but they also reinforce business informality.Hence, meso institutional environments are theanchor around which informality develops despitethe codified rules to the contrary.

METHODOLOGY

Case studies and empirical setting

We used qualitative grounded theory methodologyorganized around a series of case studies (Eisenhardt,1989; Eisenhardt and Graebner, 2007; Glaser andStrauss, 1967; Strauss and Corbin, 1990; Yin, 2003).A qualitative approach is appropriate for buildingtheory (Lee, 1999). Grounded methods allow us todevelop a highly textured view of informality inemerging economies (Bruton et al., 2011). Informalfirms are complex and remain largely unexaminedfrom an entrepreneurial perspective.

Empirical setting

Our research is set in Santo Domingo, the capital ofthe Dominican Republic, a country with a large,economically significant informal economy (42% ofGDP, Vuletin, 2008) and high rates of poverty (50%of the population living on less than $2.50 a day). Werestricted our focus to informal vendors who princi-pally sold prepared food and fruit from stands alongstreets and in local markets. Vendors either had fixedretail locations or delivered goods as they rolledthrough the community on bicycles or in othervehicles. In the Dominican Republic, as in manyother countries around the world, entry into streetvending is easy and levels of informality are high.Although countries in the Latin American and Carib-bean region are heterogeneous, they share a cultureof business informality. Looking in-depth at onenation and at a typical industry allowed us to explorebroad questions but within a focused setting. Ourgoal is to provide insights that would spur futureresearch across multiple countries and with the useof multiple methods.

Cases

We used a purposive research, case selection processwhere, to be selected, specific cases had to meet

1 One should note that this view of meso institutions is notuniversal. Droege and Johnson (2007) and Potts (2007) viewmeso institutions not as reflective of levels but as a processthrough which institutions pass in their development. If they arein the process of developing, they are referred to as mesoinstitutions. We adopted the more dominant view of institutionsas occurring at different levels.

Informality and Institutional Environments 77


desired underlying firm characteristics. We workedwith individuals who had deep knowledge of entre-preneurs in these communities and could direct us toa broad cross-section of firms with variable out-comes. We conducted 40 interviews of which 31were with informal vendors (14 fruit sellers and 17food sellers) and nine with experts and key industryinformants. Both groups of vendors included sellerswho had permanent locations and those who movedtheir locations. We captured differences of type andsize across vendors. Out of 31 firms, two firms hadover $1 million a year in sales, two firms were in the$100,000 to $450,000 range, six firms had from$30,000 to $100,000 a year in sales, while six otherssold $10,000 to $30,000 per year. The remainingfirms sold less than $10,000 per year. In a countrywhere minimum salary is $150 USD a month, themajority of the firms we interviewed are far largerthan would be expected of informal firms that areonly self-employment vehicles. Indeed, half thefirms had more than two employees and nine out of31 also hired individuals from outside the family.Our cases represent a cross-section of informalvendors in the capital of the Dominican Republicand make for an appropriate empirical setting tounderstand informality. Table 1 summarizes keyinformation about our cases.

Summary of qualitative steps

We analyzed the data in seven steps, employingwell-established methods for grounded fieldresearch (Strauss and Corbin, 1990; Auerbach andSilverstein, 2003) that had previously been used toprovide insights into new domains (i.e., Brutonet al., 2011).

Step 1

In the initial step, we defined research questionsand broad categories a priori to guide the fieldresearch (Strauss and Corbin, 1990). We establishedthese research questions from the literature inentrepreneurship and on informal firms. To supple-ment the literature and confirm that the researchquestions were salient, we conducted preliminaryconversations with field and content experts. Wethen established the parameters of the purposivesampling, which involves selecting participantswith specific characteristics (Lincoln and Guba,1985).

Step 2

Next, we generated an interview protocol. The pro-tocol provided a framework that guided our discus-sions with participants at the informal firms. Indeveloping the protocol, we discussed expected cat-egories of outcomes based on the theoretical andempirical literature from economics, sociology, andeconomic development.

Step 3

We then conducted 31 semi-structured, face-to-face,in-depth interviews with informal firms (Weiss,1994). Initial prescreening questions ensured that allthose interviewed self-identified as informal entre-preneurs. The face-to-face interviews lasted from 45to 90 minutes. We used a local interpreter experi-enced in assisting social studies research conductedfor international organizations (The World Bank,Inter-American Development Bank, etc.). To ensureconsistency, we had all interviews taped and tran-scribed in Spanish and then translated into English.To ensure accuracy, a team member fluent in Spanishand English sampled and translated the interviewsindependently and compared the translations tothose of the expert. These experts had few disagree-ments on the translations. Most queries dealt withlocal idioms and word usage. We asked each entre-preneur similar questions; however, as the respon-dents raised issues that provided rich insights, wewould discuss those particular issues in greater depthwith each interviewee. As of the end of the inter-views, no new concepts emerged (though new storiesstill emerged).

Step 4

We compared patterns observed in the cases andfocused on the similarities and differences identifiedacross them. This interaction among the authorsrequired extensive discussion of the details of theinterviews we observed and the implications forthose observations. We built and modified the cat-egories generated by Step 1 as we discovered infor-mation that either supported or countered ourexpectations. In addition, we created new categoriesto reflect insights that did not fit into existing catego-ries. In those few instances in which the authorsdisagreed on the impact of the case on the researchquestion, we discussed the discrepancies until wereached a consensus.



Table 1. Case studies

Case 16 family members in business14 other people cooperate in businessStrong connections to suppliers (4) and strong connections

to policeAnnual sales $1.2 million

Case 22 family members in business—no othersStrong relationships with customers (wholesales to suppliers

to hotels and other higher-end clients) and suppliersAnnual sales $1 million

Case 31 family member in business3 other employeesStrong connections to suppliers (6) and customers

(wholesales to suppliers of resorts and high-endhotels)

Annual sales $450,000

Case 44 family members in business9 other employeesWorks with those in market to grow business (was critical of

one woman in market who does not network with others)Annual sales $172,000

Case 5No family members in business2 employeesNo connections to suppliers: buys strictly on price each day

and has no connections to other stalls in marketAnnual sales $80,000

Case 6No family members in business6 employeesStress no connections to community and weak connection to

suppliers (Haitian immigrant)Annual sales $51,000

Case 7No employees (although girlfriend seemed to be working

consistently)Supplier brought him the chickens and offered credit to

himWorked at night so did not have to register but knew police

in area and offered them free food periodicallyAnnual sales $50,000+

Case 82 employees, all familyLoans and credit cardsStarted the business with a friend, then bought him out2 suppliers and they provide creditAnnual sales $30,000

Case 92 family members in business—no othersNo relationships with community, customers, or suppliersAnnual sales $30,000

Case 103 family members in business—no othersAll financial instruments, credit cards, loans, savings accounts;

multiple suppliers who provide creditAnnual sales NA but estimated to be in top one-third of

interviews

Case 112 employees, all familyNo banking instrumentsHelp from church pastorMultiple suppliers who provide creditAnnual sales $30,000

Case 122 family members in business—no othersSavings accountsMultiple suppliers who provide creditAnnual sales $20,000

Case 13No family members in business2 other employeesParticipates in a coop, which provides loansHelp from church pastorMultiple suppliers who provide creditAnnual sales $25,000

Case 141 employee, an assistant, no family membersLoans from loan sharksStarted the business with a friend, then bought him outChanges suppliers based on prices; pays cashAnnual sales $15,000

Case 15Husband and wife teamLoans from bank; savings accountHelp from church pastorMultiple suppliers who provide creditAnnual sales $20,000

Case 164 family members in business4 others part-time employeesLoans with those in market and credit with suppliersAnnual sales $12,000



Table 1. (Continued )

Case 173 employees, all familyLoans from bank; savings accountHelp from church pastorMultiple suppliers who provide creditAnnual sales $10,000

Case 18No employees; self-financed standNo credit from suppliersNo relationship at all with other food stands in area around bus

station; does not even know their namesAnnual sales $9,500

Case 192 employees, all familyLoans from banks, saving accounts, and credit cardsThe idea from the business came from the daughter who

works with her5 suppliers and some provide creditAnnual sales $8,000

Case 203 family members in business—no othersRelationship with supplier strong and relationship with stadium

owner is the reason he can sell at cock fightsAnnual sales $7,000

Case 214 employees, all familyOwns another business, a butcher shopLoans from banks,Business was ‘my’ idea but the family helped a lot3 suppliers and some provide creditAnnual sales $6,000

Case 22No employeesLoans from loan sharksSister help start the business2 suppliers, no creditAnnual sales $6,000

Case 231 family member in businessNo other employeesLoans only from loan sharksNo suppliers, buys at the market and supermarketAnnual sales $5,000

Case 242 employees, all familyAll financial instruments, credit cards, loans, savings accountsOne supplier who does not provide creditAnnual sales $3,200

Case 251 family member in businessNo other employeesLoans only from loan sharksNo suppliers, buys at the market and supermarketAnnual sales $2,400

Case 26Self onlyNo relationships with community, customers, or suppliers

(buys damaged fruit and resells it cheap)Annual sales less than $1,000

Case 272 family in business—no othersStrong relationship to community; lends money to even

potential competitorsAnnual sales less than $1,000

Case 28Self onlyNo relationships with community, customers, or suppliers

(Haitian illegal immigrant); reported harassment by policeAnnual sales less than $1,000

Case 29No family in business1 employeeNo connections to suppliers; buys strictly on price each day

and no connections to other stalls in market area; newbusiness, the entrepreneur owns successful clothing store

Annual sales less than $1000

Case 301 family member in businessNo other employeesBank loansNo suppliers, buys at the market and supermarketAnnual sales does not know, has no sales data. Buys daily and

does not know how much is left over. Estimated to be in thelower one-third of interviews.

Case 31No family members in businessNo other employeesLoans only from loan sharksMultiple suppliers who do not provide creditAnnual sales does not know, has no sales data. Buys daily

and does not know how much is left over. Estimated to bein the lower one-third of interviews

***Confirmatory interview conducted also with an entrepreneur who moved from informal to formal with more than $2.5 million in revenue andmultiple employees. Eight other interviews also conducted with experts on informal firms. All amounts in U.S. dollars.‘Family’ refers to the number of family members working in the business.



Step 5

We made extensive use of secondary data, includingthe nature of the business registration process inSanto Domingo and the Dominican Republic. Table 2summarizes those registration requirements. Inaddition, we examined all major newspapers inSanto Domingo, January 1, 2012 through June 1,2013, looking specifically for illustrations of wherethe practice of macro and meso institutions con-flicted. Table 3 summarizes our findings from thenewspapers.

Step 6

To increase the validity of the findings, we inter-viewed eight experts on informal firms. Theseexperts included academics, government research-ers, a supplier to the firms, and NGO managers. Inaddition, we interviewed a respondent at one infor-mal business that had moved from informal to par-tially formal. Our analysis was consistent with thatof outside experts, yet this step is particularly impor-tant in reconciling any differences or explainingdisparities.

Table 2. Requirements for business registration in the Dominican Republic and the City of Santo Domingo

TO REGISTER WITH THE FEDERAL GOVERNMENT, THREE THINGS ARE NEEDED:

1. National taxpayer registry. 2. Registry of the commercial name. 3. Copy of the mercantile registry.Cost: around $10. No notarization of documents or fees needed. The government requires payment only by certified

check, but that can be done in any bank and is not a complicated procedure, as many organizations requirecertified checks because regular checks are not usually trusted and the government does not like cash payments(they make corruption easier).

You could also register as a person and get only the Registro Nacional de Contribuyentes (RNC). So this is the keyregistration.

With the RNC you are able to:1. Operate as a business or as a professional. 2. Obtain fiscal papers. 3. Declare and pay taxes. 4. Transact with the

tax authority.To obtain the RNC document you need:1. To fill a form that includes: a. Data of the person. b. Data of the business. c. A questionnaire (nine questions) to

determine the tax obligations.2. National identity card.3. Document of registry of the commercial name (if applicable).In going over the interviews, a constant response is: (1) nobody pays and (2) it is a way of extracting taxes without

providing services, and respondents feel they pay enough taxes and duties.

REGISTRATION WITH THE CITY:There is now a new requirement for registration of informal businesses for the three districts that constitute Santo

Domingo.

The requirements for registration are:1. Be a Dominican citizen or a legal resident and older than 18. 2. Fill out a form soliciting to own an informal

business. 3. Provide two 2x2 pictures.4. Present letter of nonobjection from at least four neighbors that live near the solicited location. 5. Present a

certificate of food handling from the Ministry of Health and the municipal clinic. 6. Provide a certificate ofnondelinquency from the district attorney. 7. Get a security certificate from the fire department.

This is recent (2008) and no firm we interviewed signed up for it. Both the Ministry of Health and the city havestarted to go after these businesses to make them register and comply.

REGISTRATION FOR DUTIES AND TAXES OF THE CITIES:

The City of Santo Domingo is actually divided into three areas and each has its own rules, but they are fairly similarin terms of charges and requirements for taxes and duties for specific issues:

1. Use of space in government-owned markets. 2. Use of city sidewalks and spaces. 3. For signage and signs: signs,street banners, etc., codified by size and type. 4. For covers and sun screens. 5.Parking spaces. 6. Trash collecting.

For a great majority of these items, the city will go to the entrepreneur to collect.



Step 7

Finally, we used the field evidence to generate a set oftestable propositions that lay the groundwork forfuture research. Each of these propositions in turngenerated a corollary insight that flows from theproposition and expands the understanding of infor-mal firms. Earlier, we posed three research questionsthat we will now examine in detail. We offer illustra-tive quotes and stories for each proposition in Table 4.

FINDINGS

Research question 1: how do the macro andmeso institutional environments affectentrepreneurs’ decisions to formalize theirbusinesses?

Registration

In the Dominican Republic, as in most countriesaround the globe, business formality is the law of the

Table 3. A selection of commentaries on the popular press of the Dominican Republic regarding street sellers in SantoDomingo

1. Street vendors occupy and destroy the Andres and Boca Chica beaches (El Nacional, Tejada, 2008)• ‘In addition to the bad condition of the beaches, the most depressing part is the conditions of the products and the

food stalls in the beach. The food is served without minimum standards of hygiene, with broken chairs, tables, andumbrellas, surrounded by trash.’

2. Near Duarte Av. there is everything except order (El Nacional, Torres, 2008)• ‘The offers of every kind, both yelled and with megaphones, cars honking, streets strewn with all kinds of food

sellers, all under the indifferent eye of the local authorities is what happens when you venture into Duarte Ave.,which is the top commercial street of the city of Santo Domingo.’

• Quote from a fruit seller: ‘In this business, we have no protection; we are exposed to the traffic and the elements.I have done this for 27 years and I sell between 2,500 and 3,000 pesos a day’ (between $85 and $100).

3. Street food without supervision or health (Eco del Ozama, 2008)• ‘Informal food vendors are starting to take hygiene measures with their products, but lack of good space and

contamination from the environment make it hard. . .whereas fruit vendors seem to have some minimum standardsof hygiene, sellers of juice and fried foods lack any standards.’

• Quote from a member of the foundation for the rights of the consumer: ‘We are not opposed to those men andwomen earning their living selling street food: the problem is that their services, if they are not regulated, couldendanger the lives of the consumers.’

4. The Ministry of Health and the Mayor’s Office will regulate the sale of street food (Hoy, Ortiz, 2009)• ‘The Ministry of Health and the Mayor’s Office of the City of Santo Domingo promised to maintain the vigilance,

control, and order of the food stalls and sale in the streets of the city. . .from today on, every seller in the streetwill need a sanitary permit from the Ministry of Health and a certificate of good conduct from the police.Moreover, there will be a census of sellers, and all sellers will have to wear uniforms.’

• Quote from the Minister and the Mayor: ‘The process will ensure that the city will be better organized andcleaner, and citizens will have a guarantee of what they are eating.’

5. Street sellers occupy and destroy the area near the Moscoso Puello Hospital (Al Momento, Diaz, 2011)• ‘The area around the hospital Moscoso Puello has been retaken over by street vendors even though the mayor

cleaned the area a year ago. . .the worst part is the amounts of trash generated by these business which lies allover the place.’

• ‘The vendors stated that they have had this location for years and that even if the Mayor’s Office cleans them upagain, they will return.’

6. Taxi drivers and street sellers occupy and destroy the area around the UASD (National University) (El Nacional,González, 2012)

• ‘In the mayor entrance to the university, there are around 20 food stalls, on top of two bus routes and a taxi carstop. . .sellers arrive with chairs tables, and umbrellas and install kitchens and cafeterias where they sellsandwiches, hot dogs, pizzas, and fried foods; others arrive in tricycles to sell juices and pastries.’

• From a customer: ‘I believe that even though this is not right, they are coming to earn a living and help, since inthe interior there are no cafeterias.’

• ‘In the year 2009, there was an agreement between the Ministry of Health and the Mayor of Santo Domingo toprovide a census and do health inspections of food street vendors in the streets of Santo Domingo, but it was neverdone’ (our emphasis).



Table 4. Illustrative and supporting quotes for propositions

Proposition 1: The weaker the formal macro environmental institutions, the more likely informal entrepreneurs are torely on norms in the meso institutional environment.

• I don’t register with the government. It is a hassle and I don’t need to. . .I might if the taxes were used insomething useful. . .other businesses similar to mine do not pay taxes. I registered with the city because theinspectors became annoying. They came and registered everyone. I pay about 3,000 ($100) pesos a month, butthey leave no note or receipt; they are swindlers. . .I would like to have my business formalized because I couldbenefit and improve, just like they do in the United States where everything is formal. . .It is necessary to educatesmall business owners about taxes and hygiene because informal businesses have little hygiene and it is notbecause they don’t want to, but because there is little support for the government. C17

• I am registered with the city; I pay a permit. I don’t register with the federal government, maybe because theopportunity has not come or because the business does not deserve to be registered yet. . .Other informal businessdo not pay taxes. If I lose money with a client, no one will compensate me. It does not matter if I am registered ornot. Then I don’t see the advantages of registering. If government aid was provided, they would help me expand orprovide me with new equipment; then it would make sense to register. C11

• The business is inside the house; there is no need to pay taxes. When I buy at the supermarket, I am alreadypaying taxes even if my business is not registered. There are people that pay taxes and others that don’t. C21

• I think I don’t have to register. I understand that only businesses that make more than 50,000 pesos a month($1,500) have to register. . .I pay to the city water and electricity. C13

• I don’t pay taxes now, but I don’t know whether the city will make me pay in the future. We sell about two boxesof fruit a day. We don’t know if we will keep it here in the future. The business is not mine; it belongs to mybrother-in-law. C26

• I have not applied (for registration) with the city or any public administration, but when I move the business (outof my house), I will put everything in order. C21

• Of the businesses similar to me in this area, none pays taxes; they are all little businesses. If I had to pay, it wouldbe a proportion since I am a little business. C9

• I pay the city so that I can show the fruit I sell. Before I start, I pay them all that is required. To the centralgovernment, I don’t have to pay because I have a moving business. Businesses like mine that are moving do notneed to pay more taxes than those we pay when we buy our products and merchandise; in fact, we pay the valueadded tax in our receipts. C4

• I have a permit from the city; I pay 100 pesos ($3) every Friday. It is for garbage collecting and they come everyFriday to collect. The city built this area for us. Nobody from the central government has come by to ask (me) toregister. I could register and pay to be in order, but the money keeps me from doing it. I know how it is done.More control from the city would be good. At night, no one can walk around here. There are no street lights;they installed street lights knowing that they would get damaged. There is no support from the city—look around.C14

• I have three businesses—a barbershop, a fruit stand, and a coffee shop. I pay taxes to the city for them. For theplace where I cut the hair, I pay 30 pesos ($1) a day to the city. For the coffee shop, I pay the owner of thebuilding and he pays the city. For the fruit stand, I don’t pay because I have been in the same location for a longtime. If I was an established business, it would be worth it to pay, but like it is, it is not worth it. C27

• My business is not even registered with the city because it does not generate enough revenue to warrant it. . .thebusiness must be profitable, and I do not have the means to earn 50,000 pesos ($1,500) or more; everything isexpensive. C19

Proposition 2: At each stage, entrepreneurial firms will choose, within each institutional dimension, a level ofcompliance where the benefits of formalization outweigh its cost.

• I register with the city (and) pay 140 pesos ($4.60) a week. I have around 10 suppliers and some days sales aregood, sometimes not so. C6

• I have three businesses. One constituted as a company, but the other two not. One is registered and the other twonot. I pay taxes for that one. I registered that one because it was a recommendation from my lawyer. . .I decided toregister that business because the banks were asking for it. Because since we started to make money and haveassets, people start to think that what I had was due to corruption.




• I am not paying now because the city is not coming to collect. I sell about 2,000 pesos ($65) a day, butthings are tough; before I used to sell double that. After Christmas, we will close that and go back to mynight business selling cigarettes and candy. When the police come, we have to move fast or we lose thebusiness. C29

• Nothing impedes me to register with the government, I just have not thought about it. C11• We have permits from the city. What is the advantage of registering with the central government? There is no

advantage. We would pay taxes and get nothing from it. Now if I make 2 pesos, they are for me and I don’thave to share them with anyone. C31

• We move the business around. If we were to stay in one location, I would think about registering. If the busi-ness grows and is worth it. The way things are now, we have a good sales day and a bad sales day. If I don’tsee that things (will) get better, I will sell the business. We try to register, but the city does not help or provideservice. The person at the counter when we went said that we had to move from this place because they do notprovide permits. . .I would only register if I had a fixed income. C15

• The business is inside my house; there is no need to register with the city. C21• I don’t have any obligation to formalize now. I would formalize if I needed some benefits, for example access

to insurance for the business. Everyone that has the opportunity to formalize their businesses should do so sothey can get the benefits of formalizing. I have heard taxpayers get tax refunds. C19

• I pay for a license with the city, yet nothing prevents me from registering with the government. C11• My business is not registered with the government or the city. Every time the city comes around, we have to

pick up and leave. I have not have the time or opportunity to register, but I know that businesses similar tomine do not pay taxes. C23

• I have not thought about registering the business since it implies paying taxes. Better I take whatever money isleft over home and in case they come for me, I have money to pay the taxes. C15

Proposition 3: As the wealth of informal entrepreneurs increases, they become more attuned to formal rules in themacro institutional environment and launch their firms on the path to formalization.

• One of the disadvantages of my informal business is that (it is) on the street. It does not have a roof—it’s aprovisional business. Yet, for many years I have taken care of that spot there and everybody recognizes it—themunicipal authorities and the general public. C4

• I don’t pay taxes to the government, but I pay to the city, around 2,000 every month. I keep accounting recordsbecause every year I sell more and more fruit. I work with two banks; they offer me lines of credit, but I don’t usethem. I do have a credit card from Banco Popular. Some people are all about cash, but I put my money in thebank. C2

• As unregistered businesses, nobody protects us. We pay lots of taxes when we buy our products, but if I couldgrow the business, then I would register so I can get better financing, etc. The government now does not helpat all. The main reason for not registering is fear of taxes. What I earn is barely enough and, besides if I paidtaxes, I would not have enough money to send my daughters to the university and to put food on the table.C24

• I am not registered with the federal government, but I do have a permit from the city. There are no advantages ofregistering with the government. The current economic environment is very harsh and if I had to pay taxes, there isno advantage for me. Now at least when I make some money, I get to keep it. If my business did better, I wouldthink about formalizing, because when you make money, things go smooth. . .if I had my business at a better level,then I would think about it. C31

• We have an art business that we run at the same time. In this restaurant, we sell to both individuals and companies,for employees’ lunches. We have three employees here that are all family. We keep a record of all served food andaccounting records. . .Paying a percentage of income to the government is a disadvantage, because what we pay tothe government we can save. Unless someone comes and makes me register I will not, because more than 80percent of the country does not pay taxes. We are not registered with the city or any other place. We do have manysavings and checking accounts and credit cards that we use for the business, plus there are some business loans.We have a couple of suppliers that provide us with credit. C10




Proposition 4: As the wealth of informal entrepreneurs increases, they become more attuned to the constraints of themeso institutional environment.

• Similar businesses are moving around and they don’t pay taxes. You would have to make a reasonable amount ofmoney on a daily basis to be able to invest that way. One way or another, we pay taxes. We have to buy theproducts, the detergent for cleaning the place and keeping it neat. . . I would only register if I had a fixed income.C9

• Other businesses similar to mine do not pay taxes to the government. They pay to the city; everyone here pays tothe city. I make a payment to the city every Saturday, like it is a permit. People from the city come here tocollect. . .What would make me register would be the tax obligation to present an invoice; some of the clients havebeen asking for it. C13

• In the markets, we are paying electricity and paying taxes to the municipal government. We try to avoid taxes sowe can pay all the other things. Maybe because I am ignorant, I don’t know what would be the advantages ofregistering the business, so I keep it like that. C1

• I am not registered because they have told me that I don’t qualify to become a formal business. Every year, theinspectors from the IRS evaluate me, but they say I don’t qualify to be formal. I am not paying taxes because Idon’t qualify. C1

Story—Fruit Vendor (rather than quotes, this was observed in our very successful entrepreneurs)The most successful entrepreneur interviewed had moved to be more formal. He had three locations for his small

stores. The turnover in these stores was great, with them generating over $1 million a year in revenue. He,however, dressed in heavily worn clothes that were somewhat dirty, shaved every other day, drove a used truck,and still lived in the same neighborhood. While he had improved his house, he reported he did not want it tostand out too much in the community. Instead, he consciously sought to still fit into the community in which hisincome was derived.

• In all the cases we interviewed, regardless of company sales data, the attire and grooming was similar to andconsistent with that of the successful entrepreneur. In all cases, it was almost impossible to differentiate differentlevels of sales with regard to appearance.

Proposition 5: The more developed the channels of interaction between informal firms and formal organizations inlocal environment, the lower the incentive for informal firms to formalize.

• I have (had) a credit with the bank for about three years. Any bank would give me a million pesos (around$25,000). They have called me many times and offered me money. They don’t care that I am informal and don’thave papers. They see the movement in my bank account. C2

• I have a loan through a coop, and the church pastor told me to start something here and gave me some space. . .I have three suppliers—the meat products provider, one in the market, and the company that provides me theplastics—I use and they all provide credit for me. C11

• My father (the owner) has all kinds of financial products: loans, business credit cards, and savings accounts.We have multiple suppliers and they give us significant credit. We have another business in the plastic artsconcurrently. C10

• Now we don’t have money in the bank because I have to buy the fruits every day. We keep the money in a safebox, so we can access it easily. C1

• I have about five suppliers. From two, I buy the food, cups, and plastic plates. I also buy from the supermarketand the pastry shop. Finally, I buy about 2000 pesos a day ($ 65) in the market. . .My wife and one of mydaughters work with me. My wife prepares the breakfast and juices and my daughter does the cleaning.C24

• On a good month, we earn about 50,000 pesos ($1,500). We keep a record and have a book where we keep theaccounting. I have three suppliers—one for cups and spoons, one from the market, and the butcher; they all sell(to) me on credit. My stepfather bought the spot we are in for my mother and got the taxi drivers as customers.C12

C# = Case number from Table 1.



land. However, few of our entrepreneurs registeredtheir firms in the way that national rules and regula-tions require. Indeed, the informal entrepreneurs weinterviewed were surprised and occasionally aston-ished when we asked them about registration. ‘Whyregister?’ they replied.

Dominican informal entrepreneurs generallyregard the central government as ineffectual and com-pliance with it as not worth the effort. For a case inpoint, consider just one recent effort to regulate streetvendors. In response to numerous complaints to thepress about the health and nuisance risk vendors pose(see Table 3 for archival data), the central governmentproduced new regulations requiring vendors to wearclean uniforms. Although visions of starched anduniformed street vendors may appeal to policymakers, such requirements are utterly unrealistic inthis emerging economy. Indeed, most street sellersquickly realized that the government had neither themeans nor the will to enforce the requirement. Whatthe government did do was make considerable noiseon the issue, but everyone knew full well that theserequirements could never be, and never were, actedon. Such scenarios are ongoing and conditionDominican entrepreneurs to make decisions in anenvironment that predictably fails to provide signalsof consistent and strong institutions.

Over time, observations of inconsistent and tooth-less government policy lead to self-reinforcing pat-terns of behavior based on accepted norms in themeso institutional environment. The informal entre-preneurs we interviewed knew of no one in theircommunity who had registered with the central gov-ernment and believed that they would be an excep-tion if they openly chose to do so. In fact, there wasa profound sense that if the entrepreneurs pursuedregistration, they would be outliers bucking theinformal rules of the meso environment that othersfollowed. Entrepreneurs made passionate argumentsthat the cost and complexity of registration pre-vented them from becoming formal. Yet, most entre-preneurs we interviewed had no firsthand experiencewith registration and relied on limited informationthat circulated in their environment and supportedaccepted meso institutional practices. Thus, thechoices entrepreneurs make are consistent with thenarratives developed within communities of practicefound in their meso institutional environments. Thissuggests that:

Proposition 1: The weaker the formal macro envi-ronmental institutions, the more likely informal

entrepreneurs are to rely on norms in the mesoinstitutional environment.

Corollary 1: Meso institutional narratives andbeliefs influence the decisions of entrepreneurswith respect to formalization of their firms.

Shades of grey

Entrepreneurs we interviewed self-identified asrunning informal firms when they did not pay taxes,duties, fees, or register in any way with the centralgovernment. Indeed, much of the management lit-erature would identify such firms as informal.However, informal firms often paid duties, fees, andtaxes that registered them with other levels of gov-ernment including local zones, city government, andcounty municipalities. Although the total amountpaid to the local government was significantly lowerthan firms would need to pay to the central govern-ment, entrepreneurs selectively paid when theyregarded the services provided as relevant to thewelfare of their business. For example, entrepreneurspaid fees to register with the local authorities inorder to have space in local markets, be able to putup signs to their businesses, and have health inspec-tions. Such fees and taxes secure basic propertyrights and legitimize the firms in the eyes of theirpeers, customers, and suppliers. Although they com-plained about the quality of the services theyreceived from the city or municipality, the entrepre-neurs we interviewed (as well as an importantnumber of their peers) did register at the local level.They were unwilling to pay fees or taxes to higherlevels of government from whom they saw nobenefit. For most firms that self-identified as infor-mal, the meso environment (the informal, unwrittencommunity standards) set an expectation that regis-tering with the local authorities, to some degree, wasacceptable and even desirable. However, we cer-tainly did observe that the very poorest and worst-performing firms (often itinerant mobile vendors)did not register with anyone and disengaged fromgovernment at all levels. Such firms fly under theradar and perceive themselves as invisible. Thesecompletely informal firms were often migrants fromHaiti who operate in ethnic enclaves and are poorlyintegrated into Dominican society. Their marginal-ized status in society, the transience of their busi-nesses, and the subsistence nature of their businessesmean they feel little pressure to register. However,Haitian entrepreneurs, though informal, are not



invisible; in fact, their presence attracts public scru-tiny and debate.

If full registration and complete compliancedefine business formality, then such formal firms arein the minority in the Dominican Republic and otherdeveloping economies. The vast majority of firm inthe Dominican Republic are, to some degree, infor-mal. Our findings suggest that what is commonlyreferred to in a binary way as informality versusformality should be viewed along a multidimen-sional continuum with multiple points in betweencomplete informality and total formalization andvariation in the level of compliance across institu-tional dimensions. In this conceptualization, entre-preneurs make strategic decisions about where toposition their firms along the continuum. Our evi-dence suggests that there are clear cost-benefit cal-culations that entrepreneurs make when it comes tothe decision to formalize. In addition, they adopt aportfolio approach to compliance along multipleinstitutional dimensions such as health laws, laborlaws, tax laws, and others (Perry et al., 2007).However, the decisions about whether to register ornot are conditioned on the unwritten but well-understood and taken-for-granted rules found in theentrepreneur’s meso institutional environment. Thisstrategic approach to informality suggests that firmsmight choose compliance levels to meet some of theexpectations of their macro institutional environ-ment without violating its overall norms and prac-tices of their meso institutional environments(Godfrey, 2011). This suggests that:

Proposition 2: At each stage, entrepreneurialfirms will choose, within each institutional dimen-sion, a level of compliance where the benefits offormalization outweigh its cost.

Corollary 2: Informality is a multidimensionalcontinuum that ranges from no formal registra-tion with any government agency to degrees ofpartial registration with intermediate authoritiesand across multiple institutional dimensions.

Research Question 2: as their firms becomemore successful, how do the countervailingdemands of the macro and meso institutionalenvironments influence the informalentrepreneurs’ cost-benefit considerationsrelated to formalizing?

The last two propositions and their attending corol-laries suggest that informality is not an all-or-

nothing decision for most informal firms. Weshowed that informal entrepreneurs make calculateddecisions based on the perceived costs and benefitsof formalization along multiple institutional dimen-sions. Moreover, the norms and taken-for-grantedrules of the meso institutional environment serve toreinforce this approach. In this section, we focus onwhat happens to successful entrepreneurs and showhow macro and meso institutional environments,especially when in conflict, influence the cost-benefit decisions that entrepreneurs make.

Trade-offs with rules in the macro environment

Informality presents successful entrepreneurs withthe countervailing demands of rules in the macroenvironment and norms in the meso environment.Consider the practical dilemma of a successful entre-preneur. As profits grow, the entrepreneur has todecide what to do with the accumulated cash. Themost common investments involve real property:building homes for the immediate and extendedfamily and the purchase of rural land. At some stage,too much cash accumulates and the entrepreneur isforced to turn to a bank. In the Dominican Republic,as in many Latin American countries, banks aresubject to strong currency controls. Such controls,although intended to prevent the laundering of drugmoney, are useful for identifying successful informalfirms that should be paying taxes. As bank assetsincrease, the entrepreneur becomes more visible andat risk of being called to pay income tax. This vis-ibility initiates the process of formalization that goesbeyond the local authorities, but even as the processof formalization unfolds, entrepreneurs continue tostrategically manage the formal and informal bound-aries of the firm.

One of our respondents who had a multilocationbusiness initiated the process of formalization on theadvice of his attorney who recommended that heregister one of his three business locations becausethe amounts of money he was depositing in thebanks were becoming suspicious and the authoritiesmight believe that he was laundering money or par-ticipating in other illegal activities. Thus, as theentrepreneur and his business became more success-ful, he became more attuned to the demands of theformal rules in the macro institutional environment.At a certain level, the risks of playing the ‘see if youcan get me game’ became too great. Nevertheless,the entrepreneur continued to straddle both theformal and the informal worlds even as his business



had more than $1 million in sales. Partial registrationprovides protection of the firm’s assets, but stilloffers ways around employment, retirement, andhealth care costs. A strategy of partial business reg-istration provided him with strategic flexibility at thesame time as registration provided a legitimizingcover. This suggests:

Proposition 3: As the wealth of informal entrepre-neurs increases, they become more attuned toformal rules in the macro institutional environ-ment and launch their firms on the path toformalization.

Corollary 3: Financially successful informalentrepreneurs adopt staged formalization whenthe level of their commercial activity threatens toexpose them to formal scrutiny.

Trade-offs with norms in the meso environment

As firms grow and become more successful, we findthat the informal hold of the meso institutional envi-ronment on the entrepreneurs becomes more, ratherthan less, intense. The successful entrepreneurs inour study initially lived in severe poverty, yet someof their informal firms grew relatively large in termsof revenue (see Table 1). However, financial successdid not translate into outward manifestations ofwealth as one would find among successful manag-ers, doctors, and other professionals with relativelyhigh incomes. These people have desirable houses,maids, drivers, and guards to protect their assets;none of the successful entrepreneurs we interviewedpursued such public displays of wealth. They con-tinued to live in the communities in which they madetheir income and without the trappings that accom-panies financial success. Certainly, they improvedtheir homes, bought hard assets for family members(e.g., homes for mothers or mothers-in-laws), andpaid for better educations for their children. Yet, forthe most part, they were quite humble in theirappearance and demeanor.

There are clear reasons for such behavior. Overtdisplays of wealth would attract attention to theirbusiness, increase the risk of resentment, and openthem to criminal extortion. Moreover, the entrepre-neurs we studied lived, worked, and traded withinthe communities from which they originated.Moving out of the community in which one hasestablished a firm is not a simple task, even withincreasing wealth. Consequently, to avoid a backlash

from those on whom their success depended, entre-preneurs took measures to minimize visible symbolsof success. Thus, as their wealth increased, entrepre-neurs had to negotiate trade-offs within meso insti-tutional environments that engender conformity andreinforce the maintenance of community norms.This suggests:

Proposition 4: As the wealth of informal entrepre-neurs increases, they become more attuned to theconstraints of the meso institutional environment.

Corollary 4: Financially successful informalentrepreneurs avoid strong displays of theirsuccess to prevent a backlash from their mesoinstitutional environment.

Research Question 3: how does the interactionbetween informal firms and formalorganizations affect the cost-benefit decisionsthat informal entrepreneurs make with respectto formalization?

Twenty years ago, Portes and Schauffler (1993: 46)noted ‘the dynamism of informal enterprises and itsmanifold connections with larger firms are centralissues entirely missed by an analyst that defines thesector as consisting in survival activities.’ Our inter-views show that informal entrepreneurs can and dointeract with formal organizations and are an integralpart of the network of formal organizations andinformal firms in the local business ecosystem(Roberts, 1994; Portes and Benton, 1984). More-over, our data strongly suggest that interactionsbetween formal organizations and informal firmsinfluence the cost-benefit considerations of entrepre-neurs as they contemplate formalization.

In the Dominican Republic, city and districtauthorities allow firms to register locally and operatein their communities without reporting them tocentral authorities. As long as the informal busi-nesses are up-to-date and registered with the localauthorities, they operate in the same manner andwith the same rights as formally registered firms.Specifically, they exercise property rights over theirlocations and business names. Moreover, localauthorities assist informal firms in the resolution ofdisputes and enforcement of agreements. Notably,administrative bodies at different levels of govern-ment in the Dominican Republic appear to haveno coordinated effort to ensure that their recordsaligned. Thus, a firm could pay local fees and



registration taxes but still completely avoid regis-tering with the central government or other govern-ment levels in which income taxes are much moreextensive or severe. However, at the local level, offi-cials had the power to collect fees on-site, pressurethose who did not comply, and—in the extreme—extort what was due. For those firms registered withthe local authorities, the regulatory rules of the macroenvironment seemed far removed and a cost not worthconsidering.

When we then looked at which parts of the privateformal sector engaged with informal firms, we foundthat banks were key support structures for informalfirms. We found that although informal businesses inour study were mostly cash operations, banks werewilling to lend them relatively large amounts ofmoney. For example, at least two entrepreneursstated that they had rejected loans for significantamounts of money (more than $25,000) because theydid not need the money for the business. Banks werealways offering significant sums to them as personalloans on generous terms. In addition, we noted thatinformal entrepreneurs had access to various finan-cial instruments, including credit cards. Likewise,we found, on the basis of their operating history,suppliers—often multiple suppliers—providedcredit (in some cases significant amounts of creditplus generous repayment terms) to firms both smalland large. Clearly, excluded from the banking andsupplier relationships were the smallest and the mostmobile of the vendors who bought and sold goodsdaily on a cash basis. However, for informal firms,the lack of formalization did not appear to be asignificant barrier to working with formal organiza-tions. In fact, in choosing to work with informalfirms, formal organizations adopt the implicit normsof the meso institutional environment and, in theprocess, lend legitimacy to it. Banks are a clearexample of this behavior. Banks want local informalfirms as customers and structure the relationships inways to serve them effectively. Generally, theyignore the letter of the law regarding registration. Bysupplying financial services, banks enable informalfirms to continue to operate and grow. Since theboundaries between the formal and the informaleconomies can be crossed so easily, even in theheavily regulated financial sector, informal entrepre-neurs see no specific urgency to become formal. Insum, we observed that the interactions between theformal and informal sectors reduce the cost of infor-mality. If a business can operate in the informaleconomy and have largely unrestricted access to the

formal economy, then why pursue formalizationgiven its obvious cost and uncertain benefit?

Proposition 5: The more developed the channelsof interaction between informal firms and formalorganizations in local environment, the lower theincentive for informal firms to formalize.

Corollary 5: Informal firms interact with a varietyof formal organizations in their environment toweave together an exchange system that legiti-mizes the persistence of informality.

DISCUSSION AND CONTRIBUTIONS

In this article, we argued that understanding howinformal firms in emerging economies navigatebetween the enabling and constraining forces in themacro and meso institutional environments yieldscore insights into why business informality persists.Building on prior literature that had focused on theregulatory aspects of the macro institutional environ-ment, we consider the persistence of informalitythrough the added lens of meso institutional environ-ments where taken-for-granted social behaviorstoward informality become institutionalized. In thissection, we set our findings in the context of priorstudies, and we offer future research directions.

Why informality?

In asking why informal firms do not register, schol-ars principally advance two hypotheses (Perry et al.,2007). The first suggests that the cost and complexityof registration prevents entrepreneurs from pursingformalization and excludes them from the formaleconomy. Thus, in order to change entrepreneurialbehavior, it has been argued that laws need to bechanged and costs need to be reduced (de Soto,1989). The competing hypothesis advances thatentrepreneurs make rational cost-benefit calculationsand when they find that the benefits of formalizationare lacking, they exit (or more likely never enter) theformal economy (Maloney, 2004). Our findingsalign with the rational decision-making side of thedebate. Although entrepreneurs in our study invokedthe high initial costs and complexity of registrationas a reason for not registering, they rapidly broad-ened this narrative and argued more passionately thatbenefits from acquiescing to the demands of the



macro institutional environment were limited andthe penalties for failing to do so were remote. Theyperceived the macro institutions as weak and reliedon the meso institutional norms in their local envi-ronment as support for remaining informal.

As we look in the broad literature on informality,there are contemporaneous field experiments in eco-nomics that strongly support our qualitative findings.For example, de Mel et al. (2013: 123) recently ran acontrolled experiment in Sri Lanka to test whether‘the exclusion or exit view of informality betterreflects reality.’ With a set of firms similar to ours,they created multiple treatment groups. For somegroups, de Mel et al. (2013) reduced the costs ofgathering firsthand information about the registra-tion process and, for others, they offered differentlevels of financial incentives (reimbursement ofcosts and direct payments) to induce registration.The results were startling and revealed much aboutthe demand for formality and the persistence ofinformality. Neither reducing the cost of informationnor incentivizing registration by reimbursing the(relatively small) financial costs of registering hadany effect on the rates of registration. However,direct payments, proportional to the monthly profitof the average firm, did induce firms to formalizeinitially at an increasing rate but then at a diminish-ing one. This experiment ruled out the idea thatinformation search costs and the direct costs of reg-istration are the principal barriers to formalization.Sri Lankan entrepreneurs, in a weak macro institu-tional environment, were making rational cost-benefit calculations similar to the Dominicanentrepreneurs we interviewed. Thus, they remainedinformal not because of entry barriers to formaliza-tion, but because formalization did not make eco-nomic sense in terms of what they received inexchange for their tax contributions. Moreover, in anenvironment where they also did not believe in theenforcement powers of the central government,the decision to formalize could be made only whenthe balance of economic consequences changed.

Informality as a multidimensional continuum

The relentless focus by scholars on economics offormalization, we believe, has narrowed the concep-tualization of informality. That is, most managementstudies classify firms as either formal or informal,but as we show in this article, this does not capturethe nuanced empirical realities of what it means to bean informal business in an emerging economy. At

first pass, we find that entrepreneurs do, indeed, self-identify as informal: they do not pay taxes and arenot fully registered with all levels of government. Onthis basis alone, much macro (national) level empiri-cal data classifies firms as informal. In fact, empiri-cal evidence suggests that informal firms do registerand do pay fees at multiple levels and for multiplereasons. Much as we had, de Mel et al. (2013) alsoshowed that Sri Lankan entrepreneurs may have self-identified as informal but were often registered at thedistrict and other levels. This insight forced de Melet al., (2013) to revise the assignment of firms intheir large-scale experiment. Hence, reliance onmacro data often will result in misclassification, andit amalgamates informal firms in a way that willobscure important underlying effects. In our view,creating an additional category called semiformalobscures the issue. We propose that the concept ofinformality should be treated along a continuum thatreflects the multiple levels of engagement of the firmwith its environment.

Understanding the shades of grey that typify theinformal economy requires more precision in datacollection as well as an embrace of cross-countrydifferences in the levels of formalization that firmscan achieve within the norms of their meso institu-tional environments. Although ours is a single-country study, taken in conjunction with evidenceprovided by de Mel et al. (2013) and earlier obser-vations of this in Perry et al. (2007), we wouldhypothesize that context matters as does the appro-priate placement of informal firms along a finer-grained multidimensional continuum. For futurestudies, mapping multiple dimensions along whichfirms can and do choose to comply with regulationsacross the jurisdictions (local, regional, and nationallevels) would serve to unpack the extent of formal-ization. In addition, such maps can be combined intofirm-level portfolios of compliance and help usunderstand the heterogeneous choices firms makewith respect to formalization and the impact suchchoices have on firm survival and performance.

In further support of the rational cost-benefithypothesis, we find clear evidence that informalfirms approach formalization strategically. Firmscomply with registration at levels where the per-ceived benefit of formalization is clear and withinthe bounds of communal norms in the meso environ-ment. Our contention is that in the future, research-ers need to move beyond seeing firms in binary termsand embrace the shades of grey. Scholars should beasking more complex and revealing questions that



can explain the persistence of informality and theoften frustrating policies to eradicate it. Our evi-dence suggests that no reduction in the time or costof registration would move our informal firms toformality. If their peers are not registered and gov-ernment services are not in line with expectations,the entrepreneurs we interviewed would not register.

Institutional pluralism

In the Dominican Republic, as in many emergingcountries around the world, there are successfulinformal entrepreneurs who eventually chose tobegin the formalization process. One of the goals ofour research was to understand how such successfulinformal entrepreneurs managed the countervailingforces of the macro and meso institutional environ-ments. Although the literature often categorizesfirms as formal or informal, our research suggeststhat for those who elect to do it, formalization is aprocess that exposes entrepreneurs and their firms tothe challenges of institutional pluralism. That is, theybegin to operate in multiple institutions spheres.Thus, the question of how informal entrepreneurs inthe process of formalizing manage the countervail-ing forces of multiple institutional environments isparticularly intriguing and relevant to answeringwhy and how informality persists.

We found that as entrepreneurs became more suc-cessful, they had to become more attune to both themacro and meso institutional environments. Wherethe macro environment is concerned, success pushesthe entrepreneurs to launch their firms on the path toformalization. We contend that successful entrepre-neurs adopt staged formalization when their level ofcommercial activity threatens to expose them toformal scrutiny. Thus, the benefits of formalizationbegin to outweigh its costs. Success brings entrepre-neurs into the open, but they strategically reveal theirfinancial hand one card at a time. As this processunfolds, we found successful informal entrepreneurshave to become more, rather than less, attuned to theoften constraining norms of the meso institutionalenvironment.

The challenge for successful informal firms andthe entrepreneurs who run them is to operate withininstitutional spheres that are potentially at odds withone another. Commitment and conformity with insti-tutional environments confer recognizable identitiesand legitimacy to the organization and its leadership.In the context of informality, we argued that in theabsence of strong macro institutions, the norms of

the meso institutional environment serve as effectivesubstitutes. In our data, it was clear that entrepre-neurs are attuned to the norms in the meso environ-ment as they reject or skirt the rules of the macroenvironment. Successful informal entrepreneurswho begin the process of formalization are forced toplay more than one game at a time (Kraatz andBlock, 2008). That is, they make a strategic choice toengage with the rules in the macro environment,which may be at odds with meso norms. The com-peting demands of the macro and meso institutionalenvironments force the entrepreneur to continuouslyresolve tensions that arise from, ‘multiple regulatoryregimes, embedded within multiple normativeorders, and/or constituted by more than one culturallogic’ (Kraatz and Block, 2008: 243). Successfulinformal entrepreneurs must meet the expectationsof multiple audiences, often while juggling identitiesthat are growing at odds with each other.

Theorizing about formalization in terms of anentrepreneurial journey into institutional pluralismopens a series of opportunities that we think are ripefor research. Take, for instance, identity conflictsthat may arise when successful informal entrepre-neurs begin to respond to the demands of the macroenvironment. What types of symbolic exchangeswould they engage in to help validate their new iden-tities and maintain their old ones? We argued thatsuccessful entrepreneurs become more attuned to thedemands of their meso environment in order not toface delegitimization in the process. If the path toformalization entails a risk of losing a core identity(a cost), then it might be a plausible deterrent toformalization. If successful informal entrepreneursdo manage their countervailing forces in identity-enhancing and legitimizing ways, what could be theeffect on the community-level adoption of the for-malization process? Finally, is formalization astable, time invariant process or does it ebb and flowas strategic priorities change and entrepreneurialopportunities emerge? Thus, unfolding the processof formalization should give us greater insights intothe multiple levels at which entrepreneurs and theirfirms manage the transition.

Crossing boundaries

Given the size of the informal sector in many emerg-ing economies, it is likely that the formal and theinformal sector, rather than being sealed off fromone another, are, in fact, tightly bound. Our researchshowed that the informal firms we interviewed were



part of well-developed local ecosystems that, atworst, tolerated their presence (e.g., itinerant mobilerefugees), but more often deeply engaged with them.As a result of this research, we offer several insightsabout the mutual dependence between the formaland informal economy that underscore the embed-ded nature of the informal sector.

Informal firms receive support from private,formal, and often regulated organizations. Forexample, suppliers extend credit and banks giveinformal firms loans. These are private economicdecisions that operate in the large grey zone of com-mercial activity in the Dominican Republic. Theentrepreneurs we interviewed regarded exchangewith formal organizations as affirming of the mesoinstitutional norms under which they operate. Theexisting close relationship between formal and infor-mal firms reduces the perceived benefit of formal-ization. Other studies (Bruton et al., 2011; Khavulet al., 2013) also documented how banks cross overbetween the formal and informal economies in theprovision of loans to growing firms. In contrast, deMel et al. (2013) found that formalization did nothelp Sri Lankan informal businesses access loansfrom banks. Here we emphasize again the impor-tance of properly capturing the different institutionalcontexts in which informal firms carve out their exis-tence. Countries differ in how tight the formal andinformal sectors are bound and in the opportunitiesthat informal firms have absent of registration.

In the Dominican context, one of the most intrigu-ing observations we report is the role local authori-ties play in perpetuating informality and creatingbarriers to formal registration at the central govern-ment level. As we showed, business owners, espe-cially those with fixed retail locations, want toprotect their space, put up signs, pass health inspec-tions, and generally avoid excessive local pressure.Many register at this level and see no reason to goany further. Such a strategy is accepted practicewithin the norms of the meso environment. It is morethan a symbolic gesture. Electing to comply with thelocal authorities reduces the inefficiencies associatedwith informality. The local authorities, however,have no obligation (or for that matter, tools) to reportthe registrations to the central authorities. Moreover,they also lack any incentive to do so. The adminis-trative layers of government operate largely in iso-lation. The central government collects income andprofit taxes and they send little of that down to thelocal authorities. As such, the only viable sources ofrevenue for local authorities are the fees and licenses

they issue to businesses. Thus, while the central gov-ernment has limited means of tracking informalbusinesses and meager means of enforcing their taxobligations, the local authorities are in a differentposition and have every incentive—and often themeans—to capture formalization-related revenue. Ineffect, we see a partitioning of the public revenueresource environment between the central govern-ment and the local authorities. Such partitioningeffectively creates a barrier to the sort of full formalregistration that reflects the letter of the law. If localauthorities are charging fees from which entrepre-neurs see at least some benefit, entrepreneurs regardthis as sufficient contribution to the public finances.Payments at the local level (even if coerced) fulfillthe rational cost-benefit calculation. Given theadministrative structures in the Dominican Republic,formalization at the central level seems a remotepossibility, even if the costs were reduced and pro-cesses reformed.

CONCLUSION

Entrepreneurship and management research oftenmakes passionate pleas for increasing cross-leveltheorizing and empirical work. In this article, weexplicitly conceptualize as meso the space in whichtaken-for-granted local norms toward informalityemerge and are reinforced. We show that meso insti-tutions serve as the connective tissue that cross-linkslevels of the environment and shapes the context inwhich entrepreneurs make decisions. Specifically,meso institutions influence the decisions of entrepre-neurs with respect to formalization of their firms andthe trade-offs they make as they become successful.Likewise, we suggest that meso institutional normsare legitimated by the intertwined formal and infor-mal economy. Our insights into the meso institu-tional environment and the role it plays in the contextof informality should stimulate a renewed interest incross-level research. In a variety of contexts andacross different communities, meso level institutionscan both attenuate and amplify the effects of macroinstitutions on societal outcomes. Our goal is toignite more meso level research.

ACKNOWLEDGEMENTS

We want to thank the editors of the special issue and thereviewers for their developmental help with the article.



Thanks also to Jeff McMullen, Ramon H. Mejia, HaroldRueda Alvarez, and Guillermo E. Vanderlinde fortheir assistance with this research and their thoughtfulcomments on earlier versions of this article. ResearchReported in this paper was partially funded by theSpanish Ministry of Economy and Competitiveness.Grant No. ECO2012-30932.

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