Are formal institutions ineffective for firm performance? Evidence from the economic community of West African States

Abstract

PurposeThis study examines the interconnected effects of formal, informal, environmental and skill-based institutional barriers on firm performance. The Economic Community of West African States (ECOWAS) region has implemented various reforms and policy initiatives to support small businesses yet are unsuccessful as formal institutional framework and governance remains a challenge.Design/methodology/approachThe authors employ a sample of 3,515 small and medium enterprises (SMEs) from the ECOWAS and a two-stage instrumental variable approach to control for endogeneity. Additionally, the authors check for robustness using various measures of firm performance such as profitability, productivity and export intensity.FindingsThe authors confirm that formal institutions are insignificant for firm profitability and productivity, whilst reducing informal, environmental and skill-based institutional barriers are associated with firm performance. However, when barriers to informal, environmental and skill-based institutions are at the lowest, formal institutions are associated with firm performance.Research limitations/implicationsThe major limitation lies in the policy implications. Informal institutions come into play when formal institutions are weak. However, informal practices must be addressed in the form of formal enforcement. This leads to a conundrum.Practical implicationsPolicymakers should continue to market-supporting institutions and a conducive business environment to complement the formal institutional framework.Originality/valueThis study provides new empirical evidence on how institutional quality affects firm performance by examining whether other institutional factors, such as the informal, environmental and skill-based institutional barriers, can moderate this effect.