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Country- and Firm-Level Determinants of Law Compliance

By Harvard Law School Program on Corporate Governance

(Editor?s Note: This post comes to us from Alberto Chong of the Inter-American Development Bank and Mark Gradstein of Ben-Gurion University.)

In our paper, Is the World Flat? Country- and Firm-Level Determinants of Law Compliance, which was recently accepted for publication in The Journal of Law, Economics, and Organization, we revisit the effects of a country?s institutional framework on individual firms? behavior, in particular focusing on their propensity to comply with legal rules. We focus on the compliance with legal rules, primarily for two reasons. The substantive one has to do with the apparent importance of institutions such as the rule of law and legal enforcement for economic performance. The practical reason is that our data contain proxies for law compliance by thousands of business firms from a wide range of countries that display large institutional variation.

While the data contain information on several aspects of law compliance, such as the scope of corruption, bribery, and the extent of informality?by which we mean the propensity of firms to hide output?the main analysis focuses on the latter. This analysis reveals that many of the available firm-level characteristics are indeed relevant for explaining the variation in informality. For example, firm size matters; smaller firms appear to be hiding a larger share of output, while exporting firms and those with foreign ownership appear to be hiding less. Yet, there is strong evidence that most of the variation is driven by differences across countries in their respective levels of institutional quality, thus rejecting the null hypothesis in favor of what is implied by our theoretical model. In particular, commonly used measures of institutional strength emerge as the most statistically significant variables.

We use the same methodology to explain the variation in other proxies for noncompliance with the rule of law, such as corruption and bribery. Generally, the results are similar to?and often even stronger than?those obtained for informality: while firm characteristics matter, most of the relevant variation is explained by country-wide measures for institutional strength, and less so by firm-specific characteristics.

Our conclusion is that countries still matter in providing institutional infrastructure, which determines to a large extent the context within which firms operate.

The full paper is available for download here.

Full post as published by The Harvard Law School Corporate Governance Blog on July 15, 2009 (boomark / email).