Firm-Level Impact of Regulatory Compliance Costs on Small Business Growth

Research by: Jamil Paolo Francisco, John Paul Flaminiano, Jose Gerardo Santamaria & Joshua Uel Abad

Executive Summary

The conventional wisdom among business leaders and economists is that while there may be good intentions behind government regulations such as protecting public interest, facilitating economic transactions, and promoting a level playing field among competing firms, these regulations impose time and money costs on entrepreneurs, and are essentially a burden to business. However, in their recent comprehensive review of the literature, Mallett et al. (2018) found that very few studies empirically investigated the relationship between regulation and growth at the firm level. Without empirical evidence to support the argument that regulation or the cost of regulatory compliance stifles business growth or performance, particularly at the firm level and among SMEs, prioritizing regulatory reform to improve the ease of doing business and create more “business-friendly” regulatory environments over other more direct forms of small business support such as facilitating access to finance or access to markets, may not be sufficiently justified.

Our paper contributes to the entrepreneurship literature by adding to the relatively short list of studies that empirically investigate the relationship between regulatory compliance costs and firm performance using firm-level data. Using data from a survey conducted in 2019 among a representative sample of 590 small and medium-sized enterprises (SMEs) in the Philippines, we tested whether time and monetary costs of regulatory compliance had a negative impact on the incidence of firm growth. We also examined whether the relationship between regulatory compliance and firm growth was affected by firm age. Although numerous studies have analyzed the link between firm size and firm growth, the relationship between firm age, regulatory burden, and firm growth has yet to be explored sufficiently.

We found that 57 percent of SMEs experienced delays —“long lines, too many procedures, or too many signatories”— in processing regulatory requirements. Sixty percent of those surveyed found regulatory compliance at least “moderately burdensome” for their firm. Most SME owner/managers said they began to consider regulatory compliance as a concern from the very beginning when they were starting up the business.

Using determinants of firm growth commonly identified in the literature, we empirically tested if the cost of regulatory compliance impeded the incidence of growth among SMEs in the Philippines. To identify the incidence of firm growth, we combined two commonly used indicators—increase in sales and increase in number of employees. We performed three regressions. In the main regression, we used the full sample of SMEs surveyed, while the two secondary regressions used the samples of old firms and young firms, respectively. Separate regressions for young and old firms were performed to compare how compliance costs may affect young and old firms differently.

Our analysis showed spending more time dealing with government regulations decreased the probability of sales revenue and workforce growth among SMEs. This supports the argument for improving the ease of doing business by reducing bureaucratic red tape—i.e., minimizing the number of steps and procedures involved, decreasing the number of approvals and documents required, and reducing waiting time. This result also supports the argument that businesses face opportunity costs in diverting their limited resources away from value-adding activities into regulatory compliance.

The negative effect on the probability of growth was larger for younger firms. Each additional working day spent dealing with government regulations was associated with a 1.34 percentage point lower probability of growth for younger firms compared to a 0.53 percentage point lower probability for older firms. Younger firms also spent longer time complying with regulations. This may be a result of their relative lack of experience in dealing with regulation or their relatively limited access to resources and networks that help older firms cope. Furthermore, when we studied the effects of firm age on firm growth, we found that each additional year of operations increased the likelihood of growth, particularly for younger firms. These findings suggest that making it through the early years of the business is particularly important for the chances of growth among younger firms to increase. For these reasons, we recommend that governments prioritize the regulatory concerns of younger firms whose potential as engines of economic growth and job creation is significantly undermined by the cost of regulatory compliance.

Another important finding we wish to highlight is that familiarity with the regulatory environment and the adoption of compliance-related process improvements among SMEs increased their probability of experiencing growth. This finding supports policies aimed at increasing transparency and awareness of regulatory procedures and requirements, and policies that support adoption by SMEs of internal process improvements that make use of digital compliance tools, which enable them to comply at a lower cost.

Keywords: compliance cost, growth, regulation, SMEs, small business

To cite this article: Francisco, J. P., Flaminiano, J. P., Santamaria, J. G., & Abad, J. U. (2022). Firm-level impact of regulatory compliance costs on small business growth. International Review of Entrepreneurship, 20(1), 1-26.

To access this article: https://www.senatehall.com/entrepreneurship?article=707

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International Review of Entrepreneurship (IRE) aims to publish cutting-edge research and case studies on entrepreneurship which have relevance for entrepreneurial policy, management, performance, and practice. Articles should provide value added for at least one segment of the entrepreneurial community which includes researchers, students, faculty, entrepreneurs, managers, business angels, VCs, banks, and those engaged with public policy.

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