Institutional Perspectives on Entrepreneurial ... - Wiley Online Library

Journal of Small Business Management 2011 49(1), pp. 107–125

Institutional Perspectives on Entrepreneurial Behavior in Challenging Environments jsbm_317 107..125

by Friederike Welter and David Smallbone

This paper examines the institutional embeddedness of entrepreneurial behavior. The institutional context influences the nature, pace of development, and extent of entrepreneurship as well as the way entrepreneurs behave. This is particularly apparent in challenging environments such as emerging market and transition economies with an uncertain, ambiguous, and turbulent institutional framework. The paper develops suggestions as to how to extend the current institutional approach by emphasizing that institutions not only influence entrepreneurs but entrepreneurs may also influence institutional development by contributing to institutional change. This also includes acknowledging the heterogeneity of entrepreneurial responses to institutional conditions, depending on the situational configuration of institutional fit, enterprise characteristics, and entrepreneur’s background, in which the role of trust as an influence on entrepreneurial behavior needs to be investigated. By focusing on these interrelationships, the paper aims to make a theoretical contribution to the field of entrepreneurship, illustrating how entrepreneurial behavior is linked to its social context.

Introduction Most entrepreneurship research focuses on micro-level explanations for entrepreneurial behavior related to, for example, the role of cognition and emotions (e.g., Shepherd, Wiklund, and Haynie 2009; Katz and Shepherd 2003) or behavioral responses such as effectuation or bricolage (e.g., Baker and Nelson 2005;

Baker, Miner, and Eesley 2003; Sarasvathy 2001). At the same time, there is growing recognition that entrepreneurial behavior needs to be interpreted in the context in which it occurs. This includes the institutional context that is composed of the economic, political, and cultural environment in which the entrepreneur operates (Shane 2003). The sociocultural and the politico-institutional

Friederike Welter is Professor at Jönköping International Business School and TeliaSonera Professorship at Stockholm School of Economics Riga. David Smallbone is Professor of Entrepreneurship at Small Business Research Centre, Kingston University. Address correspondence to: Friederike Welter, Jönköping International Business School, PO Box 1026, Jönköping 551 11, Sweden. E-mail: [email protected].

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environments influence entrepreneurial attitudes and motives, the resources that can be mobilized as well as the constraints and opportunities on/for starting and running a business (Martinelli 2004). As a consequence, the context has an impact on the nature, pace of development, and extent of entrepreneurship as well as the way entrepreneurs behave. This is particularly apparent in institutional environments characterized by a high level of ambiguity, uncertainty, and turbulence, such as in economies with a recent history of central planning, making them a fascinating laboratory for scholars interested in the interface between institutions and behavior. By focusing on this interrelationship, the paper aims to make a theoretical contribution to the field of entrepreneurship while drawing on empirical evidence from transition environments where the number of private businesses per capita, their behavioral characteristics, and their contribution to economic development is affected by the social context. Examples are mainly taken from research projects undertaken in former Soviet republics, which continue to constitute challenging environments for entrepreneurs as compared with Central European countries such as Poland or Hungary, which are now members of the European Union (EU). Previous research has drawn attention to a number of distinctive features of entrepreneurship in such conditions. This includes variations in the pace of development of entrepreneurship over time following the initial explosion of entrepreneurial activity associated with reforms that made it legally possible for nonstate-owned enterprises to be established. As in mature market economies, significant regional variations in entrepreneurial activity are common, associated with spatial variations in the pace of restructuring as well as demand-related factors (Smallbone et al. 2001). Attention has also been drawn to the predominance of so-called “necessity-push” at

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start-up, reflecting the paucity of alternative ways of earning a living following the collapse of the Soviet system (Scase 2003, 1997). Strong external environmental influence on entrepreneurial behavior is a recurrent theme, encouraging many studies of entrepreneurship in postsocialist countries to adopt an institutionalist framework (e.g., Aidis, Estrin, and Mickiewcz 2008; Manolova and Yan 2002; Smallbone and Welter 2009b). Institutions are seen simultaneously as enabling entrepreneurship to develop by reducing transaction costs, risk, and the outcome uncertainty of individual behavior while also constraining it (North 1990). In this regard, “[I]institutional theory offers several unique insights into organization–environment relations and the ways in which organizations react to institutional processes” (Oliver 1991, p. 151). This paper will critically examine the institutional embeddedness of entrepreneurial behavior. The aim is to contribute to refining the current framework in the light of empirical evidence drawn from research in which one or both the authors have been involved. The remainder of the paper is composed of three sections. Section two examines the institutional embeddedness of entrepreneurial behavior, explaining the role of institutions as both enabling and constraining forces before taking a closer look at entrepreneurial responses as seen from an institutional perspective and the complexities of institutional change. Section three seeks to refine and extend the institutional approach, arguing the need to consider the following: first, recursive relations between institutional change and entrepreneurial behavior, which in some circumstances can involve entrepreneurs acting as change agents in relation to the institutional frame, together with the effects of path dependency; second, the heterogeneity of entrepreneurial responses in relation to institutional contexts; and

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third, integrating the role of personal trust as a substitute for deficient formal institutions in hostile environments. The paper concludes by considering the extent to which the embeddedness of entrepreneurial behavior in its institutional context is generic or a distinctive feature of transition environments.

The Institutional Embeddedness of Entrepreneurial Behavior In this section, the influence of institutions on entrepreneurial behavior is examined in three parts: first, institutions as an enabling and constraining force; second, the behavioral response of entrepreneurs to institutional influences; and third, the role of institutional change.

Institutions as Enabling and Constraining Forces for Entrepreneurial Behavior Institutions form the “rules of the game in a society” (North 1990), which when stable and operating efficiently can reduce uncertainty and risk for entrepreneurs, as well as transaction costs connected with conducting entrepreneurial activity. These rules include “formal” institutions, such as the constitutional, legal, and organizational framework for individual actions but also “informal institutions,” which refer to codes of conduct, values, and norms (North 1990), including the uncodified attitudes that are embedded in a society. North (1994) suggests it is the interaction between the rules of the game and organizations that shapes the institutional evolution of an economy in which organizations and entrepreneurs are players, constrained, enabled, and guided by the institutional frame (Nooteboom 2002, p. 34). In all countries, the development of entrepreneurship and the behavior of entrepreneurs are influenced by the appropriateness and operation of formal

institutions. For example, the legal frame regulates market entry and exit as well as venture development through contract and bankruptcy laws. Other examples of formal institutions that can affect entrepreneurship development include property rights or specifically for women entrepreneurs, a constitution that ensures equal opportunities, family, and social policies. The design and operation of formal institutions is directly under the influence of the state, which can also indirectly influence the values, attitudes, and norms of a society through its pronouncements and actions and those of its officials. Alongside formal institutions, values, attitudes, and norms of a society constitute the informal institutions, including attitudes toward entrepreneurship. Values and norms reflect whether a society tolerates and accepts entrepreneurship, which in turn influences entrepreneurial responses. For example, research on women entrepreneurs in former Soviet countries has illustrated the diversity of behavioral responses by women to deal with the post-Soviet traditional role in society, including some who openly defied post-Soviet gender roles, whereas others accepted them, at least on the surface (Welter and Smallbone 2010). Just as a stable, predictable, and efficiently operating regulatory regime can facilitate the development of productive entrepreneurship through reducing transactions costs, enabling an economy to move from a relationship-based, personalized transaction structure to a rulebased, impersonal exchange regime (Peng 2003), so can a deficient legal infrastructure, which includes implementation gaps, a lack of judges, specialists in commercial law, and economic courts constrain it. This especially applies where institutional voids allow for arbitrary discretionary actions by officials, thus fostering rent-seeking, corruption, and noncompliant or defiant behavior of


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entrepreneurs (Puffer, McCarthy, and Boisot 2010; Smallbone and Welter 2001a). For example, an entrepreneur who started a minibus route in Moldova represents a typical case illustrating the institutional difficulties faced in starting a business (Welter and Smallbone 2010). It took her several months to register her business and obtain licenses. For each document she brought, clerks asked for payment or presents, sometimes having established fixed sums per document. Once up and running, she needed to continue bribing the police, the State Traffic Inspectorate and pay to her “roof,” which is a Mafia-like structure offering protection to her business. The day before the interview, her driver had been stopped four times, each time paying a “fine” to four different officials from the State Traffic Inspectorate. At the same time, there are circumstances where institutional deficiencies can create opportunities for alert individuals to commercially exploit as in the case of business service providers in Ukraine in the late 1990s (Smallbone et al. 2010). At this time, some of the most successful management consultancy firms were those offering not just business advice but also the acquisition of the necessary licenses and permits needed to run an enterprise and/or develop a new project, which required personal contact with appropriate officials as well as technical expertise. The consultancy firms that had developed to fill institutional gaps were not graysector enterprises but some of the most innovative and successful firms in the business services sector. In these cases, new opportunity fields for entrepreneurs were associated with institutional change that malfunctioned or was incomplete resulting in deficiencies in the institutional structure. Though the specific nature of the opportunities may be transient, the behavior demonstrated by these enterprises showed a high level of sensitivity and responsiveness to the

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needs of customers, which are themselves heavily influenced by institutional conditions.

Entrepreneurial Responses to Institutional Embeddedness In those former Soviet republics where the business environments is characterized by major institutional deficiencies, not surprisingly, the types of entrepreneurship identified and the behavioral characteristics of enterprises are heavily influenced by the external environment (Peng 2000; Peng and Heath 1996) in general and the institutional context in particular (Welter and Smallbone 2003). In this regard, previous empirical research by the authors in former Soviet countries identified six types of management behavior, representing distinctive responses to the external environment in which entrepreneurs were operating (Smallbone and Welter 2009a, 2009b). The first type was “prospecting,” which is a term Peng (2000, p. 178) used to characterize firms “with a changing market, a focus on innovation and change and a flexible organizational structure.” Such a description is a rather idealized version of reality in, for example, a Belarusian context where frequent change in products/services may typically be regarded less as a positive feature associated with proactive management but rather reflect an approach that is often forced on entrepreneurs as a necessary part of their attempt to survive, albeit made possible by the flexibility that is common in small owner-managed businesses. The second type of behavior identified was characterized as “evasion” (Leitzel 1997), which allows private entrepreneurship to survive in an environment where an inadequate legal environment leads to arbitrariness and corruption. Such evasion strategies on the part of entrepreneurs include combining legal and informal production (termed boundary blurring by Peng


2000) and/or setting up “shell” enterprises in order to lower or avoid taxes. Tax avoidance or evasion may almost become a necessity for business survival in situations where the level of taxation is penal, bribes for tax officials is a necessity, and working capital is in short supply. Feige (1997, p. 28) characterized such actions as the “legacy of noncompliance.” The third behavioral category was “financial bootstrapping” in a situation where access to finance from formal sources is extremely scarce. Financial bootstrapping refers to attracting the resources needed without using external finance (Freear and Wetzel 1990) at low or no cost (Winborg and Landström 2001). Serial entrepreneurship represents one way for entrepreneurs to accumulate the financial resources necessary to start a business in a context where the financial system is inadequate (Smallbone and Welter 2001a). In such circumstances, entrepreneurs may start with a simple business in trade or services that often includes illegal petty trade before proceeding to more sophisticated ventures, for example, in manufacturing (Welter and Smallbone 2009). This can be illustrated with reference to a firm located in Western Ukraine, which since 2000, has been an official representative of a Czech firm, selling second-hand clothes and footwear to a network of enterprises in Ukraine. By Ukrainian standards, this firm is a large supplier, ranking 13th in 2002. The company employs 11 persons, including four drivers in another small business providing cargo services. The entrepreneur is 37 years old. He attended the Kiev Institute of Light Industry, obtaining a degree from the Department for the Automation of Technological Processes. Since he was a teenager, he occupied himself with trading different goods in order to earn money. Already in 1991, he registered as an individual entrepreneur. At that time, he mainly was involved in—illegal—

shuttle trade. After having earned some capital, he opened a company (with friends) selling materials and accessories for light industry in Kiev. When he moved to the Western Ukraine, he sold his share in that company and opened two other enterprises, only one of which turned out to be successful. For someone who started his life as a petty trader, this individual has acquired the attributes of a habitual entrepreneur. Another form of financial bootstrapping involves borrowing from family, friends, and other informal sources, although low average incomes of the population limit the extent to which substantial capital can be raised from these sources. The fourth behavioral type was “diversification and portfolio entrepreneurship.” Previous authors have described the propensity of microenterprises in transition countries to diversify their activities, which some estimates have put at 25 percent of the total number of firms in this size group (Lynn 1998). In sectors such as manufacturing and construction, additional activities in trade and/or service activities can contribute to financing the main activity of a business in a situation where access to external capital is scarce and demand may be fluctuating and uncertain. At the same time, diversification behavior can also be encouraged by institutional deficiencies and corruption. In early-stage transition environments, diversification commonly represents a deliberate strategy of making business success less visible to officials and those who may seek to make money from offering “protection.” This can be illustrated with reference to the owner of a successful business involved in managing and letting advertising hoarding space in Minsk, Belarus, who was actively considering opening an upmarket coffee shop rather than continuing to expand her core business. When asked to explain this strategy, she referred to the latter as being too risky because her successful enterprise was


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“beginning to attract too much attention of the wrong sort.” The fifth type of entrepreneurial behavior was the use of “networking” and personal contacts for business purposes. This involves friends and acquaintances being tied together in a web of favors and counter-favors in order to facilitate access to commodities and services that are in short supply (Sahlins 1972). During the Soviet period, “blat” was an integral part of the everyday lives of Soviet citizens (Rehn and Taalas 2004; Ledeneva 1998). Such behavior represents part of the inheritance of citizens in countries, such as Belarus, providing a base of experience on which one of the mechanisms for dealing with resource constraints facing entrepreneurs during the transition period is based. In this context, networking can facilitate market entry and it can also facilitate daily business operations, such as dealing with authorities (Barkhatova 2000; Roberts and Zhou 2000). The sixth behavioral type refers to the forms of adaptation used by entrepreneurs to cope with administrative and bureaucratic burdens. A recurrent theme in studies of entrepreneurship in early-stage transition economies is the adaptive capability of entrepreneurs to external conditions, which typically include serious institutional deficiencies. For example, in Belarus, the use of information technology and tax consultants is normal even in very small enterprises in order to facilitate compliance with highly complicated tax laws, which change rapidly and are often implemented in an aggressive manner by tax officials. Though this shows how entrepreneurs find ways of adapting to difficult external conditions, such adaptation is not without cost.

Institutional Change and Entrepreneurial Behavior A focus on the effects of institutional change is helpful when seeking to identify institutional influences on entrepre-

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neurial behavior because it provides an opportunity to identify behavioral change over time. Economies that are at different stages of the transition process provide a particularly useful environment for analyzing the role of institutional change because of the extent of the changes taking place over a short period of time. For example, analysis of countries that are now members of the EU demonstrates a rapid change in the policy and institutional environments over time as well as the scale of the challenge in building institutional capacity and changing institutional behavior (Smallbone and Welter 2010). Institutional change is an integral part of the process of market reform as an economy adapts from an institutional framework developed under centrally planning to one that is more appropriate to facilitating market development. Institutional change can positively influence the development of entrepreneurship when it removes or lowers barriers to market entry and/or exit, thus creating opportunity fields for entrepreneurs (Smallbone and Welter 2009b, p. 63). One such example includes the initial reforms in former Soviet countries that made it legally possible for nonstateowned enterprises to exist. This process began in 1987 with cooperatives, which represented the most politically acceptable form of nonstate-owned enterprise during the first stage of the reform process since in theory, at least, any profits or surplus were distributed between employees (members) of the cooperative in proportion to their participation. A further example is the introduction of private property rights, which occurred in several former socialist countries at the beginning of the transformation process. Institutional change may also exert a constraining influence on entrepreneurial behavior, such as in Belarus in 1996 when the effect of an increasingly hostile regulatory stance on the part of government toward the


private sector led to legislative changes, which resulted in 54 percent of all registered enterprises becoming illegal because of new registration rules (Zhuk and Cherevach 2000). At the same time, uncertainties in institutional rules associated with institutional change also can provide opportunities to be exploited as reflected in the aforementioned case of business service providers in Ukraine. In identifying so-called institutional holes, Yang (2004) draws on Burt’s concept of structural holes, which are said to exist when gaps in information flows mean that complementary resources remain poorly connected (Burt 1995). Yang (2004) sees institutional holes as structural gaps that exist between persons or organizations that are located in different institutional fields. As such, these institutional holes may be considered a distinctive characteristic of economies in transition. The shift from one set of institutional arrangements to another, which is integral to the transition process, is likely to involve institutional disjunctions and the creation of transient niches by virtue of the extent of the changes occurring and their inherent lumpiness. Just as entrepreneurial opportunities arise from gaps in the market, which entrepreneurs may seek to address by creating new ventures, entrepreneurial opportunities can arise from institutional holes, although entrepreneurs vary in their ability to identify and exploit them. It is important to recognize that institutional change does not have a mechanistic effect on entrepreneurial behavior because of the mediating influence of inertia and socialist legacies, which can act as a behavioral constraint in the face of institutional change (Chavance 2008; Peng 2003). For example, the time lag effects apparent in human actions and individual preferences for known patterns of behavior emphasize the recursive links between individual and societal perceptions (i.e., informal insti-

tutions) and changes in formal institutions. Though changes in formal institutions may create opportunity fields for entrepreneurship, informal institutions have an impact on the collective and individual perception of any entrepreneurial opportunities. Williamson (2000) suggested that informal institutions mainly have spontaneous origins; in other words, they self-organize as the organic growth of informal institutions in post-Soviet countries and other emerging market economies demonstrates (Polishchuk and Savvateev 2004). At the same time, informal and formal institutions coevolve. Informal institutions may be triggered to emerge over time out of intentional human behavior, whereas formal institutions might be a result of the cumulative effect of the uncoordinated actions of individuals instead (BenNer and Putterman 1998, p. 38). Informal institutions may also result from formal institutions as collective, oftentimes implicit and unwritten, interpretation of formal rules, which they, in turn, modify. For example, though a specific legal framework may contain explicit regulations for implementing laws, over time, these regulations may be complemented by an implicit understanding of their content. In this sense, informal institutions may complement the formal legal framework, filling gaps in some cases, which may only become apparent when laws and regulations are actually applied. However, since informal institutions are embedded in society, they tend to change more slowly than formal institutions. “Although formal rules may change overnight as the result of political and judicial decisions, informal constraints are much more impervious to deliberate policies” (North 1990, p. 6). This results in conflicting formal and informal institutions and has a major impact on entrepreneurial behavior insofar as entrepreneurs draw on previously “learned” behaviors, which in


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some cases contradict the current formal rules. Such entrepreneurial behavior “may bear little resemblance to the legitimate courses of action stipulated by the formal rules” (Nee 1998, p. 86). At the individual level, this results in entrepreneurs choosing viable but not necessarily the best courses of actions (Whyte 1986), which at the macro level results in suboptimal resource allocation (Arthur 1994). Where formal and informal rules conflict, previous experience and tacit knowledge are typically the main influences on entrepreneurial behavior. This is of particular importance in transition contexts because the environment in which opportunities are created is qualitatively different from that in mature market economies and conditions can also change very quickly.

Refining the Institutional Approach Previously, the authors of this paper have argued that although institutional theory is well-suited to drawing attention to the impact of external contexts on entrepreneurial behavior, it has several shortcomings when it comes to explaining the behavioral patterns that may be observed in different environments (Smallbone and Welter 2006). This section will take a closer look at some of these shortcomings in order to develop suggestions as to how the institutional approach to entrepreneurial behavior may be extended and refined.

Acknowledging Recursive Links: How Entrepreneurs Can Influence Institutional Change One of the criticisms that has been made when institutional theory is applied to a fluid and often seemingly irrational phenomenon such as entrepreneurial behavior refers to its rather mechanistic emphasis in which entrepreneurial behavior is viewed as a reaction to institutional pressures despite the recursive nature of institutions, institu-

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tional change, and behavior (Zafirovski 1999). Just as institutional change can influence entrepreneurial behavior, so too can entrepreneurial behavior impact on institutional change: “Action (. . .) develops in a duality between agency and structure” (Beckert 1999, p. 789). This implies that an institutional approach to entrepreneurial behavior needs to acknowledge that entrepreneurial behavior might trigger institutional change just as the latter can impact on behavior. Oliver (1991) suggested five types of behavioral response to the institutional framework, namely conformity or acquiescence, compromise, avoidance, deviance, and manipulation. Conformity, acquiescence, and compromising strategies acknowledge the existing institutional framework, signaling that entrepreneurs have recognized the changed institutional framework and adapted their behavior accordingly. Avoidance, defiance, and manipulation all reflect varying degrees of nonconforming behavior in relation to existing institutions. Avoidance includes “concealing their [the organizations] nonconformity, buffering themselves from institutional pressure, or escaping from institutional rules and expectations” (Oliver 1991, p. 154). In challenging environments, for example, diversification strategies of entrepreneurs fall into this category as illustrated by the aforementioned Belarusian entrepreneur renting out advertising hoarding space who engaged in unrelated diversification in order to escape notice by the state. Defiance and manipulation strategies represent more active forms of resistance to institutional pressures. The former includes entrepreneurs ignoring, circumventing, or openly challenging institutional rules, which especially happens in situations where there is low potential for external enforcement as is commonly the case under transition conditions. For example, two sisters, 58 and 61 years


old, started trading Moldovan food to Romania in 1994 after losing employment at a state factory. Later, they added the importation of textiles from Romania to their portfolio. Until 1999, they transported their goods by regular buses without any regulation of the trade activity. At the customs, they usually bribed officers to allow them to pass the frontier with large amounts of goods. As controls on the border and at local markets became stricter after 2001, it was necessary for them to obtain a license to trade. At the same time, in order to earn more income from their trading activities, they continued to circumvent (some of) the import procedures. Finally, “manipulation” refers to entrepreneurs or organizations actively attempting to change the institutional environment, which is normally less of an option for new and young entrepreneurs because of their lack of legitimacy and power. The exception is where they are well-connected as can be frequently observed in post-Soviet states, where “state capture” by party members-turnedentrepreneurs was a dominant process in the early stages of transition (Hellman, Jones, and Kaufmann 2003; Voszka 1994). Henrekson and Sanandaji (2010) identified three behavioral mechanisms through which entrepreneurs can influence institutions, namely abiding, evading, and altering. Altering behavior or in Oliver’s terminology “manipulation,” refers to direct actions of entrepreneurs aiming at reforming formal institutions, although not surprisingly, their ability to do so typically depends on their power and social standing (Kalantaridis 2007). Abiding behavior, or in Oliver’s terminology, conforming to existing institutions, can trigger institutional change through disruptive actions as, for example, the introduction of new technologies (Kalantaridis 2007). Evasion behavior contributes to institutional change because it challenges existing

institutions by weakening their effectiveness. However, in turbulent and hostile business environment, it is not only evasion behavior that might contribute to institutional change but rather any entrepreneurial behavior that questions existing institutions. This occurs in situations where institutions are not legitimized in economy and society (Beckert 1999) as happened in the early stages of the transition process where governments were quick to introduce market-based formal institutions but oftentimes, slow in driving and backing their implementation. In this regard, Kalantaridis (2007) identified the way entrepreneurs interpret formal institutional change in their local context and develop their own solutions to institutional deficiencies, which can become one of the mechanisms toward institutional change. This may be illustrated with reference to the business services firms in Ukraine mentioned earlier. By commercially exploiting institutional holes, these entrepreneurs might trigger change in the formal institutions aimed at leveling out the institutional deficiencies that created the opportunities. Another mechanism through which entrepreneurs may influence institutional change concerns path-dependent behavior. As discussed in the previous section, entrepreneurs in former Soviet economies where the business environment is particularly challenging are prone to rely on previously learned behaviors, some of which reflect socialist heritage. Chavance (2008) pointed out that in a transition context, such path-dependent behavior frequently is seen as perpetuating unwanted informal institutions, such as a reliance on networks and personal trustbased relationships, because this reinforces “inertial informality” (p. 65), which is considered detrimental to the much needed institutional change, in particular of informal institutions (Greif and Laitin 2004). Recently, however, studies of institutional change have


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started to acknowledge “positive pathdependent informality” (Chavance 2008, p. 67). In this regard, Martin (2010) drew attention to the processes of pathdependent institutional evolution: informal institutions are changed gradually by adding new procedures or structures (layering); they are reoriented toward new purposes (conversion) or recombined (recombination). In this regard, not all entrepreneurial behavior that draws on informal institutions from the socialist period can be considered as a hindrance to institutional change. On the contrary, the examples presented in this paper as well as evidence from several other studies (e.g., Smallbone and Welter 2009a; Welter and Smallbone 2008, 2003; Ledeneva 2006, 1998; Stark and Bruszt 2001; Stark 1996) illustrate how entrepreneurs who rely on trusted and learned behavior may simultaneously reinterpret, reorient, and recombine socialist informal institutions, thus contributing to institutional change in the long run.

Not All Entrepreneurs (Re-)Act the Same—Toward a Situational Understanding of Entrepreneurial Behavior Another shortcoming of institutional theory in explaining entrepreneurial behavior is its apparent lack of accounting for the heterogeneity of entrepreneurship since not all entrepreneurs act and react in the same way as implicitly assumed in typologies of responses to institutional pressures (Peng 2000). On the contrary, entrepreneurial behavior is neither a mechanistic nor a homogenous response to external pressures but is rather influenced by complex and situational different interactions of internal and external factors. Three main groups of factors are of particular importance in this regard, namely contextual and venture- and person-related factors. Whereas the former refers to the institutional and general business environment,

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particularly with respect to the level of institutional development and institutional fit, the latter includes enterprise size, the nature of the venture, and human capital of entrepreneurs as reflected in, for example, the previous working and management experiences of entrepreneurs, their level of education, and the entrepreneur’s social position during Soviet times. Regarding enterprise size, one might expect younger and smaller ventures to more often recur to evasion and avoidance strategies, faced with an inefficient institutional environment because their smaller resource base would not allow them to (fully) comply with the demands of the institutional framework. The same argument can be applied to ventures operating outside the legal frame. Entrepreneurs in young, small firms and those operating in the informal sphere simply might not have access to the financial resources and/or the social capital, such as connections in local administrations, needed for compliance so instead, they resort to bribery and circumventing legal rules. This results in a self-reinforcing circle of avoidance and evasion behavior even in legalized businesses, illustrated by the case of a young entrepreneur (36 years) in Moldova who owns a private limited company with seven employees. This entrepreneur started out as an illegal shuttle trader, exporting and selling Russian and Moldovan-produced television sets to Romania. During the late 1990s, the entrepreneur also developed television activity in his region and provided cargo transport services abroad to domestic and foreign firms. Since 2001, he has exclusively concentrated on importing agricultural goods from Poland and Romania and exporting fruits to Russia, although the statutes of his firm stipulate several other activities. Although his company has been officially registered since 1996, parts of its activities are still illegal. For example, when crossing the border, the entrepreneur


usually declares lower quantities in his documents and lower costs for his goods in order to avoid customs dues. Several studies have shown the frequent occurrence of such avoidance behaviors of entrepreneurs in early stages of transition (e.g., Round and Williams 2010; Welter and Smallbone 2009; Williams 2009a, 2009b). In such challenging situations, human capital may help entrepreneurs to adapt. Previous research has emphasized the role of prior knowledge as important for opportunity exploitation (Shane 2000). In this regard, research in early-stage transition conditions has shown a high propensity for entrepreneurs to be welleducated (see the literature review in Smallbone and Welter 2009b). This is partly explained by the specificities of conditions that can lead even welleducated people to be faced with limited opportunities for satisfying and sufficiently rewarding employment, encouraging them to consider the entrepreneurship option. The human capital possessed by these individuals means that they are well-equipped to identify and exploit opportunities in these challenging environments. In relation to entrepreneurial behavior, these individuals are capable of adapting their responses to external conditions but also of proactively anticipating the best possible behavior. In other words, the higher the level of human capital, the wider the expected repertoire of entrepreneurial behaviors with entrepreneurs combining conforming and defiant behaviors for the respective situation and institutional context. An additional factor impacting on entrepreneurial behavior refers to the social capital that has its roots in the social and professional positions held by individuals during Soviet times. For example, parents of current entrepreneurs in Russia were less likely to have been workers during Soviet times (Djankov et al. 2005). Other studies on

post-Soviet societies illustrate how members of the party “nomenclature” or individuals in leading positions in state enterprises were able to exploit their network resources when setting up new or privatizing existing firms (e.g., Welter and Smallbone 2010; Kshetri 2009; Smallbone and Welter 2001a; Frydman and Rapaczynski 1993). For example, insider knowledge, former nomenclature status of the owner, and shady dealings appeared to have played a role in the creation of a small retail store in Russia in 1997 that specializes in trading foodstuff (Smallbone and Welter 2009b). Currently, the store is 100 percent privately owned. Although when interviewed, the entrepreneur refused to give details of how the shop was transferred to private ownership, his employees later explained this in terms of their employer’s connections to the municipal authorities in Moscow where the owner had previously been a deputy of the Moscow Municipal Duma (parliament). This suggests that well-connected entrepreneurs also may find it easier to conform to the new institutional frame than their less well-educated counterparts as they can draw on contacts and social networks to overcome institutional deficiencies. Moreover, they might succeed in manipulating the institutional frame to their advantage, thus initiating further institutional change, although this might not benefit all entrepreneurs equally.

Substituting for Inefficient Formal Institutions: Trust and Entrepreneurial Behavior Trust can be a key factor influencing entrepreneurial behavior in challenging environments. It can play a role as a sanction mechanism, gaining importance in situations where formal and informal institutions conflict. Helmke and Levitsky (2004, p. 727) drew attention to the role of enforcement and sanctioning mechanisms by defining informal institutions as


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“socially shared rules, usually unwritten, that are created, communicated, and enforced outside of officially sanctional channels.” It is here that trust can perform an important role in either complementing or substituting for the formal institutional framework. In this regard, Helmke and Levitsky (2004) differentiate between four types of relationship depending on whether the formal institutional framework is effective or not (Table 1). Early-stage transition economies (cf. Smallbone and Welter 2001b) are typically characterized by ineffective formal institutions, which go hand-in-hand with weak or absent enforcement mechanisms. In such cases, informal institutions can be either competing or substituting. The former refers to informal institutions coexisting alongside formal institutions, fostering ruleviolating entrepreneurial behavior as entrepreneurs draw on familiar routines and rules to guide their behavior as illustrated previously in the paper. Situations where informal institutions substitute for formal institutions as enforcement mechanisms may be illustrated with reference to the role of institutional and personal trust in relation to entrepreneurial behavior. Both can be important mechanisms in this regard, although their importance varies according to environmental hostility and turbulence. Williamson (1993) introduced the distinction between personal trust, which he

limits to noncommercial relations; risk, which characterizes commercial transactions; and institutional trust, which refers to the social, cultural, political, and organizational embeddedness of economic transactions in, for example, the legal and regulatory system. Formal institutions such as the legal framework require a basic level of trust on the part of participants in the reliability of any exchanges as well as in any sanctions and penalties that may need to be imposed. In this way, institutional trust complements formal institutions by acting as an enforcement mechanism. Personal trust can complement institutional trust when an individual does not want to rely merely on institutional arrangements or when institutional arrangements are unfamiliar to them (Granovetter 1985). Generally, personal trust assists in lowering the transaction costs of commercial actions that do not have to be (fully) based on formal regulations (such as contracts) in those cases where the participants know each other either personally or by name. In some circumstances, personal trust can substitute for inefficient formal institutions as is frequently the case in countries with slow or little progress in transforming from central planning to a market-based system. In such situations, institutional trust often does not exist because it is highly dependent on an overall functional and efficient institutional structure in the society as a whole.

Table 1 Relations between Formal and Informal Institutions Effective Formal Institutions Complementary informal institutions

Accommodating informal institutions

Ineffective Formal Institutions Competing informal institutions

Substitutive informal institutions

Source: Adapted from Helmke and Levitsky (2004, p. 728).

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This means that “transactions that are viable in an institutional environment that provides strong safeguards may be nonviable in institutional environments that are weak (. . .)” (Williamson 1993, p. 476). “Our offices are public, but all of them work for their pockets” is a typical statement made by an entrepreneur in Ukraine, reflecting a low level of institutional trust, whereas at the same time, indicating the need for bribing behavior when dealing with public officials. In such contexts, personal trust gains importance for entrepreneurs, especially where they can not draw on connections and networks with public officials. This is visible in some of the behavioral responses described previously as well as in evidence from several other studies that have emphasized the extensive use of networks in order to mobilize resources for entrepreneurial activities (e.g., Höhmann and Welter 2005; Radaev 2005, 2004; Welter et al. 2005; Peng 2000). Moreover, in turbulent and hostile environments, personal trust can be essential in helping entrepreneurs to sustain and develop their ventures, particularly where this involves progressing from semilegal or illegal activities toward more substantial enterprises (Welter and Smallbone 2009). Opportunity discovery and exploitation can depend on personal trust as reflected in the use of family connections. For example, one entrepreneur living in Belarus was regularly visiting his relatives who lived on the coast of the Baltic Sea in Lithuania through which he identified amber jewelry production as a profitable business opportunity. His close family helps him in business: the son is involved in manufacturing jewelry and sometimes joins him to Lithuania in order to collect amber. His wife and mother-in-law are responsible for selling the finished products on markets, including Russia. Personal trust results from group characteristics, such as kinship or ethnicity. It can also emerge in bilateral (business)

relationships, particularly longstanding ones where individuals have come to know and trust each other. In both cases, they know or assume that the relative, partner, or friend will not behave opportunistically even when there are no written or explicit rules set out. This means that these relationships are governed by informal norms and rules. By contrast, a high level of trust in the formal institutional framework allows entrepreneurs to enter into transactions beyond the trusted circle of people known to them personally (Raiser 1999). In this regard, institutional trust allows for the use of anonymous sources in business relationships (such as new partners or consultants for business assistance) because there are legal safeguards and sanctions that may be applied in cases where the relationship fails. Whereas personal trust can exist regardless of any formal institutions, institutional trust requires stability and predictability in the institutional context. Formal institutions need to be legitimized through societal norms and values and they also need to be stable over time. In situations where formal rules fail or are absent, institutional trust is low or absent, whereas personal trust becomes dominant and substitutes for the deficient formal framework. It is only in situations where formal and informal institutions form a coherent framework that formal regulations and the rule of law will predominate and shape entrepreneurial behavior, whereas in fragile settings with institutional conflicts, personal trust typically dominates. This highlights the role of, and interplay between, institutional and personal trust in explaining entrepreneurial behavior patterns in challenging environments.

Conclusions and Outlook As entrepreneurship has increasingly become a global phenomenon, the contexts in which it occurs have become more varied, including some where the


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business environment is often extremely challenging. As a result, it is necessary for our approaches and methodologies to incorporate the role of social context if variations in the nature and extent of entrepreneurship development and the behavioral characteristics of entrepreneurs are to be understood. More specifically, this emphasizes the need to pay sufficient attention to the social, cultural, and political or in other words, the institutional environment in which entrepreneurship emerges because of its effect on societal attitudes toward entrepreneurship, the nature and extent of business opportunities, and the resources that can be mobilized to exploit them. Although entrepreneurship results from the creativity, drive, and commitment of individuals, the business environment can have a major influence on the nature and extent of entrepreneurship and the behavior of entrepreneurs. In order to develop this argument, the paper has focused on some of the most challenging environments for entrepreneurship in the world, namely former Soviet republics where the legacy of central planning has created a very specific institutional context. In these circumstances, institutionalist theory can provide an appropriate interpretative frame of reference because of its emphasis on the role of external influences on individual behavior or the institutional embeddedness of entrepreneurial behavior as presented in the paper. At the same time, institutionalist perspectives, grounded in the work of theorists such as Douglass North, may be criticized for being overly deterministic in circumstances where human agency can also play a role. This draws attention to the potential role of entrepreneurs themselves as change agents rather than simply being passive recipients of the rules of the game. As a consequence, it is suggested that the institutional approach as usually applied needs to be extended to take into

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account recursive relations between institutions and entrepreneurial behavior. This is demonstrated with specific reference to institutional change, which both impacts on entrepreneurial behavior as well as, in some circumstances, being affected by it. In this context, the current discussion in the literature on institutional entrepreneurship is potentially relevant in seeking to explain the role of individual and organizational agents in institutional change (e.g., Beckert 2010, 1999; Pacheco et al. 2010; Battilana, Leca, and Boxenbaum 2009). However, although entrepreneurs can contribute to institutional change in different ways, the examples described in the paper would seem to fall short of “institutional entrepreneurship” as interpreted by DiMaggio (1988, p. 14), who defined so-called institutional entrepreneurs as those who are “organized actors with sufficient resources” to see in new institutions “an opportunity to realize interests that they value highly.” Similarly, Battilana, Leca, and Boxenbaum (2009) argued that for change agents to be institutional entrepreneurs, they need to have initiated changes that break with the existing institutional framework and also actively participate in implementing those. In this context, the examples in the paper demonstrate how entrepreneurs may act as change agents (sometimes involuntarily) but without having an explicit aim of changing institutions. Instead, their aim is to exploit institutional loopholes and deficiencies to their own profit, although collectively, such behavior may contribute over time to increasing pressure for wider institutional change. In accommodating a stronger role for human agency, the application of institutional conceptual frameworks must also recognize the heterogeneity of entrepreneurship as entrepreneurial behavior will not only be influenced by institutional deficiencies but also by micro-level characteristics such as


venture size and type and the background and characteristics of the entrepreneur. In examining the interplay between structure and agency in this context, particular attention is paid to the role of trust in explaining entrepreneurial behavior, with institutional trust complementing the formal institutional framework and personal trust acting as a substitute for deficiencies in the formal institutional framework. Since the focus is on some of the most challenging environments in the world for entrepreneurship, one question that arises is the extent to which the argument developed in the paper with respect to the relationship between institutional context and entrepreneurial behavior is specific to these former Soviet republics. Though clearly, the balance between environmental and micro-level influences will vary according to the appropriateness of the external environment for market-based entrepreneurial activity, it may be argued that the conceptual framework described is appropriate for a wider range of contexts. This includes those former transition countries in Central Europe that are now members of the EU as well as other mature and emerging market economies around the world, although further comparative research may be needed to convincingly demonstrate this. Certainly, as entrepreneurship becomes more global in scope, it is important that our theories and methodologies are robust in a variety of contexts. The cognitive principles of entrepreneurial behavior are similar regardless of environment, although the meaning and understanding of institutions is specific to particular cultures and time periods. This may lead to differences in entrepreneurial behavior despite similar contexts. For example, in an environment where there is a high level of societal acceptance of entrepreneurship as an integral part of the economic well-being, which means that entrepreneurship is culturally

embedded, institutions are known and well-established, and entrepreneurs know how to deal with them. This also implies that their behavioral responses are learned over time and entrepreneurs can draw on sets of strategic options. At the same time, sanctioning mechanisms for rule-deviant behavior are implemented and known to all players. Thus, in familiar environments with strong coercive pressures, such as those associated with a well-functioning legal system, one would expect the behavior of new and small firms to mainly conform to institutional pressures. Mimetic behavior is also much more common in these environments compared with those countries where business models have to be built up from scratch. By contrast, in countries where “learned” behavioral responses no longer fit the newly emerging institutional framework, entrepreneurs can be expected to more frequently resort to avoidance and evasion behaviors as illustrated throughout this paper. Thus, what is different in challenging environments, such as those discussed in the paper, is the specific interplay and balance between individual entrepreneur/firm behavior and the external environment, which itself changes as the process of market reform unfolds. All this underlines the importance of recognizing the embeddedness of entrepreneurship and entrepreneurial behavior in its social context, which a modified institutional approach emphasizes.

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