Small Firms and Formality: The Influence of Judicial Efficiency and Regulation Costs

Small firms face three serious problems, namely, the high costs of regulation, of contract enforcement, and of finance. A simple model is developed to explain why in dealing with these problems small firms choose different strategies. Special emphasis is given to the effects of regulation costs and judicial efficiency on these choices. Several propositions concerning these effects are derived from the model and tested with data on Mexican microenterprises. The results support most hypotheses, and show that firms obtain more credit when they either register with official entities or participate in private associations and especially when they do both.