Petty corruption on firm level innovation of MSMEs: Evidence from emerging economies

Abstract

In this study, we examine how petty corruption affects micro, small and medium firms (MSMEs)'s innovation in emerging economies. Innovators from emerging economies face considerably high bribing pressure from corrupt public officials and no or little institutional support for innovative firms (Kotabe, Jiang, & Murray, 2017). Corruption undermines the foundations of institutional trust, which is necessary to develop entrepreneurial and innovative activities. It has been argued that corruption increases transaction costs, which makes innovative opportunity much less attractive. Since innovators have been recognised as the main driver of long-term economic growth, a clear understanding of how corruption affects innovation can assist the MSMEs development. Our examination of the relationship between innovation and corruption uses firm-level data for 3368 MSMEs in South American countries. We observe some firms that pay bribes and others that do not, but a direct comparison between them leads to an identification problem because the engagement with bribery may correlate with unobserved determinants of firms. To overcome this potential bias, we use propensity score matching (PSM) to find a comparison group for individual firms in the bribe-paying group. After controlling for firm characteristics and taking care of firms' observable characteristics typically linked to innovation decisions, we find systematic differences in firm-level innovation activities associated with paying bribes. In particular, results indicate that the estimated average effect of paying bribes on innovation outcome for firms who engaged in bribery is 11 percent. However, significant heterogeneity in innovation and paying bribes is also observable. Empirically, we find that the average effect of paying bribes on innovations is significantly higher on process innovation outcome than product innovation. We also observe that with weaker institutions, the effects of bribery on innovation is more pronounced. The main knowledge contribution of this paper is twofold. First, to the best of our knowledge, this paper is the first investigation of innovation in MSMEs from the perspective of innovation and corruption, using cross country micro-data, which are rich and recent. Also, extending prior research, we further report a heterogeneity effect of paying bribes on product and process innovations. Prior innovation studies, which use micro-data, mainly examine a single country Comparative studies using micro-data focus on large firms in developed markets.Policy derived from these large firm and mature market studies seems problematic for MSMEs in emerging economies, given the size effects, corruption levels etc. Second, this study provides a fresh perspective to that of previous studies of corruption in emerging economies, highlighting the importance of formal institutions in dealing with corruption. While prior studies on the role of institutions has focused on mianly formal tension (Cuervo-Cazurra, 2006, 2008), this study emphasizes the importance of the local environment in gaining legitimacy in the role of innovative entrepreneurs or MSMEs. In emerging economies, ineffective legal enforcement of contracts, weak regulations, and difficulty in enforcing property rights encourages private entrepreneurs to rely on informal forms of security (Ahlstrom, Bruton, & Lui, 2000). Consequently, informal ties and relational governance tend to fill the 'institutional void' where there is inadequate formal institutional infrastructure.