YOU SAY ILLEGAL, I SAY LEGITIMATE: ENTREPRENEURSHIP …people.tamu.edu/~ltihanyi/InfeconAMR.pdf ·...

YOU SAY ILLEGAL, I SAY LEGITIMATE:ENTREPRENEURSHIP IN THE INFORMAL

ECONOMY

JUSTIN W. WEBBLASZLO TIHANYI

R. DUANE IRELANDDAVID G. SIRMON

Texas A&M University

The entrepreneurial process drives economic activities in the formal economy; however,little is known theoretically about how the entrepreneurial process works in the informaleconomy. To address this theoretical gap, we employ a multilevel perspective integratingentrepreneurship theory (microlevel) with institutional (macrolevel) and collective iden-tity (mesolevel) theories to examine the role institutions and collective identity play in therecognition and exploitation of opportunities in the informal economy. Additionally, weexplore factors that influence the transition to the formal economy.

Societies are composed of groups that often havedifferent opinions about what is socially acceptable(Bickford, 1999; Rokeach, 1973). Contrasting norms,values, and beliefs are the source of these differ-ences. When concerned with salient issues, thegroups that form as a result of individuals’ coales-cence around different norms, values, and beliefsoften become large. The Prohibition era and the civilrights movement in the United States, for example,led to protracted struggles between large groupsof supporters and antagonists. Currently, largegroups in society with different norms, values, andbeliefs are struggling to reach agreements aboutsocially acceptable positions regarding severalissues, including immigration, balancing individ-uals’ civil liberties and national security, and so-ciety’s role in protecting the environment.

Each individual in a society may not actively par-ticipate in defining social acceptability about issuessuch as those mentioned above; however, all citi-zens are affected by the outcomes of interactionsbetween groups with different views (Davis & Silver,2004). Moreover, when large groups in a society dis-agree about what is socially acceptable relative tosalient issues, one group’s norms, values, and be-liefs may eventually become the basis of laws and

regulations (Scott, 1995), but this set of laws andregulations may differ from the laws and regula-tions that would be the product of another largegroup’s norms, values, and beliefs (Weber, 1978). Be-cause of these differences, a gap often exists be-tween what some large groups in a particularsociety understand to be legal—as specified bylaws and regulations—and what they consider tobe legitimate—as specified by norms, values, andbeliefs (Dowling & Pfeffer, 1975; Scott, 1995). Thistype of gap is important in that when a largegroup defines social acceptability more broadlythan is specified by established laws and regula-tions, members of that group may consider what isdeemed illegal to be legitimate.

Of interest to us is the fact that a gap (orvariance) between what is legal in a society andwhat some large groups consider to be legiti-mate in that society allows an informal economyto emerge. Drawing from different social disci-plines (e.g., anthropology, economics, and sociol-ogy), we define the informal economy as the set ofillegal yet legitimate (to some large groups) activ-ities through which actors recognize and exploitopportunities (Castells & Portes, 1989; Feige,1990).1 In this context an opportunity is the poten-

We thank the guest editors—David J. Ketchen, Jr., ViolinaRindova, and Daved Barry—and three anonymous reviewers forconstructively challenging us to improve this paper, as well asoffering support throughout the review process. We also thankMike Hitt for his valuable feedback on an earlier version of themanuscript.

1 The irregular, underground, shadow, and illegal econ-omy are terms others use to describe what we label theinformal economy. Our definition of the informal economy isgenerally consistent with definitions used in anthropology,economics, and sociology research (e.g., Castells & Portes,1989; Feige, 1990).

� Academy of Management Review2009, Vol. 34, No. 3, 492–510.

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tial to create more efficient or effective means—that is, production/distribution—and/or ends—that is, goods/services (Casson, 1982).

A significant amount of activity takes place inthe informal economy, suggesting its theoreticaland practical importance. Schneider (2002) esti-mated that informal economy activities accountfor approximately 17 percent of gross domesticproduct (GDP) in developed economies and ap-proximately 40 percent of GDP in developingeconomies. The International Labour Organiza-tion (2002) offered similar statistics. The associ-ated societal costs are also significant. For in-stance, the U.S. Department of Justice (2006) hasestimated the annual costs of counterfeit goodsat $250 billion and 750,000 lost jobs. Revenueslost from uncollected taxes on counterfeit goodsand unlicensed services and the costs of curbingthese activities by means of regulation, inspec-tion, and/or enforcement are examples of addi-tional costs resulting from activities in the infor-mal economy (Fadahunsi & Rosa, 2002).

Here we argue that entrepreneurial activitiestaking place in the informal economy fall withininformal institutional boundaries (i.e., norms,values, and beliefs of large groups in a society)but outside formal institutional boundaries (i.e.,laws and regulations). By default, entrepreneur-ial activities outside formal institutional bound-aries are illegal. The illegality of these activitiessurfaces because the means and/or ends em-ployed do not comply with the mandates of laws(e.g., not adhering to labor laws) and regulations.However, some groups may deem these activitiesto be socially acceptable/legitimate when they areconsistent with those groups’ norms, values, andbeliefs. Trader tourism (Konstantinov, 1996), activ-ities involving undocumented workers (Raijman,2001; Villar, 1994), and music/software piracy(Givon, Mahajan, & Muller, 1995) are examples ofactivities taking place in the informal economythat are illegal but legitimate for some groups.Informal economy entrepreneurs acting illegallyrely on the legitimacy that comes by operatingwithin informal institutional boundaries to exploitopportunities and operate their ventures outsideformal institutional boundaries.2

As in the formal economy, different types ofentrepreneurs (e.g., those seeking to replacetheir current income, those desiring a certainlifestyle, and those committed to growing theirventures) compete in the informal economy. Be-cause of the scale of their operations comparedto salary-substitute and lifestyle entrepreneurs,we focus on growth-oriented entrepreneurs (i.e.,individuals who continuously seek substantialgrowth for their ventures; Miller, 2005). Growth-oriented entrepreneurs use an entrepreneurialprocess as the foundation for growing their ven-tures. Entrepreneurial alertness, opportunityrecognition, opportunity exploitation, and deci-sions concerning growth are the stages com-monly associated with the entrepreneurial pro-cess (Bygrave & Hofer, 1991; Kirzner, 1979). Wedevelop theoretical arguments examining theentrepreneurial process in the informal econ-omy and the ability of some entrepreneurs tothrive outside formal institutional boundaries.

We draw from three theoretical levels to de-velop our arguments. To describe the contextualnature of the entrepreneurial process, we inte-grate microlevel (individual), macrolevel (insti-tutional), and mesolevel (group) effects. We useinstitutional theory to explore the boundariesaround the formal and informal economies andto explain why entrepreneurs are able to recog-nize and exploit opportunities in the informaleconomy. In short, because formal institutionscondemn the exploitation of a set of opportuni-ties by deeming them illegal (Jepperson, 1991;Scott, 1995), a realm of opportunities exists forentrepreneurs willing to operate outside formalinstitutional boundaries. Based on collectiveidentity theory (Lounsbury & Glynn, 2001; Pol-letta & Jasper, 2001) at the meso level, we showhow entrepreneurs rely on cooperative groups torecognize and exploit opportunities in the infor-mal economy. These cooperative groups formthrough a shared identification with similar oth-ers or through a shared disidentification withformally institutionalized practices. The collec-tive identity theory lens suggests how and whyinformal economy entrepreneurs create and ac-cess factor and product markets that substitutefor the lack of support from formal institutions.

Several theoretical contributions and policyimplications result from our work. First, inte-grating different social disciplines to explainthe use of the entrepreneurial process in theinformal economy contributes to an emerging

2 Institutional theorists refer to both formal and informalinstitutions as conferring legitimacy. For the purposes of ourarguments, we refer to activities with respect to formal in-stitutions as legal or illegal and activities with respect toinformal institutions as legitimate or illegitimate.

2009 493Webb, Tihanyi, Ireland, and Sirmon

theory of entrepreneurship (Phan, 2004). Second,we enhance institutional theory by describinghow opportunities arise within the informaleconomy, as well as why entrepreneurs can ef-fectively pursue some of those opportunities. Indoing so we answer calls for multidimensionalperspectives regarding institutions (Glynn, Barr,& Dacin, 2000). Third, we contribute to identitytheory by describing how an entrepreneur’s col-lective identity facilitates opportunity recogni-tion and exploitation in the informal economy.Finally, from a policy-making perspective, weinform efforts taken to develop policies that (1)more effectively encourage entrepreneurs to usethe entrepreneurial process in the formal econ-omy and (2) influence entrepreneurs’ transitionsfrom the informal economy to the formaleconomy.

First, we establish the theoretical context forour arguments at the micro, meso, and macrolevels. We then form propositions to discuss howinstitutional incongruence and weak enforce-ment of formal institutions enable the entrepre-neurial process in the informal economy, howcollective identity facilitates opportunity recog-nition and exploitation in the informal economy,and what the influences are that affect the tran-sition from the informal to the formal economy.We conclude by discussing the implications ofour work for research and policy.

THEORETICAL BACKGROUND

The Entrepreneurial Process

The entrepreneurial process’s activities un-fold in stages: entrepreneurial alertness, oppor-tunity recognition, opportunity exploitation, anddecisions concerning growth (Bygrave & Hofer,1991; Shane & Venkataraman, 2000). These activ-ities are the source for realizing an opportunity’spotential. Entrepreneurial alertness refers to anindividual’s ability to recognize opportunities.Opportunity recognition may occur as a flash ofspontaneous superior insight (Kirzner, 1979); al-ternatively, entrepreneurs sometimes recognizeopportunities after taking what can be a lengthyamount of time to evaluate ideas concerningspecific market needs (Sarason, Dean, & Dillard,2006). Opportunity exploitation refers to activi-ties entrepreneurs pursue to gather, bundle, andleverage new and existing resources in order todevelop more efficient means and/or ends (Sir-

mon, Hitt, & Ireland, 2007). Entrepreneurs sustaintheir venture’s growth by leveraging the sameopportunity in additional markets and/or by le-veraging different opportunities in the samemarket.

Institutions and an entrepreneur’s collectiveidentity affect the entrepreneurial process (Al-drich & Fiol, 1994; Polletta & Jasper, 2001; Sine,Haveman, & Tolbert, 2005). We use institutionaltheory to describe how institutions affect the useof the entrepreneurial process in the informaleconomy. Following this, we discuss how collec-tive identity facilitates access to both factor(e.g., financial capital, labor, material, etc.) andproduct markets for the informal economy entre-preneur.

Institutional Boundaries of the InformalEconomy

Legality and legitimacy. Legitimacy is “a gen-eralized perception or assumption that the ac-tions of an entity are desirable, proper, or appro-priate within some socially constructed systemof norms, values, beliefs, and definitions” (Such-man, 1995: 574). As socially constructed reflec-tions of laws, regulations, norms, values, andbeliefs, institutions “negatively constrain ac-tion, define opportunity, and facilitate patternsof interactions” (Clemens & Cook, 1999: 445).That is, institutions confer legitimacy to sanc-tioned opportunities to promote socially accept-able actions (Jepperson, 1991). By sanctioningsome opportunities, institutions simultaneouslyspecify a set of unsanctioned opportunities.

Scholars have developed various typologiesof institutions (Aldrich & Fiol, 1994; North, 1990;Scott, 1995).3 North’s (1990) well-established ty-pology divides institutions into formal and in-formal dimensions. Formal institutions refer tolaws, regulations, and their supporting appara-tuses (enforcement agencies, regulatory bodies,etc.). Through a wide range of mechanisms such

3 Scott’s (1995) categorization includes regulatory, norma-tive, and cognitive institutions. Aldrich and Fiol (1994) dis-tinguish sociopolitical (which essentially combines Scott’sregulatory and normative) and cognitive institutions. North(1990) provides a third typology, distinguishing formal (reg-ulatory) and informal (normative and cognitive) institutions.The distinction between formal laws/regulations and val-ues, norms, and beliefs establishes the informal economy’scontext.

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as enforcement, incentives, and precepts (Such-man, Steward, & Westfall, 2001), formal institu-tions establish the boundaries of entrepreneur-ial activities. Informal institutions refer tonorms, values, and beliefs that define sociallyacceptable behavior. Informal institutions en-courage conformity with social groups’ sharednorms, values, and beliefs (Aldrich & Baker,2001).

Despite distinguishing the two dimensions,scholars have yet to examine the effects of thepotential incongruence between what formaland informal institutions define as legitimate.Glynn et al. noted that “ignoring the dimension-ality of legitimacy . . . can be costly in terms ofover or underestimating the attention given tothe variable expectations and power of key con-stituents” (2000: 730). As laws, regulations, andsupporting apparatuses, formal institutions em-body the values, norms, and beliefs of certainlarge groups in society. For these large groups,formal and informal institutions are congruent.Because of dispositional characteristics, per-sonal experiences, and contextual elements,however, individuals differ in their norms, val-ues, and beliefs (Meglino & Ravlin, 1998). There-fore, some large groups in society may come tohold notions of what is legitimate that conflictwith formal institution’s prescriptions. In fact,entire communities, enclaves, and other identity-based groups can adhere to norms, values, andbeliefs that conflict with the laws and regula-tions specified by formal institutions (Safran,2003). Formal and informal institutions are, thus,incongruent for these large groups.

We assert that the informal economy existsbecause of the incongruence between what isdefined as legitimate by formal and informalinstitutions. “Legitimacy” is commonly used inthe literature to describe the prescriptions ofboth formal and informal institutions; however,using the word in this manner can create ambi-guity for those seeking to study the differencebetween formal and informal institutional re-quirements. Therefore, we explicitly refer to op-portunities as being legal or illegal (as specifiedby formal institutions) and legitimate or illegit-imate (as specified by informal institutions). Thelegal/illegal distinction captures prescriptionsguiding economic activities that have been for-malized and codified in laws and regulationsthat govern society. Our use of the terms legiti-mate and illegitimate more narrowly captures

prescriptions for social acceptability based ononly norms, values, and beliefs of large groupsin society, disregarding prescriptions of lawsand regulations. In other words, the meansand/or ends of an opportunity can be assignedclassifications of both legality and legitimacy.By “means,” we refer to the factors and pro-cesses directly involved in the production of fin-ished goods and services. Factors include rawmaterials, labor, and other inputs; processesparallel Porter’s (1985) conceptualization of pri-mary activities, such as inbound logistics, oper-ations, outbound logistics, marketing and sales,and service. By “ends,” we refer to the output(goods or services) produced by the venture.Combinations of legal/illegal and legitimate/illegitimate means and ends create three sec-tors of the economy (see Figure 1).

The formal economy. As suggested in Figure1, entrepreneurs exploiting legal and legitimatemeans to produce legal and legitimate ends op-erate in the formal economy. Formal economyentrepreneurs create new combinations ofknowledge as the foundation for exploiting rec-ognized opportunities but seek to conform to es-tablished formal and informal institutions (Zim-merman & Zeitz, 2002), even perhaps at theexpense of increased efficiency (DiMaggio &Powell, 1983).

The renegade economy. In some cases meansand ends can be illegal and illegitimate. There-fore, opportunities outside both formal andinformal institutional boundaries lack any nec-essary level of legal support and social accept-ability. We refer to the set of activities taken toexploit illegal and illegitimate opportunities asthe renegade economy.

As an important distinction between the ren-egade and informal economies, we limit ouranalysis of legitimacy to that conferred by largegroups in society supporting a given set ofnorms, values, and beliefs. Drug cartels, bankrobberies, and dog-fighting syndicates are ex-amples of activities occurring in the renegadeeconomy. The broader society does not conferlegitimacy to such activities (Johnson, Dowd, &Ridgeway, 2006). Although lacking social ac-ceptability, some renegade economy activitiescan grow substantially. The renegade economyis an intriguing research context; however, an-alyzing how renegade economy activities growthrough such mechanisms as addiction, coer-cion, and secrecy is outside our scope.


The informal economy. The informal economycouples illegality with legitimacy. Drawing fromour earlier discussion, the informal economycontains the activities to recognize and exploitopportunities occurring outside formal institu-tional boundaries but within informal institu-tional boundaries. For example, an alert entre-preneur in the informal economy may useillegal yet legitimate means (e.g., undocu-mented workers) to produce legal, legitimateproducts (e.g., residential homes, farm output).Although means and ends in the informal econ-omy are illegal (as specified by formal institu-tions), some large groups in a society considerthem to be legitimate.

Entrepreneurial activities in the informaleconomy fall into three categories (see Figure 1).Case A represents the combination of illegal yetlegitimate ends with legal and legitimatemeans. Therefore, concerns for Case A revolvearound the good or service itself, not its produc-tion. Examples here include pirated software

and counterfeit products. The means associatedwith making copies of compact discs or counter-feit products are not illegal; however, the endsproduced by those means are illegal. Sellingdrugs with medicinal purposes that have regu-latory approval in other countries but not in afocal country is another example of Case A ac-tivities. A product-specific example here is us-ing ozone to sterilize a patient’s mouth whencompleting dental procedures. Although illegalin the United States, ozone for dental proceduresis legal in parts of Europe. Thus, some largegroups in the United States may view the use ofozone as legitimate because of its medicinalvalue and acceptance in other countries.

Case B combines legal and legitimate endswith illegal yet legitimate means, such as em-ploying undocumented workers. While undocu-mented workers may provide services similar tothose of documented workers, they may be will-ing to accept lower wages and work withoutbenefits—conditions that increase operational

FIGURE 1Institutional Categories of Entrepreneurial Activities


efficiency. Ignoring emission requirements dur-ing manufacturing processes is another exam-ple of Case B. Although producing a legal prod-uct, entrepreneurs can again improve efficiencyby avoiding engineering, construction, and cer-tification costs associated with fulfilling emis-sion requirements.

Case C combines both means and ends thatare illegal yet legitimate. Using undocumentedworkers to produce counterfeit products is anexample of this type of entrepreneurial activity.

While some individuals engage in the infor-mal economy because certain factors (e.g., lackof requisite financial capital, discrimination)bar their entry into the formal economy (Pessar,1995; Raijman, 2001), others, even those who areaffluent, may also opt to enter the informal econ-omy (Williams, 2006). Affluent individuals mayfind the informal economy attractive because oftheir business acumen, motivations to increasewealth, and access to the resources needed toexploit illegitimate opportunities (Cloward,1959). Regardless of socioeconomic factors, fo-cusing on the growth motivation of informaleconomy entrepreneurs highlights processesgermane to our arguments. Specifically, to rec-ognize and exploit opportunities in the informaleconomy, growth-oriented entrepreneurs proac-tively seek to take advantage of institutionalincongruence and weak enforcement of the for-mal institution’s laws and regulations. Addition-ally, because of their need for resources, growth-oriented entrepreneurs operating in theinformal economy are highly dependent on theircollective identity (Portes & Haller, 2005).

Collective Identity and the Entrepreneur in theInformal Economy

Because they lack access to the resources andto the markets available within the boundariesof formal institutions, informal economy entre-preneurs may rely on cooperative groups assubstitutes for formal channels and markets.Collective identity, which refers to the commonbond tying individuals to a group (Polletta &Jasper, 2001), is one way cooperative groupsform between entrepreneurs and others. Identi-fication refers to an individual’s cognitive,moral, or emotional attachment to a groupbased on similar attributes (Nahapiet &Ghoshal, 1998). For example, identity may formaround values, behaviors, or general attributes

such as one’s race or cultural background(O’Reilly & Chatman, 1986).

Ethnic enclaves, perhaps the most salient andstudied collective identities in society (Pessar,1995; Raijman, 2001), are concentrations of firmswithin a generally defined location that areowned and operated by workers from the sameethnic background and serve the ethnic and/orbroader community (Portes & Jensen, 1989). Iden-tification within ethnic enclaves or other groupscreates an environment conducive to entrepre-neurial activities in the informal economy,partly because the group substitutes for formalinstitutions (Sanders & Nee, 1987; Wilson &Portes, 1980). For example, Portes and Sensen-brenner (1993) illustrated this role of collectiveidentity with the presence of informal loan op-erations granting credit to entrepreneurs in acommunity of primarily illegal Dominican immi-grants in New York City (also see Aldrich &Zimmer, 1986). This community ostracized entre-preneurs who failed to repay their loans, limit-ing the entrepreneurs’ access to different factormarkets. Similarly, the employees of Spanish-language radio stations in South Florida andprivate “security services” in other ethnic com-munities maintain strong collective identities(Portes & Sensenbrenner, 1993).

Other attributes that meaningfully highlight asalient norm, value, or belief may also be thefoundation for a collective identity. Regardlessof the focal attribute, individuals often definethemselves and others within social categoriesand perceive a positive contribution to their ownidentity by belonging to a group of others withsimilar attributes (Dutton, Dukerich, & Harquail,1994; Turner, 1975). Individuals sharing a com-mon identity cooperate with each other andcompete with those who do not share the sameattributes (Ashforth & Mael, 1989). Moreover, tosupport their group’s collective identity, individ-uals are motivated to act, even in the face ofgreat personal risk (Akers, Krohn, Lanza-Kaduce, & Radosevich, 1979). Such actions areexplained by “interaction in or [being] under theinfluence of those groups which control individ-uals’ major sources of reinforcement and punish-ment and expose them to behavioral models andnormative definitions” (Akers et al., 1979: 638).

Through discourse, informal economy entre-preneurs are able to create common identitieswith potential investors, employees, suppliers,


and customers and to mobilize collective action(Lounsbury & Glynn, 2001). Discourse refers todiffering modes of communication, such as con-versation, text, pictures, and symbols (Grant,Keenoy, & Oswick, 1998). For example, entrepre-neurs sometimes tell stories to increase culturalalignment with and support for their venture.Stories facilitate identity formation by “empha-sizing the distinctiveness of the new venturethrough a focus on identifying its unique char-acteristics” and “by stressing the normative ap-propriateness of the new venture by identifyingits symbolic congruence” with other individuals’commonly shared attributes (Lounsbury &Glynn, 2001: 551). Furthermore, recursive dis-courses allow individuals to establish their rolewithin a group or network (Robichaud, Giroux, &Taylor, 2004), their expectations of membership,and the meanings of the collective identitywithin the context of previous discourse. In thisway a set of standards guiding behavior is es-tablished (Burke, 1991). In turn, a collective iden-tity can create a cognitive awareness of why theventure in the informal economy exists, of iden-tity-imposed norms or rules guiding the ven-ture’s activities, and of mechanisms enablingsuccess in factor and product markets (Law-rence, Hardy, & Phillips, 2002).

A MULTILEVEL FRAMEWORK OF THEENTREPRENEURIAL PROCESS IN THE

INFORMAL ECONOMY

Based on the theoretical context given here,we develop propositions specifying the relation-ships among institutions, collective identity,and the entrepreneurial process in the informaleconomy. Napster, which was a growth-orientedentrepreneurial venture that Shawn Fanning es-tablished in the informal economy (Green, 2002),is the primary example we use to illustrate ourarguments. A software-based venture that de-veloped peer-to-peer file-sharing capabilities,Napster allowed the transfer of hundreds of mil-lions of song files among “pirating” users whopaid no royalties to music companies or artists.Napster’s business model resulted in facilitat-ing infringement of existing copyright lawthrough the venture’s software. Some analystsbelieve that Napster’s success contributed to adownturn in the music industry—a downturnfrom which the industry is still recovering (Chaf-fin, 2007; Schuman, 2007).

Incongruence Between Formal and InformalInstitutions

Entrepreneurial alertness generally increasesthe recognition of opportunities (Kirzner, 1979).Research on microlevel processes in entrepre-neurship supports this relationship; however,we suspect that institutions play a role in thisrelationship as well. Specifically, we describeincongruence between formal and informal in-stitutions as exerting an important effect on en-trepreneurs’ recognition of opportunities in theinformal economy.

The boundaries established by formal institu-tions prescribe preferred methods for conduct-ing entrepreneurial activities in a society (Such-man et al., 2001), which, in turn, allow forlegality and its benefits (e.g., reputation effects,reduced transaction costs, etc.) to be procured byventures adhering to such methods. Differencesin institutional boundary conditions arise whenformal and informal institutions send differentsignals about the acceptability of certain meansand/or ends as the foundations for entrepreneur-ial activities. We label these differences institu-tional incongruence. Increasing institutional in-congruence magnifies the gap between what islegal and what is legitimate.

Napster’s launch demonstrates an entrepre-neur’s decision to take advantage of institu-tional incongruence. Long before Napster, copy-right laws specified the property rights for themusic industry and its artists. Although Napsterfacilitated copyright law infringement, the com-pany experienced phenomenal growth. Napsterwas a “catalyst for the normative reconceptual-ization of copyright in society” (Green, 2002: 799).Various norms, values, and beliefs (informal in-stitutions) contradicted copyright laws (formalinstitutions), legitimizing Napster. For example,some individuals believed that (1) the courtswere wrong to target Napster given other avail-able, nontargeted avenues for piracy (CD burn-ers, blank tapes, etc.); (2) Napster introduced di-verse music to consumers, actually helpingmany artists; and (3) Napster allowed users tosample music before purchasing CDs (Merriden,2001).

Most often, the type of incongruence that isrelevant to our arguments arises from formalinstitutions that are more restrictive than whatinformal institutions deem socially acceptable.


We demonstrate this relationship in Figure 2,where the outermost boundary represents theoverall realm of opportunities available to en-trepreneurs. The white region corresponds to op-portunities available to entrepreneurs withinthe formal economy. The gray region representsthe informal economy, while the black regionrepresents the renegade economy. The bound-aries between the formal and informal econo-mies are dynamic and shift over time. As formaland informal institutions change, the level oftheir congruence changes as well. Increased in-congruence increases opportunities, whereasdecreased incongruence decreases opportuni-ties in the informal economy (i.e., the grayspace).

At least two factors explain change in theformal institutional boundary. First, legislative

efforts to acknowledge and accept new technol-ogies and services shift the formal institutionalboundary outward, transitioning opportunitiesfrom the informal to the formal economy. Forexample, Sellin (1963) described how the concep-tion of the lottery in the United States, currentlyfound in the formal economy, was once part of theinformal economy. As laws became more tolerantof lotteries, formal institutions grew more congru-ent with informal institutions. Second, interestgroups may lobby successfully for shifts in regu-lations that align formal institutions with certaingroups’ norms, values, and beliefs (Aldrich & Fiol,1994; Suchman et al., 2001). Currently, for example,some are lobbying for legalizing the use of mari-juana for medicinal purposes.

One can assume that entrepreneurs are alertto legitimate opportunities. The lack of legiti-

FIGURE 2Locus of the Formal, Informal, and Renegade Economies and Their Participants


macy implies that there are comparativelysmall markets for the entrepreneurs’ goods orservices. Entrepreneurs are not alert to (or atleast do not consider in depth) opportunitiesthey deem as unacceptable. Because of institu-tional incongruence, entrepreneurs have differ-ent perspectives on legitimacy. When informalinstitutions guide entrepreneurs’ perceptions oflegitimacy more strongly than do formal institu-tions’ prescriptions, the entrepreneurs becomealert to opportunities in the informal economy.

As the benefits of using the means and ends toconduct entrepreneurial activities dictated byformal institutions decrease, alert entrepreneursmay recognize more opportunities in the infor-mal economy. Despite being illegal (as definedby formal institutions), institutional incongru-ence allows legitimate opportunities in the in-formal economy and increases the chance thatalert entrepreneurs will recognize these oppor-tunities. Therefore, we suggest the following.

Proposition 1: Institutional incongru-ence strengthens the relationship be-tween entrepreneurial alertness andopportunity recognition in the infor-mal economy.

While effective institutions may reliably reg-ulate social action without the need for collec-tive mobilization or consistent intervention(Clemens & Cook, 1999; Jepperson, 1991), entre-preneurs may recognize opportunities in the in-formal economy when formal and informal insti-tutions are incongruent. However, institutionalincongruence is a necessary yet insufficientcondition for explaining entrepreneurial activi-ties in the informal economy. Additionally, weakenforcement of formal institutions is a precursorfor exploiting opportunities in the informaleconomy.

Weak Enforcement of Formal Institutions

Institutional theorists consider the stability offormal institutions to be a function of surveil-lance or enforcement power (Scott, 1995). Thestate’s enforcement of formal regulations isthird-party enforcement. Ideally, third-party en-forcement implies neutrality, costless measure-ment of contracts, and costless enforcement(North, 1990). In reality, though, enforcementcosts are substantial, particularly as the numberand complexity of laws and regulations in-

crease. To enforce all activities effectively, thecosts could possibly exceed the value created bythe desirable activities.

Entrepreneurs exploit opportunities in the in-formal economy by taking advantage of the im-perfections in the enforcement of laws and reg-ulations. Although formal institutions not linkedwith enforcement may discourage some entre-preneurs from developing their products, the po-tential for additional wealth through increasedefficiency or effectiveness encourages other en-trepreneurs to exploit recognized opportunitiesin the informal economy.

A number of imperfections contribute to weakenforcement of formal institutions, including thefact that a significant portion of enforcementtends to concentrate on the activities and out-comes of prominent firms or industries. Targetedenforcement increases awareness of violationsand is viewed as an effective method of settingan example for other ventures that violate for-mal institutions. However, targeted enforcementalso allows the activities of smaller entrepre-neurial ventures to continue undeterred.

Other imperfections surface owing to the en-forcement methods agents have available. En-forcement agents are often visible manifesta-tions of the formal institutions. As such,entrepreneurs in the informal economy benefitfrom the ability to exploit opportunities outsidethe purview of these enforcement agents. Born-stein (2001) described the Palestinian-Israeliborder as a constraint regulating the flow ofproducts and workers. Road checkpoints and pa-trols severely limit the flow of Palestinians totheir businesses and jobs in Israel. Therefore,tens of thousands of Palestinians merely avoidthese visible obstacles by undertaking clandes-tine off-road crossings into Israel (Bornstein,2001). A similar source of imperfection surfaceswhen one set of formal institutions obstructsagents from enforcing other formal institutions.More specifically, laws defining privacy andcivil rights may limit the detection and termina-tion of informal economy activities.

Self-interested motives and negligence of for-mal institutional agents may further undermineefforts to control deviant behaviors. Bribery of-ten fulfills the motives of self-interested institu-tional agents. Some institutional agents mayalso lack the expertise or desire needed to en-force regulations guiding economic activities.Finally, the values of institutional agents may


align with those of the informal economy entre-preneur, leading the agents to believe that en-forcing more restrictive formal institutions is notworthwhile or necessary.

The weak enforcement of copyright laws wasa major contributor to Napster’s growth. The in-ternet provides a global marketplace with anenormous number of vendors. Because of itssize, most informal economy entrepreneurs op-erating on the internet are not visible to enforce-ment agents (Zimmerman, 2006). But Napster’sgrowth eventually became its source of demise.The music industry targeted Napster and its cus-tomers in a series of lawsuits. As noted, how-ever, targeted enforcement controls the majorviolators but allows smaller entrepreneurialventures to escape detection and possible pun-ishment. While the music industry targeted Nap-ster, numerous imitators established similar op-erations (The Economist, 2002).

Proposition 2: Weak enforcement offormal institutions strengthens the re-lationship between opportunity recog-nition and opportunity exploitation inthe informal economy.

Entrepreneurs in the informal economy may beeffective not only at taking advantage of weakenforcement of formal institutions but also atmaintaining a strong market position for theirventure’s products. They may do so by leveragingcooperative groups based on the formation of acollective identity to broker factors of productiontheir venture needs to continue operating.

Collective Identity and OpportunityRecognition in the Informal Economy

Individuals define themselves within a sys-tem of social categories based on numerous at-tributes, including norms, values, and beliefs(Turner, 1975). Whether an individual is born amember or joins a group later, others within thatgroup reinforce the individual’s perspectives. Aconfluence of geographic, cultural, and otherfactors and events can characterize the uniquehistorical context through which a collectiveidentity forms. The collective identity strength-ens over time as the group behaves in ways toprotect and reinforce its defining characteristicsin the face of broader contextual changes (Pol-letta & Jasper, 2001). Furthermore, the norms,values, and beliefs that develop in the collective

identity of such groups can differ from the pre-scriptions put forth by formal institutions.

As a valuable social source of information toits members, a group’s collective identity canincrease its members’ ability to recognize oppor-tunities (Ozgen & Baron, 2007; Singh, 2000). Morespecifically, through membership in a collectiveidentity that is outside formal institutions, in-dividuals may recognize opportunities throughthree types of valuable experiential knowledge: (1)knowledge that a market of opportunities existsoutside formal institutions, (2) knowledge of col-lective identity members’ needs and customerproblems, and (3) knowledge of how to serve theneeds of the collective identity (Shane, 2000).

To elaborate, institutional incongruence cre-ates opportunities in the informal economy (asspecified in Proposition 1). However, an individ-ual’s membership in a collective identity at-tunes the individual to these opportunities andto the existence of a market with actors possess-ing similar norms, values, and beliefs that canbe served. Individuals sharing a collective iden-tity also may be more capable of understandingthe group’s needs and desires. Given members’specific group knowledge formed through con-sistent interaction and discourse with the group(Yu, 2001), alert individuals become aware of thegroup’s specific needs that cannot be servedthrough formal economy activities. Because in-dividuals who are not members of such a collec-tive identity do not participate in the everydayinteractions of the group, they do not possesskey sources of knowledge needed to identifyrelevant opportunities for the collective identity(Gaglio & Katz, 2001). Finally, members of agroup also understand the mechanisms to effec-tively engender identification with the groupand to create factor and product markets(Bletzer, 2003), allowing these members to under-stand how to serve the collective identity.

Napster is an interesting example of how acollective identity facilitated an entrepreneur’srecognition of an opportunity. Fanning was astudent at Northeastern University when he rec-ognized the opportunity that developed intoNapster. He and other students were using ear-lier versions (e.g., Scour) of music-downloadingprograms. Alert to others’ complaints about out-dated and empty links to song files, Fanningrecognized an opportunity to develop softwarethat would automatically update links as userslogged onto the internet with the program run-


ning. The group’s music-loving collective iden-tity was the basis of the recognized opportunity(Menn, 2003), manifesting through Fanning’sknowledge of a potential online market for mu-sic by internet users, the issues underminingcurrent methods of accessing music online, andhow to develop a better service for this marketsegment.

For collective identities that do not sharenorms, values, and beliefs that are congruentwith the legal requirements of formal institu-tions, alert members may become more attunedto and able to recognize opportunities in theinformal economy.

Proposition 3: A group’s collectiveidentity, as framed by at least somecharacteristics outside formal institu-tions, strengthens the relationship be-tween entrepreneurial alertness andopportunity recognition in the infor-mal economy.

Collective Identity and OpportunityExploitation in the Informal Economy

Formal institutions do not facilitate access toimportant factors of production (e.g., labor, sup-plies, and financial capital) for informal econ-omy entrepreneurs. Because of this, these entre-preneurs leverage identity-based groups that, inpart, act as a substitute for formal institutions(Wilson & Portes, 1980). A group with a strongidentity can enhance cooperation among mem-bers and provide access to resources and mar-kets. Informal economy entrepreneurs maygather needed resources from other members oftheir group through financial bootstrapping—the “highly creative ways of acquiring the use ofresources without borrowing or raising equityfinancing from traditional sources” (Freear,Sohl, & Wetzel, 1995: 102). They may borrowequipment or acquire loans from other groupmembers, maintain flexible credit arrange-ments, and establish other efficient relationalroutines (Winborg & Landstrom, 2000). This isimportant, because as a venture’s risk in-creases, so does the significance of its financialbootstrapping strategies (Van Auken, 2004).

Growth-oriented entrepreneurs in the infor-mal economy pursue opportunities beyond theirlocal group of family, ethnic enclave, or commu-nity. In growing into the broader society, they

recognize similar others by identifiable at-tributes. Entrepreneurs solidify relationshipswith these individuals and increase the sa-lience of their collective identity through inter-action and discourse. The degree and frequencywith which they utilize these forms of identifica-tion depend on the entrepreneurs’ inherent will-ingness to accept risks of detection by formalinstitutions’ enforcement agents. Interestingly,attempting to elicit illegal yet legitimate behav-iors from others may be unsuccessful when anentrepreneur fails to engage adequately withother group members, since these others maysuspect the entrepreneur has ties to enforce-ment agents (Wiegand, 1994). This reflects theneed to foster a shared identity as a precursor toacquiring and leveraging resources.

Much of Napster’s early success resulted fromthe help Fanning received as a member of anidentity-based group. The group, known asw00w00 Security Development, emerged from ayounger generation of programmers and hack-ers. Being a somewhat clandestine group, mem-bers recruited others after observing in themspecial skills in programming or hacking, orthey were drawn from similar other groups (e.g.,Association de Malfaiteurs and e18.org). Fan-ning bootstrapped valuable programming as-sistance from numerous individuals in thegroup at various stages of Napster’s develop-ment. Much of this assistance was without cost,since these individuals wanted to help more forthe enjoyment of programming than for finan-cial gains (Menn, 2003; Merriden, 2001). Thus,Fanning’s identity-based relationships were in-strumental to the financial bootstrapping of crit-ical resources.

Cooperative groups in the informal economyalso form through the collective disidentifica-tion of individuals with a common institutional-ized entity or practice. Disidentification occurswhen an individual perceives the characteris-tics of his or her identity as divergent from an-other group’s identity (Kreiner & Ashforth, 2004).As a collective disidentification coalescesaround a common institutionalized entity,groups may form to circumvent the entity.Flynn (1997) provided a compelling descriptionof entrepreneurial activities in the informaleconomy of the Shabe along the Benin-Nigeriaborder. These entrepreneurial activities prin-cipally involved the smuggling of variousproducts, from clothing to petroleum, for these


border residents. A strong border identity, so-lidified in large part by disidentification withinstitutions erected by the respective Beninand Nigeria states, facilitated these activities.As Flynn describes:

Local antagonisms toward the Nigerian and Be-ninois states have intensified markedly in thewake of a series of economic developments thathave restricted opportunities for trade and wagelabor at the border. Because border residents per-ceive the state as the catalyst and cause of theeconomic hardships and because the state offerslittle or no infrastructural or economic developmentto this marginal rural border area, a heightenedsense of border solidarity has emerged. A growingdistrust and suspicion of government . . . has con-tributed to a strengthened border identity . . . thatdefines, on the one hand, their roles in transborderexchanges and, on the other, their relations withboth the state and nonborder residents (Flynn, 1997:315, 318).

By defining who or what the competition isand the “team” to which one belongs, disidenti-fication may facilitate entrepreneurial activi-ties. Increased levels of disidentification withformal institutions engender support for the en-trepreneur, regardless of the business activity. Inorder to undermine the formal institution withwhich they disidentify, individuals more stronglysupport the survival of entrepreneurial activitiesthat ignore specific laws and regulations. There-fore, entrepreneurs in the informal economy relyon existing rhetoric and animosity to transformothers’ disidentification into a concerted effortagainst the source of discontent. Regardless of thebasis of their groups, entrepreneurs with strongercollective identity may be able to increase thechances of exploiting the opportunity they recog-nized in the informal economy.

Proposition 4: A group’s collectiveidentity, as framed by at least somecharacteristics outside formal institu-tions, strengthens the relationship be-tween opportunity recognition and op-portunity exploitation in the informaleconomy.

Growth and Transition of Informal EconomyVentures

The growth of ventures in the informal econ-omy creates a paradox. On the one hand, growthallows successful entrepreneurs to enjoy gainsin wealth; on the other, growth increases the

possibility of detection by enforcement agents.The risk of detection motivates a transition tothe formal economy. However, differences in thelocus of illegality (i.e., means or ends) amonginformal economy ventures likely affect the fea-sibility of a transition. In fact, we argue thatventures feeling the greatest pressure for imme-diate transition are the least likely to be able totransition successfully.

As noted, growth of a venture in the informaleconomy increases its visibility to enforcementagents. Increased visibility exerts greater pres-sure that leads informal economy entrepreneursto consider various growth options. A partialtransition, in which entrepreneurs maintain thesize of their venture at less visible levels whilepursuing formal economy opportunities, is oneoption. Two other options are (1) resisting anytransition to the formal economy and insteadexpanding within the informal economy by ex-ploiting existing or new opportunities thereinand (2) fully transitioning to the formal economy.We expect differences in the locus of illegality(i.e., means or ends) to influence this decision.Specifically, we expect entrepreneurs pursuingillegal yet legitimate ends to feel greater pres-sure to fully transition to the formal economythan those exploiting illegal yet legitimatemeans.

Exploiting illegal yet legitimate means(Case B, Figure 1) affords a distinct growthadvantage over exploiting illegal yet legiti-mate ends (Case A, Figure 1). Innovation the-ory logic suggests that, in general, means areless imitable because they take place behindclosed doors; in contrast, end products are dis-tributed within a market where both competi-tors and enforcement agents can study them.Therefore, innovations in a venture’s means—that is, processes—tend to lead to a more sus-tainable source of competitive advantage thaninnovations in a venture’s ends—that is, prod-ucts (Kotabe, 1990).

In contrast, it is easier to detect entrepreneurs’efforts to exploit illegal yet legitimate ends. Forexample, informal economy entrepreneurs sellends (products) in markets over which they havelimited influence. Because they share a commoncollective identity with the entrepreneurs, cus-tomers purchasing illegal products likely per-ceive these ends as legitimate. However, cus-tomers may use products in public, share themwith others, and communicate various aspects


of their buying experience with others. Each ofthese actions increases the likelihood of detec-tion by enforcement agents. Even without cus-tomers undermining an informal economy entre-preneur’s activities, though, too much growth forventures exploiting illegal yet legitimate endsincreases the potential for detection and sub-sequent termination. As noted, Napster’s sub-stantial growth and visibility contributed to itsdetection by enforcement agents and its sub-sequent problems.

Therefore, informal economy entrepreneursemploying illegal yet legitimate means may bemore likely to resist transition to the formaleconomy. Because means are more sustainablein the informal economy, these growth-orientedentrepreneurs do not feel the acute pressure tooperate within the formal economy’s bound-aries. Conversely, entrepreneurs pursuing ille-gal yet legitimate ends feel greater pressure totransition from the informal economy to the for-mal economy in that their ends are visible toenforcement agents.

While informal economy entrepreneurs ex-ploiting illegal ends feel greater pressure topursue transition to the formal economy, the riskand uncertainty in redefining the entrepreneurs’ventures make the probability of successfultransition low. Specifically, because selling ille-gal ends is unacceptable in the formal economy,a transition requires these informal economyentrepreneurs to redefine their market offering.The uncertainty of the market substantially in-creases downside risk associated with chang-ing ends (Sarasvathy, 2001; Shane & Venkatara-man, 2000). In contrast, entrepreneurs usingillegal means merely need to replace thosemeans while continuing to exploit their current(legal) ends within existing markets. These en-trepreneurs have much more control over theresources and processes used in their ventureand do not have to redefine their product offer-ing or establish a new customer base. Therefore,the probability of a successful transition to theformal economy is greater for informal economyventures exploiting illegal yet legitimate meansrather than ends, because replacing means in-volves less uncertainty and risk than develop-ing new ends.

Generally, this logic suggests a paradox. Theenforcement pressures are greater for growth-oriented informal economy ventures exploitingillegal yet legitimate ends rather than means.

However, the probability of successful transitionis greater for the ventures exploiting illegal yetlegitimate means.

Proposition 5: Although informal econ-omy ventures exploiting illegal yet le-gitimate ends feel more pressure totransition to the formal economy, theprobability of successful transition forinformal economy ventures exploit-ing illegal yet legitimate means isgreater.

DISCUSSION AND CONCLUSIONS

Despite its widespread use, the entrepreneur-ial process in the informal economy has re-ceived little theoretical attention. We have inte-grated entrepreneurship theory with argumentsfrom institutional and collective identity theo-ries to explain the origin and use of the entre-preneurial process in the informal economy. Themultilevel analysis we have used may have thepotential to inform future theoretical work ex-amining these phenomena. Additionally, the re-sults of future research could shape the devel-opment of public policy.

A focus on the influence of institutional incon-gruence and weak enforcement of formal insti-tutions provides the macrolevel effects in ourtheoretical framework. First, we suggested thatthe incongruence between formal and informalinstitutions creates the potential for an informaleconomy. In contrast to the formal economy,means and/or ends are illegal yet legitimate inthe informal economy. Consistent with prior lit-erature, our arguments differentiate the infor-mal economy from the renegade economy (e.g.,Portes & Haller, 2005); in the latter, means andends are illegal and illegitimate. We excludedthe renegade economy from our analysis. Givenour context, we developed a series of proposi-tions focusing on macrolevel and mesolevel ef-fects on the entrepreneurial process in the infor-mal economy.

We proposed that incongruence between for-mal and informal institutions strengthens therelationship between entrepreneurial alertnessand opportunity recognition in the informaleconomy. Additionally, weak enforcement of for-mal laws and regulations enhances the rela-tionship between opportunity recognition andexploitation in the informal economy. Next, we


considered the potential of collective identity,which provides the mesolevel effects in ourmodel, to facilitate the entrepreneurial processin the informal economy. We argued that collec-tive identity positively moderates the relation-ships between (1) entrepreneurial alertness andopportunity recognition and (2) opportunity rec-ognition and opportunity exploitation. Our fi-nal proposition explored the transition of en-trepreneurial ventures from the informal to theformal economy. Here we argued that informaleconomy ventures producing illegal ends aresubject to greater pressure to transition to theformal economy compared to ventures usingillegal means to produce legal products. Incontrast, we suggested that the probability ofsuccessful transition from the informal econ-omy to the formal economy is lower for ven-tures making illegal ends than for venturesusing illegal means.

We believe our theoretical analysis can in-form future informal economy research. First,understanding entrepreneurial activities in theinformal economy may facilitate further analy-sis of this underexamined topic. For example,studies of competitive dynamics among firmsoften exclude competitive threats by ventures inthe informal economy. In addition to their neg-ative effects, though, some previous work notesthe positive contributions to society that flowfrom the efforts of informal economy entrepre-neurs. For instance, although software piracycaptures legal sales from software providers inthe formal economy, such activities frequentlyhelp solidify the critical threshold of a customerbase for the software developers (Givon et al.,1995). In turn, this baseline set of users promoteslegal adoption of the software and establishesentry barriers to competing software products.Previous research also suggests that entrepre-neurial activities in the informal economy drivesocial cohesion in communities and offer em-ployment alternatives for many individuals whohave few options or who face discrimination(Gaughan & Ferman, 1987; Priest, 1994; Villar,1994).

Moreover, many parties may benefit when as-pects of a complex value chain include informaleconomy participants. For example, residentialhome building has long been a critical part ofthe U.S. economy. The supply chain in residen-tial home building is elaborate. While a con-sumer interfaces with a general contractor, that

contractor often employs numerous subcontrac-tors. As market pressures mount on the generalcontractor to produce an attractively pricedquality home, the general contractor, in turn,pressures the subcontractors to reduce costs. La-bor is a variable cost subcontractors can reduce.Under pressure, subcontractors may turn to un-documented workers. Using undocumentedworkers may increase societal costs (e.g., emer-gency room visits); the realized benefits to thecontractors, consumer, and undocumentedworker, however, are more immediate. Thus, theinterface between formal economy firms (i.e., thegeneral contractor) and informal economy firms(i.e., subcontractors using undocumented work-ers) creates costs and benefits. Future researchmay seek to determine the net outcome of infor-mal economy activity and, as we discuss, howpolicy can positively affect the ratio of benefitsto costs.

Furthermore, the theoretical framework devel-oped here highlights the relevance of variousdisciplines (such as sociology and anthropol-ogy) for studying questions related to entrepre-neurial activities. Beyond the talent and otherpersonal traits of the entrepreneur, the socialcontext of the entrepreneur’s activities (such asthe boundary between the formal and informaleconomy), the enforcement of regulations, andthe collective identity supporting legitimate ac-tivities are all important issues for scholarlyattention.

Our exploration of entrepreneurial activitiesin the informal economy also contributes to in-stitutional theory. Although a substantialamount of scholarly work has examined the roleof institutional constraints, little research hasfocused on organizations operating outside oflaws and regulations in different societies or onhow institutions can encourage ventures to tran-sition from the informal to the formal economy.Furthermore, institutional theory research tendsto pay limited attention to the behavior of indi-vidual actors under given institutional con-straints. We suggest that there is variationacross entrepreneurs in their desire to seek le-gality within a given regulatory system. Further-more, some entrepreneurs can operate theirbusinesses effectively outside the formal econ-omy’s institutional framework.

Another potentially interesting agenda forinstitutional theory is the study of the informal


economy in different countries.4 Although in-formal economy activities tend to be moreprevalent in developing economies, theirscope may vary based on the legal, cultural, orother historic traditions of a country, regard-less of its economic development. For exam-ple, differences across legal traditions maychange the meaning of law enforcement andmodify the pressures for transition to the for-mal economy. Specifically, countries with En-glish common law traditions tend to have lesscorruption and more transparency than coun-tries with legal traditions rooted in Frenchcivil law (La Porta, Lopez-de-Silanes, Shleifer,& Vishny, 1998). Future comparative studies ofentrepreneurial activities occurring in the in-formal economy worldwide could provide in-teresting tests of the boundaries of our pro-posed framework.

Examining entrepreneurial activities in theinformal economy has the potential to contrib-ute to collective identity theory as well. We sug-gest that entrepreneurs may replace the rules ofmarket transactions by associating with otheractors in the informal economy. Networks withinvestors, suppliers, and customers are impor-tant in many settings. However, the formation ofa collective identity by informal economy entre-

preneurs is especially critical in facilitating theprocurement of inputs for their ventures’ growth.Thus, research exploring how collective identityinfluences the different stages of the entrepre-neurial process in the informal economy mayoffer valuable insights (Schoonhoven & Ro-manelli, 2001).

In addition to implications for theory, examin-ing entrepreneurial activities in the informaleconomy has several implications for publicpolicy decisions. Developing effective laws toregulate the formal economy, as well as specificpolicies aimed at entrepreneurs in the informaleconomy, may reduce the scope of illegal activ-ity and motivate entrepreneurs to transition tothe formal economy. Incongruence between in-stitutional boundaries suggests a need for dif-ferent types of policy reform. Policy makers mayneed to redress existing formal institutions byremoving economic barriers and rectifying dis-criminatory laws. In doing so, formal institu-tions may expand the scope of available oppor-tunities in the formal economy and open legalavenues to those entrepreneurs for whom suchavenues do not presently exist.

From a policy standpoint, another potentiallyeffective approach to limit the scope of the in-formal economy is to pressure large formaleconomy firms to sever ties with suppliers usingillegal means. For example, Nike is proactivelypolicing its outsourcing firms. The company re-cently announced a shortage of soccer balls be-cause it cut ties with a major supplier that wasviolating labor laws (Kang, 2006).

A longer-term approach to managing the in-formal economy is to modify informal institu-tions. To be effective, such actions would ideallytarget specific beliefs that support entrepre-neurial activities in the informal economy,rather than the values and norms defining col-lective identities. Policies formed and imple-mented for these purposes should seek addi-tional congruence between formal and informalinstitutions.

In developing better policies, regulatory anddevelopmental agencies should address differ-ences among the three cases of informal econ-omy entrepreneurs. As suggested earlier, differ-ent informal economy entrepreneurs vary in thepressure they feel to transition to the formaleconomy, as well as in the uncertainty they per-ceive in such a transition. These differences im-ply the need for policies uniquely facilitating

4 Because informal institutions vary widely across cul-tures, what is illegitimate in one culture may be widely seenas legitimate in others, as in the following example:

Akin, who lives in Lagos, is one of a new generation ofentrepreneurs that has emerged in this city, Nigeria’slargest. . . . Call him a “Yahoo! Millionaire.” Akin buysthings online—laptops, Blackberries, cameras, flat-screen TVs—using stolen credit cards and aliases. Hehas the loot shipped via FedEx or DHL to safe houses inEurope, where it is received by friends, then shipped onto Lagos to be sold on the black market. . . . Akin’s mainoffice is an Internet cafe in the Ikeja section of Lagos.He spends up to ten hours a day there, seven days aweek, huddled over one of 50 computers, working hisscams. And he’s not alone: The cafe is crowded most ofthe time with other teenagers, like Akin, working for a“chairman” . . . who gets a 60 percent cut and reservesanother 20 percent to pay off law enforcement officialswho come around. . . . A sign at the door of the cafereads, WE DO NOT TOLERATE SCAMS IN THIS PLACE.DO NOT USE E-MAIL EXTRACTORS OR SEND MUL-TIPLE MAILS OR HACK CREDIT CARDS. YOU WILLBE HANDED OVER TO THE POLICE. The sign is ajoke. . . . Attempts to speak to government officialsabout Internet crime were futile. They all claimed ig-norance of such scams; some laughed it off as Westernpropaganda (Lawal, 2006).


each case’s successful transition to the formaleconomy. From a policy standpoint, however,society may also benefit from the revision ofsome formal institutions to usurp marginal in-formal economy activity. Both formal and in-formal institutions have dynamic boundariesthat shift over time based on broader sociocul-tural, technological, and political/legal trendsin society. Some entrepreneurs may attempt toanticipate these shifts by exploiting opportu-nities in the informal economy. These antici-patory actions allow a first mover advantagewhen the formal institutional boundary even-tually shifts outward to encompass these op-portunities.

Last, formal institutions at the local and na-tional levels are not always congruent (Ka-rush, 2007), creating difficulties in coordinat-ing informal economy policy. Although theinformal economy is often framed at the na-tional level, local government agencies nor-mally have a better understanding of informaleconomy ventures. Because of this, using localagencies’ knowledge of informal economyventures may help enforcement efforts at na-tional levels.

In conclusion, we have used the informaleconomy to highlight the importance of the so-cial context of entrepreneurship theory. Becausethe informal economy exists in many nationsthroughout the world, understanding the entre-preneurial process in the informal economy pro-vides theoretical and practical relevance. Ourframework integrates entrepreneurship theory(microlevel) with arguments from institutionaltheory (macrolevel) and collective identity the-ory (mesolevel). The roles of incongruence be-tween formal and informal institutions, enforce-ment, and collective identity form the core of ourtheoretical arguments. We have also explainedinfluences in the transition from the informal tothe formal economy. We hope this work moti-vates additional research on the informal econ-omy.

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Justin W. Webb ([email protected]) is a doctoral student in the Mays BusinessSchool at Texas A&M University. He received his MBA from the University of Rich-mond. His research interests include strategic entrepreneurship, identity and institu-tions, the informal economy, and cross-disciplinary research.

Laszlo Tihanyi ([email protected]) is an associate professor of management andMays Research Fellow in the Mays Business School at Texas A&M University. Hereceived his Ph.D. from Indiana University. His research interests include interna-tional strategies, corporate governance in multinational firms, institutional changes,and organizational adaptation in emerging economies.

R. Duane Ireland ([email protected]) is a Distinguished Professor and holdsthe Foreman R. and Ruby S. Bennett Chair in Business in the Mays Business School atTexas A&M University. His research interests include effectively managing organiza-tional resources, strategic entrepreneurship, strategic alliances, and corporate entre-preneurship. He is the current editor of the Academy of Management Journal.

David G. Sirmon ([email protected]) is an assistant professor of managementin the Mays Business School at Texas A&M University. He received his Ph.D. from theW. P. Carey School of Business at Arizona State University and has served on thefaculty at Clemson University. Resource management, family business, and strategicentrepreneurship are current research interests.


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