Many people believe that corruption, or the abuse of public power or authority for private benefit, cripples business activities. But what are exactly the underlying mechanisms explaining the relationship between corruption and business activities? Does corruption harm start-ups and established businesses equally? We answer such questions in this post by digging into the entrepreneurship research.
Studies like Estrin et al., published in Journal of Business Venturing in 2013, suggest that corruption has a more detrimental effects on entrepreneurs than on established businesses. Estrin et al. suggest that in a corrupt environment, authorities realize private benefits at the cost of some businesses (often to be small young ventures), institutionalizing corruption and leading to consistent expectations about it. Thus, imposes high costs, like taxes, on aspiring entrepreneurs since they still normally have very limited business experience and contacts.
Corruption negatively influences the rewards for innovation and entrepreneurship in a country and makes it less likely to appropriate the return of a novel successful idea by the entrepreneur. This is mainly due to the fact that in a corrupt environment, it would be very difficult to protect your (intellectual) property rights.
So, corruption does not only impose costs like a tax, it also works like a progressive tax that has a more detrimental effects on fast growing and innovative entrepreneurs.
However, the situation for established (and large) firms are totally different. Established firms have survived the corrupt environment for several years and have adapted behavior to the corresponding informal norms to limit the negative impacts of corrupt practices. Such firms have developed contacts and social networks to mitigate the effects of corruption and, perhaps, turn it to their advantage. In fact, such connections can help established firms to, for example, make entry to the market difficult and costly for entrants. Hence, established firms know the “rules of the game” better than young businesses and have the possibility to, in fact, benefit from corruption as they have made already their connections with government officials.
In addition, corruption and institutionalized trust are closely linked. Corruption usually involves the type of behavior that violates (or weakens) the trust assigned to public officials and undermines the foundations of interpersonal trust. For entrepreneurs, with limited experience with institutions, the ability to rely on indirect contacts is essential for success and growth of a new venture. In the absence of institutional trust, inter-personal trust, as an alternative to institutional trust, is economically inferior since it does not expand the target market, and subsequently the future size, of the venture.
What are implications of these findings for start-ups? First, entrepreneurs are disadvantaged to compete with incumbents in a corrupt environment. If you are an entrepreneur and thinking to start a business, you better start in a less corrupt environment if you have the option. Second, if entrepreneurs have no other option than starting in a corrupt environment, it would be best if they try to quickly make their connections with officials to protect themselves. You may argue that this type of behavior is not “productive” and you are right. But we should be realistic as establishing such connections and perhaps acts like bribery is part of “rules of the game” and it is hard to change such rules as individual entrepreneurs.
Third, be aware that if you are an innovative entrepreneur, corruption influences your business much more than if you are just an imitator. In this case or a similar case where you as an international entrepreneur try to enter a corrupt market like Brazil, Egypt or Turkey, have a partner or adviser who have connections in the government or know the unwritten rules. This helps a lot.