What is the institutional theory of entrepreneurship?
Institutional theory is about conforming to the rules of the game to gain legitimacy in an institutionalized environment (North, 1991; Scott, 2001; 2005). The rules of the game may be formal, informal, or taken-for-granted assumptions about the nature of the business environment. Institutions set forth expectations that economic actors seek to conform to in order to be treated as legitimate actors in economic society.
Entrepreneurs that do not heed the institutional logic of their social contexts risk failure because they may be seen as illegitimate and unworthy of support. This is related to the “liability of newness“, where risk of exit or failure is higher in the earlier years of an organization. When young organizations lack legitimacy, they may not receive the vital support of their stakeholders.
The main hypothesis of the theory may be that: Culturally varying social forces shape entrepreneurial success more than does economic efficiency, therefore, entrepreneurs should seek to align their strategies with the norms and regulations of their host societies’ institutions.
See Bruton, Ahlstrom and Li (2010) for a nice review that inspired me here.
Institutional factors affecting entrepreneurs are numerous, including government policies that support or detract entrepreneurs (e.g., fiscal and regulatory barriers, antitrust laws, and property rights), but also more informal social attitudes toward entrepreneurship as a career choice. For instance, in countries where entrepreneurs need to bribe to get ahead, the career choice may be viewed as less attractive than engineering or medicine. Perhaps institutional voids left by inadequate government structures and support for contracts may be filled by informal arrangements, such as close social ties with government officials. However, these ties may be prohibitively expensive to maintain and assuage, forming another barrier to entrepreneurship.
Legitimacy is less important for incumbents because of their past performance. Formal governmental regulations can also be prohibitively expensive, for instance, if the time taken to get a new business approved is too long or if too many permits are needed from too many government departments.
Bruton, G. D., Ahlstrom, D., and Li, H. L. (2010). Institutional theory and entrepreneurship: where are we now and where do we need to move in the future? Entrepreneurship theory and practice, 34(3), 421-440.