Why it Matters
Why does formal business registration matter?
In the 115 economies covered by both Doing Business and the World Bank’s Entrepreneurship Database, an estimated 2 million limited liability companies were newly registered in 2016 alone. Data from 2012 show that if these economies had followed best practice, their local entrepreneurs would have saved 45.4 million days spent in satisfying bureaucratic requirements. This valuable time could have been better employed focusing on firm growth, productive activities and innovative endeavors.
Small- and medium-sized enterprises thus continue to startup and operate under sub-optimal conditions in economies around the world. Entry barriers constitute one of the early constraints that aspiring entrepreneurs encounter while attempting to access the formal economy. Where the rules are excessively burdensome, resource-constrained entrepreneurs might not have the opportunity to turn their ideas into a business within a level-playing field. As a result, making it difficult to start a business may prevent the economy and its private-sector from reaping the benefits of business formalization.
Among those advantages, registered companies can benefit from legal and financial services provided by courts and commercial banks, services not available to unregistered businesses. Their employees benefit from social security protections. And the economy benefits from positive spillovers: where formal entrepreneurship is higher, job creation and economic growth also tend to be higher. Moreover, as more businesses formalize, the tax base expands, enabling the government to spend on productivity-enhancing areas and pursue other social and economic policy objectives.
A growing body of empirical research has explored the links between business entry regulation and social and economic outcomes. Where formal entrepreneurship is higher, job creation and economic growth also tend to be higher (1). Evidence suggests that regulatory reforms making it easier to start a formal business are associated with increases in the number of newly registered firms and with higher levels of employment and productivity. Conversely, excessively cumbersome regulation of startup is associated with higher levels of corruption and informality (2) (3). Using data collected from company registries in 100 economies over 8 years, analysis found that a simple business start-up process is critical for fostering formal entrepreneurship (4). Cumbersome regulations and administrative procedures for starting a business are found to be associated with a smaller number of legally registered firms, greater informality (a finding particularly relevant for many developing economies), a smaller tax base and more opportunities for corruption (5).
A recent study finds that barriers to starting a business are significantly and negatively correlated with business density, calculated as the total number of businesses registered as a percentage of the economically active population (ages 15–64) that year. For example, the fewer the procedures required to start a business, the greater the number of registered firms. There is also a significant relationship between the cost of starting a business (as a percentage of gross national income, or GNI) and business density. For every 10 percentage point decrease in entry costs, density increases by about 1 percentage point (6).
Regulatory reforms can have an impressive impact when they tackle the right bottleneck. After a reform simplifying business registration in different municipalities at different points in time across Mexico, a study found that the number of registered businesses increased by 5% and employment by 2.8% (7).
The legal form under which a company is registered also matters. Limited liability companies—the type of company that Doing Business focuses on—limit the financial liability of company owners to their investments, giving entrepreneurs more freedom to innovate because their personal assets are not put at risk. Sole proprietorships do not provide this kind of protection but can usually be set up with fewer procedures and at a lower cost (8).
1. Fritsch, Michael, and Florian Noseleit. 2013. “Investigating the Anatomy of the Employment Effect of New Business Formation.” Cambridge Journal of Economics 37 (2): 349–77.
2. Klapper, Leora and Inessa Love. 2011. “The Impact of Business Environment Reforms on New Firm Registration.” Policy Research Working Paper 5493, World Bank, Washington, DC.
3. Motta, Marialisa, Ana Maria Oviedo and Massimiliano Santini. 2010. “An Open Door for Firms: The Impact of Business Entry Reforms.” Viewpoint 323, World Bank Group, Washington, DC. https://www.wbginvestmentclimate.org/uploads/323-Business-entry-reforms.pdf.
4. Klapper, Leora, Anat Lewin and Juan Manuel Quesada Delgado. 2009. "The Impact of the Business Environment on the Business Creation Process." Policy Research Working Paper 4937, World Bank, Washington, DC.
5. Audretsch, David, Max Keilbach and Erik Lehmann. 2006. Entrepreneurship and Economic Growth. New York: Oxford University Press.
6. Klapper, Leora, Raphael Amit and Mauro Guillen. 2010. "Entrepreneurship and Firm Formation across Countries." In International Differences in Entrepreneurship, ed. Joshua Lerner and Antoinette Shoar. Chicago: University of Chicago Press.
7. Bruhn, Miriam. 2008. "License to Sell: The Effect of Business Registration Reform on Entrepreneurial Activity in Mexico." Policy Research Working Paper 4538, World Bank, Washington, DC.
8. According to a survey conducted by Doing Business in 2011 covering 183 economies, the process of establishing a sole proprietorship requires fewer procedures and is cheaper than establishing a limited liability company in over 90% of economies.