Institutions, entrepreneurial adaptation, and the legal form of the organization

Abstract

PurposeThis paper aims to examine how economic freedom impacts the initial choice of legal structure for startup firms. The authors do this by first exploring whether economic freedom is an essential determinant of the initial legal form of organization (LFO). The authors then explore the impact of economic freedom on firms' choice of changing their initial legal structure over time and how this change impacts their survival rate.Design/methodology/approachThe authors employ a multinomial logistic regression model to measure the initial determinants of LFO by utilizing an eight-year panel data set of 4,928 startups in the USA through the Kauffman firm survey and merge it with the Economic Freedom in North American index from the Fraser Institute. The authors then employ a logistic regression model to examine the determinants facilitating a change in legal structure over time.FindingsThe results show that economic freedom is a significant determinant in the choice of legal structure. The findings also report that the majority of startups do not change their legal form, but of those that do change the legal structure show a higher survival rate.Research limitations/implicationsMajor limitations are the size of the data and the nature of somewhat limited economic freedom differences with the USA. More nuanced measures of economic freedom would be highly desirable.Practical implicationsPolicymakers should take note that limited red tape, smoothly working labor markets and straightforward processes for changes of legal structures of organizations would improve survival and growth odds for entrepreneurs.Originality/valueDrawing on the theory of institutions, the authors attempt to bridge a gap in the literature by explicitly analyzing the determinants of the legal structure in startups in light of economic freedom. Institutional factors do not work in isolation; therefore, the authors also employ traditional entrepreneur-specific variables that affect the choice of legal structure in addition to the institutional framework.

The role of culture and government adaptability in determining countries‘ economic performance

“…Moreover, government adaptability depends on how other formal institutions, such as economic freedom, function. This is in line with other studies that found that economic freedom is a significant determinant in the choice of a legal structure (Khurana et al, 2020).…”

New model for making resilient decisions in an uncertain context: The rational resilience-based decision-making model (R2DM)

“…One of the main causes of startups and new small businesses failing is the inability to pivot (McCarthy, 2017). The entrepreneur has a problem over whether to stick with the previously chosen strategy or alter it and even adopt a new strategy, if required, in the case of any unexpected change (Khurana et al, 2020). Adaptation involves a level of flexibility, which can be defined as the ability to change easily according to the situation (George-Weinstein, 2020).…”

Revealing and Mitigating Racial Bias and Discrimination in Financial Services

“…Thus, choosing a more sophisticated and complex legal structure is an important strategic decision for the firm because it helps define its maturity (Chawla et al 2007), in addition to other factors such as age (years in business) and size (sales, employees, etc.) (Khurana et al 2021). Another challenge for a sole proprietorship is that lenders are more concerned about the business's legitimacy related to its size, such that smallness undermines the ability to secure loans; notably, sole proprietorships are often very small, with few (if any) employees (Cassar 2004).…”