Effects of formal institutions on business performance in the Philippines: An exploratory

study
Author(s): Banjo Roxas, Doren Chadee and Emilia Pacoy
Source: South East Asia Research, Vol. 21, No. 1 (MARCH 2013), pp. 27-40
Published by: Sage Publications, Ltd.
Stable URL: http://www.jstor.org/stable/23752585
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 Effects of formal institutions on business
performance in the Philippines
An exploratory study

Banjo Roxas, Doren Chadee and Emilia Pacoy

Abstract: The resilience of Asian firms in the face of the current economic
downturn in North America and Western Europe is attracting renewed atten
tion to the role of government in sustaining firm competitiveness. The paper
adds to this debate by drawing from institutional theory to assess the impacts
of selected formal government institutions on business performance in the
Philippines. Based on a large-scale survey (n = 658) of business owners in the
Philippines undertaken by the World Bank, the study finds that access to fi
nance, the rule of law and regulatory quality contribute significantly to business
performance. The policy implications of the findings are fully discussed, along
with avenues for future research.

Keywords: business performance; role of government; institutional theory;

Philippines

Author details: Dr Banjo Roxas (corresponding author) is a Lecturer and Dr Doren

Chadee is Professor of Management in the School of Management and Marketing,
Deakin University, 221 Burwood Highway, Burwood 3125, Victoria, Australia. E
mail: banjo.roxas@deakin.edu.au; doren.chadee@deakin.edu.au. Dr Emilia Pacoy
is Associate Professor in Public Administration and Chair of the Undergraduate
and Postgraduate Public Administration Programmes, College of Governance, Busi
ness and Economics, University of Southeastern Philippines, Inigo St, Barrio Obrero
8000, Davao City, Philippines. E-mail: emiusep@yahoo.com.

The recent economic downturn in much of the world's advanced industrialized

economies has attracted renewed interest in the role of government in sustaining
the competitiveness of domestic firms. Although active government involvement
in the private sector can be controversial (Wade, 1990), it is widely acknowledged
that government intervention to correct market imperfections or to create markets
where they do not exist is beneficial and results in positive welfare gains (Kumar
and Chadee, 2002). One area where government intervention can have positive
effects is in exercising its monopolistic regulatory power in ensuring that the for
mal institutional environment in which businesses operate is conducive to growth.
The institutional environment has been found to be a critical element of firm be
haviour and performance (Peng et al, 2008). Institutions, defined as 'humanly
devised constraints that shape human interactions', can potentially reduce uncer
tainty in economic transactions by establishing an efficient, predictable and stable
structure to exchange (North, 1991). Institutional theory posits that institutions
permeate the socioeconomic and political environment within a nation and play a
significant role in economic productivity and development (North, 1991; Peng et
al, 2008; Peng, 2003; Ahn and York, 2009).

South East Asia Research, 21, 1, pp 27-40 doi: 10.5367/sear.2013.0138

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28 South East Asia Research

Institutions determine the 'rules of the game' and their associated enforcem
characteristics that offer incentives and set constraints to economic players (N
1992, 2005; Peng et al, 2008). Organizations such as government agencies
nesses and other forms of collective bodies are considered the 'players o
game' governed by a wide range of formal and informal institutions. Forma
tutions include the rule of law, government policies, the regulatory framewo
businesses, legal or judicial systems and legislative ordinances. Informal ins
tions include norms of behaviour, unwritten rules, codes of conduct and conventi
observed by a group of people or society (North, 1992). The quality and effe
ness of institutions have also been found to vary greatly across countries. Fir
many developing countries often operate in an environment where institutio
either underdeveloped or do not exist at all. And yet recent experience show
many firms from developing countries can grow against all odds to become
nant global players in their respective industries. How firms in developing countr
develop and grow in an institutional environment which is different from
which exists in advanced industrialized countries remains poorly understood, d
their growing importance.
The main aim of this research is to assess the effects of three forms of formal
institutions on business performance in the Philippines. By doing so, the study
contributes to the debate on institution-business performance linkage in three
distinct ways. First, while there is a plethora of studies about the importance of
institutions, little is known about the nature and extent of their effects on busi
ness behaviour and performance (Ahn and York, 2009; Liu et al, 2011; Manolova
et al, 2008), particularly in the context of developing countries where institu
tions are either underdeveloped or do not exist at all. The vast majority of research
on the role of government in relation to business performance tends to focus on
the experience of large firms from advanced industrialized countries. By con
trast, there is little research on business performance in developing countries
where firms are technologically underdeveloped and small by Western stand
ards. Most are family-owned, have highly centralized structures and concentrate
on light manufacturing involving unsophisticated technology. Most operate in
an external environment that has become more competitive and volatile, and they
depend on an abundant supply of cheap unskilled labour as their main source of
competitiveness. Second, we explicitly distinguish between the effects of three
formal institutions on business performance: namely the rule of law, regulatory
quality and access to finance. These three formal institutions have previously
been identified as being critical for business development and growth (Chaudhry
and Garner, 2007; Kaufmann et al, 2006; Lopez-Claros et al, 2007; La Porta et
al, 1999; Fogel et al, 2006). Third, the particular focus on business-level research
in the Philippines provides valuable insights into the behaviour and perform
ance of businesses in this emerging economy where business research remains
scant.

The rest of the paper is organized as follows. The next section provid
overview of the institutional environment in the Philippines. This is follow
a discussion of the theoretical and conceptual basis of the study. The resea
methods and data are then presented, followed by the data analysis and disc
of the results. The last part of the paper contains the conclusions and limita
and offers avenues for future research.

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 Business performance in the Philippines 29

Institutional environment in the Philippines: overview

The Philippines has been undergoing dramatic reforms in governance since the
fall of the Marcos dictatorship in 1986 as part of the large-scale rebuilding of
democratic institutions (Abinales, 2010; Quimpo, 2009; Briones, 2009; Chen, 2008).
Major reforms were focused on restoring the independence of the judiciary, hold
ing free and honest national and local elections, empowering the legislature and
transforming the executive branch towards effective delivery of basic services to
the citizenry (Crouzille et al, 2011; Legaspi, 2006; Quimpo, 2009). However, the
country continues to suffer from political crises in which mob rule disguised as
mass displays of public indignation, civil disobedience, military coups, revolu
tion and scandal-ridden elections have become popular and legitimate machineries
to shift corruption-laden government power from one political dynasty to another.
The result is a weak and dysfunctional formal institutional environment that is
driven by the political convenience of the ruling elite (Dressel, 2011). It is hardly
surprising that the Philippines, tagged as the 'sick man of Asia' (Nye, 2011) re
mains a laggard in economic growth relative to other South East Asian countries
such as Malaysia, Thailand and Indonesia, whose economic development during
the 1950s and 60s pales in comparison with the socioeconomic and democratic
achievements of the Philippines.
Despite recent claims of gains in economic productivity, as indicated by gross
domestic product (GDP) growth rates of 6.1% in 2001 to 10% in 2010, the pov
erty incidence rate in the country in 2009 was 26.5%, a slight increase from the
2003 poverty incidence rate of 24.9% (NSCB, 2012). This rate suggests that ap
proximately 24 million people out of the total population of 92 million were living
below the poverty line (that is, living on less than US$1.50/day). In 2010, the
unemployment rate was 7.2% (approximately five million people), while the un
deremployment rate was 19.7% (approximately 13 million) (NSCB, 2012).
Institutional theory (North, 2005) suggests that these socioeconomic issues can
be fundamentally explained by the nature and quality of the formal institutions
that are in place.
International barometers on the nature and quality of institutions in the Philip
pines such as the Global Competitiveness Report (IMD, 2011), Corruption
Perception Index (Transparency International, 2010), Doing Business Report (World
Bank, 2010) and Human Development Index (UNDP, 2010) have noted the weak
nesses of the country's formal institutional environment that undermine
socioeconomic growth and development. Corruption, inefficient government bu
reaucracy, poor infrastructure and regressive economic policies remain the hallmarks
of the country's formal institutional environment. Table 1 demonstrates the eco
nomic performance and formal institutions in the Philippines relative to its South
East Asian neighbours. The table shows that among the four countries, the Philip
pines has the lowest per capita GDP, but has the highest incidence of unemployment
and poverty. The Philippines also performed poorly across various indicators of
institutional quality such as corruption, regulatory quality and ease of doing busi
ness.

The comparison of key indicators on the state of the Philippi

important questions about the quality of the formal institution
the extent to which it is conducive to business growth. The Ph

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30 South East Asia Research

Table 1. Stylized facts: the Philippines, Malaysia, Thailand and Indonesia.

Socioeconomic and institutional indicators Malaysia Thailand Indonesia Philippines

Population (million) 29 67 248 103

Population growth rate 1.54 0.54 1.04% 1.87
GDP per capita (PPP) (US$) 15,600 9,700 4,700 4,100
Growth in per capita GDP (%) 5.2 0.1 6.4 3.7

People below poverty line (%) 3.8 8.1 13.33 26.5

Unemployment rate (%) 3.1 0.7 6.7 7.2

Composition of GDP:
Agriculture 12 13 15 12
Manufacturing 40 34 46 33
Services 48 53 39 54
Human Development Index (2011): 187 countries 61st 103rd 124th 112th
Global Corruption Index (2011): 182 countries 60th 80th 100th 129th
Economic Freedom Index (2011): 179 countries 53rd 60th 115th 107 th

Global Competitiveness Index (2012): 142 countries

Institutions:
(a) Property rights 28th 108th 84th 105 th
(b) Intellectual property protection 31st 92nd 62nd 102nd
(c) Bribery 43rd 79th 103rd 119th
(d) Judicial independence 43rd 55th 76th 102nd
(e) Burden of government regulation 8th 45th 44th 126th
(f) Business cost of crime and violence 63rd 79th 114th 112th
(g) Organized crime 54th 73rd 109th 102nd

Ease of doing business (2012): 183 economies 18th 129th 129th 136th
(a) Starting a business 50th 78th 155th 158th
(b) Obtaining electricity 59th 9th 161st 54th
(c) Registering property 59th 28th 99th 117th
(d) Paying taxes 41st 100th 131st 136th
(e) Trading across borders 29th 17th 39th 51st
(0 Enforcing contracts 31st 24th 156th 112th

Sources: The World Factbook, CIA (2012); Transparency International (2012), Doing Business
Report, World Bank (2012); Heritage Foundation (2012); Human Development Report, UNDP
(2011); NSCB (2012).

recover from the devastation of an infamous dictatorial regime. This regime, fol
lowed by a series of fragile, weak and popularity-driven democratic governments,
left an incredibly vibrant and seemingly enduring legacy of institutionalized cor
ruption, nepotism, crony capitalism and patronage-based governance that survives
on the politics of pakikisama (that is, maintaining smooth interpersonal relations
to a fault) with business oligarchies (Chen, 2008; Hedman, 2001; Hodder, 2000;
Kang, 2002; Quimpo, 2009). While there have been well publicized government
efforts to improve the state of the institutional environment over the last 10 years,
the Philippines remains one of those developing countries that is struggling to
save its economy from institutional decay and a rapid decline in national competi
tiveness (Briones, 2009; Quimpo, 2009; IMD, 2011, WEF, 2010).

Theoretical and conceptual model

Contemporary institutional theory (Peng and Heath, 1996; Peng etal, 2008, 2009)
argues that the primary role of formal institutions is to reduce uncertainty (Peng,
2010). Businesses in developing or emerging economies often face a multitude of
risks associated with political instability, social unrest, excessive government control

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 Business performance in the Philippines 31

Formal institutions
Firm performance
• Rule of law
• Sales growth
• Regulatory quality
• Access to finance

Control variables

• Firm size

• Firm age
• Industry sector
• Location

Figure 1. Formal institutions and firm performance: a conceptual model.

of business ownership, interference in business operations and tr

These socio-political risks increase the degree of economic unce
can severely impact on business performance due to increased
The lack of protection and enforcement of proprietary rights m
prohibit activities related to innovation (Peng, 2010; Fogel et al
This study advances the view that formal institutions can red
and transaction costs by setting the 'rules of the game' in the form
and their enforcement by prosecuting misconduct and establis
system of seeking redress (North, 1992, 2005). For the purpose
formal institutions refer to the roles of government in upholding t
setting and implementing a sound regulatory framework for bu
viding the financial infrastructure that is supportive of the dev
business sector (Aidis, 2005; Busenitz et al, 2000; Fogel et al, 20
Peters, 1999; Prasad, 2003). The effects of the three formal inst
ness performance are shown in Figure 1.
Formal government institutions, such as the rule of law, regula
business support systems, support the full functioning of the
whereby no economic player enjoys undue privileges or disadva
2001). Studies have shown that entrepreneurship thrives in suc
environment (Manolova et al, 2008; Nkya, 2003; North, 2005; Shane, 2003;
Tambunan, 2007). Firms are likely to perform better if the formal institutions in
the wider environment create and maintain a level playing field for efficient mar
ket exchanges where rights and duly earned privileges held by firms are secured
and protected (Vatn, 2005). Government programmes and other forms of assist
ance to small business (business support) are also viewed as a critical institutional
support for firms, given their scarce and limited resources. The three formal insti
tutions form part of the overall governance system that builds and nurtures investor
confidence, business development and entrepreneurial undertakings (Kaufmann
et al, 2006). The three institutions are also intertwined such that a weak rule of
law brought about by political instability creates opportunities for corruption, which

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32 South East Asia Research

weakens the country's regulatory quality and undermines investor confide

business sector development (Kaufmann et al, 2006).

Rule of law
The rule of law determines the extent of protection and enforcement of the legal
rights of the local populace, including corporate entities such as business firms
(Fogel et al, 2006; Ahn and York, 2009). A place with a strong rule of law is
defined as having sound political institutions, a strong court system and provi
sions for orderly succession of power, as well as citizens who are willing to accept
the established institutions and to make and implement laws and adjudicate in
disputes (Oxley and Yeung, 2001). Rule of law promotes and sustains peace and
order. Peace and order, safety and security are basic elements in creating and
nurturing a productive community. The rule of law underscores the protection of
property rights and reduction of financial, monetary and fiscal instability, which
Hausmann et al (2005) argue to be critical elements in sustaining private invest
ment and entrepreneurship. Hence we propose the following hypothesis:

HI: A strong rule of law contributes positively to business growth.

Regulatory quality
Regulatory quality shapes the bureaucratic rigidities that firms face as they deal
with government agencies, such as when applying for business permits or licences
(Norton, 1998). Regulatory quality refers to the degree to which compliance with
the existing laws, rules and other government regulatory procedures does not impose
an unreasonable burden on business firms (Fogel etal, 2006; Geiger and Hoffman,
1998; Gnyawali and Fogel, 1994). Bureaucratic inefficiencies increase the unnec
essary costs incurred by businesses in government-business exchanges. These
costs include direct financial costs as well as the time and effort spent in the com
pletion of these transactions. The entrepreneurial endeavours of firms can be well
supported by the government through the quality of its regulatory system when it
does not impose burdensome financial (for example, excessive fees) and non
financial (for example, time and effort) costs on businesses as they comply with
the legal requirements to start and operate a business. Thus, we propose:

H2: An efficient regulatory system contributes positively to business growth.

Financial institutions

A well developed financial and institutional framework that provides businesses

with easy access to capital at competitive rates has been found to be a critical
element of firm competitiveness in developing countries where financial institu
tions are underdeveloped (Kumar and Chadee, 2002; Busenitz etal, 2000; Crouzille
et al, 2011; Tambunan, 2007). The financial environment in many developing
countries remains highly regulated and distorted due to a lack of competition among
banks and non-banking institutions. As a result, the cost of borrowing for busi
ness purposes is generally high. Furthermore, many firms in developing countries
tend to be small, family-owned and poorly capitalized, which makes them ineligi
ble for business loans due to a lack of sufficient equity. For these reasons, many
small businesses tend to rely on limited borrowing from family and friends to
expand their businesses (Kumar and Chadee, 2002). Previous studies have high

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 Business performance in the Philippines 33

lighted a strong association between a lack of access to finance as a business

constraint and the slow growth of output (Ayyagari et al, 2010; Crouzille et al,
2011; Beck etal, 2005). Thus, the government can intervene in the capital market
to stimulate competition and improve the overall financial institutional environ
ment in order to provide firms with easy access to capital on a competitive basis.
Hence we propose:
H3: A competitive financial and institutional environment contributes posi
tively to business growth.

Sample, data and measurement

The study uses data from the 2009 survey of business firms conducted in the Phil
ippines by the Enterprise Surveys Unit (ESU) of the World Bank (World Bank,
2010). The ESU conducts regular firm-level surveys in approximately 125 develop
ing countries with the main aim of developing reliable data sets on business behaviour
and performance for developing countries. The ESU survey covers a broad range of
business-related topics, including the institutional environment in which businesses
operate (World Bank, 2010). The ESU surveys are usually administered via face-to
face interviews with business owners and senior executives in order to ensure higher
rates of survey participation, integrity and confidence in the quality of data, along
with the confidentiality of survey participants. The survey uses stratified random
sampling based on firm size (5-19 employees = small; 20-99 employees = medium;
and 100 or more employees = large firm), business sector (manufacturing and serv
ice) and geographical regions within each country. This data source is considered
reliable and has been widely used by other researchers in recent years (for example,
Amin, 2009; Kaplan, 2009; Hope et al, 2011).
The current study uses the latest data from the country survey of the Philippines
conducted in 2009. The sample consisted of 1,326 firms from four major regional
locations in the Philippines. Following data extraction for the main variables con
sidered in this research, a total of 658 firms were retained for the purposes of

Table 2. Profile of firms from ESU survey (n = 658).

Firm characteristics / %

Firm size:
Small (5 to 19) 335 51
Medium (20 to 99) 236 36
Large 100+ 87 13
Sector:
Manufacturing 421 64
Services 237 36
Firm location:
National Capital Region & Manila 299 45
Central Luzon 109 17
Calabarzon 135 21
Metro Cebu 115 17
Firm age:
Less than 6 years 59 9
6-20 years 329 50
21-50 years 197 30
Over 50 years 73 11

Source: ESU 2009 survey/World Bank, 2010.

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34 South East Asia Research

analysis. The smaller final sample size is due to the large number of missing
for the variables under consideration. The information in Table 2, which summ
rizes some of the key characteristics of the sample used in this research, s
that the majority of firms in the sample were small to medium-sized manuf
ing businesses (70%), with more than half being located in the National Cap
Region (NCR). The majority of businesses in the sample were fairly well es
lished.

Measurement

Dependent variable
The dependent variable, business performance, was measured by sales growt
widely accepted and commonly used measure of firm performance (Geiger a
Hoffman, 1998; Liu et al, 2011). The growth of sales for a business captures
performance against its own sales targets, which are usually set relative to t
industry's performance and reflect the long-term prospects of the business (B
et al, 2000). Sales growth is also a term that is easily understood by mana
across firms, regardless of size and industry. In the survey, participants were a
to provide information on their actual sales for the previous three consecut
years. The study uses the average change in sales growth over the three-yea
riod as an indication of business performance and categorizes firms into thr
groups: (1) decreased sales; (2) no change; and (3) increased sales. Thus,
dependent variable is categorical.

Independent variables
In the survey, participants were asked to rate the extent to which a number
items relating to the rule of law and regulatory quality acted as constraints
their businesses to grow. Both items were rated on a five-point Likert-type s
Rule of law is a composite score of three items describing the country's poli
instability, corruption and courts of law. Regulatory quality is a composite
of three items describing the tax rates, tax administration and business licens
or permits. Access to finance is a single item requiring participants to indicate
extent to which access to various financial resources such as bank loans and
ernment financial packages affected their performance.
Principal component analysis with Varimax rotation was performed to pur
the multi-item measures representing rule of law and regulatory quality. Th
sults showed that the three items representing rule of law and the three it
representing regulatory quality loaded highly on their respective components.
two components have acceptable levels of internal consistency, as indicated b
Cronbach a values of 0.89 and 0.91 for the constructs rule of law and regula
quality respectively, suggesting that the measures used in the analysis are rel
and valid.

Control variables

In the analysis we also include four main control variables to account for varia
tions in business performance due to size (number of employees), age (number of
years in business), location (NCR/Manila, Central Luzon, Calabarzon and Metro
Cebu) and sector (manufacturing/service). The 2009 ESU/World Bank survey

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 Business performance in the Philippines 35

categorizes its survey sample according to five regional locations, with Manila as
a separate category from the NCR. Due to the small sample of firms from Manila
(N < 50 firms), Manila and the NCR were combined into one location category,
which was deemed to be acceptable for the purposes of this study, given that the
NCR and Manila have well developed institutions. However, the results of pre
liminary analysis using ANOVA show that firms in NCR/Manila significantly
differ from firms in other regions in terms of their performance. We therefore use
a dichotomized variable for location (NCR/Manila and others) in the subsequent
analysis.

Methods and analysis

In order to test the three hypotheses (H1-H3) of the study, we use partial least
squares (PLS) regression aided by WarpPLS v.3 (Kock, 2011). The PLS approach
to regression is a variance-based path analysis that has the capability to deal with
complex models with violations of assumptions of multivariate analysis such as
multicollinearity and non-normal data distribution (Kock, 2011). WarpPLS has
the capability to perform PLS path analysis for formative latent variables, to de
tect both linear and non-linear relationships, transform variables with dichotomous
response scales and deal with single-item variables (Kock, 2011).
Table 3, which shows the mean, standard deviation and correlation coefficients
of the major variables in the study, indicates that the three formal institutions -
rule of law (RL), regulatory quality (RQ) and financial institution (FIN) - are all
significantly correlated with sales growth. As expected, the correlation coeffi
cients also indicate moderate correlation among the three institutional variables.
Interestingly, the negative correlation between size and performance suggests that
smaller firms perform better than larger ones. The relationship between firm age
and performance is not statistically significant.
The PLS regression model (Figure 2) shows acceptable model-data fit, as indi
cated by the significant goodness-of-fit indicators, average path coefficient and
average R-squared. The results show that all three institutional variables have the
expected signs and are also statistically significant in explaining sales growth.
Access to finance has the strongest effects (P = 0.16) on firm performance, fol
lowed by rule of law (P = 0.11) and regulatory quality (P = 0.10). The three formal
institutions along with the control variables account for 13% of the variations in
firm performance.
The results also confirm that smaller firms that are located in the NCR/Manila
region perform better than others, while no statistically significant differences

Table 3. Correlation matrix.

Variables used Mean SD SG RL RQ FIN FS FA

Sales growth 2.29

(SG) 0.80 1
Rule of law (RL) 2.14 0.95 0.24*" 1
Regulatory quality (RQ) 2.55 0.45 0.23*** 0.64*** 1
Access to finance (FIN) 2.70 0.88 0.23*" 0.29*** 0.36*** 1
Firm size (FS) 21.17 85.52 -0.03** 0.04 0.07" 0.09" 1
Firm age (FA) 17.25 10.20 -0.01 -0.08" -0.09 -0.03 0.06** 1

Note: SD = standard deviation; *"p < 0.01; "p < 0.05; "p <0.10.

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36 South East Asia Research

Performance ]
r2 = 0.13 J

P = 0.09*" / \P = 001

Location \
(NCR v Sector

others) J \ J
Figure 2. PLS regression results.
Note: Goodness-of-fit measures: average path coefficient (APC) = 0.08 ; average /?-squared
(ARS) = 0.13""; average variance inflation factor (AV1R) = 1.416, good if < 5.
""Significant at p < 0.01; ""Significant at p < 0.05; "Significant at p < 0.10

exist between young and old firms and between firms in the manufacturing a
service sectors.

Conclusion, limitations and implications for future research

The main findings of the study underscore one of the central tenets of institutional
theory (North, 2005; Peng et al, 2009), namely that the institutional environment
is a major determinant of private enterprise growth and development. Conversely,
weak, dysfunctional, unpredictable and unreliable formal institutions that typify
the business environments in many developing economies like the Philippines
can undermine the productive and entrepreneurial activities of business enter
prises. The findings of the current study, which support the main hypothesis posited
early on, offer empirical evidence that in the context of a developing country,
institutions matter in relation to the performance of the business sector.
Several interesting findings emerge from this research. First, access to finance
is shown to have the largest effect on firm performance. To the extent that the
majority of firms in most countries are small and medium-sized (more than 70%
in our sample), an interesting public policy issue arises relating to how the finan
cial institutional environment can be improved to enhance firm performance. Small
firms are particularly vulnerable to the lack of finance for business development
and growth (Ayyagari et al, 2010; Beck et al, 2005). Improving access to a wider
range of formal financial institutions that provide capital at competitive rates to
businesses is likely to improve business performance significantly.
The presence of a strong rule of law and an efficient regulatory framework are
also considered critical elements of a reliable and predictable formal institutional
environment that provides an enabling environment for business enterprise to flour
ish. Although the Philippine government has been undertaking significant policy
reforms over the last 20 years to improve the quality of governance and delivery

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 Business performance in the Philippines 37

of public service in all layers of the government (Thomson, 2010), negative per
ceptions about the rule of law and the business regulatory framework continue to
undermine the growth and development of the private sector. The extant literature
underscores the importance of rule of law as a basic prerequisite in levelling the
playing field for productive economic activities (North, 1991; Peng, 2010). The
quality of regulatory framework determines the monetary and non-monetary com
pliance costs that the business sector must bear as companies set up and operate
amidst a wide range of governmental constraints (Beck et al, 2005; Zhang and
Thomas, 2009). The findings of this research confirm that these two types of
formal institutions have profound effects on businesses performance.

Limitations

As with any research, this study has several limitations and therefore the findings
should be interpreted with caution. First, the study takes a limited approach to
capturing the multifaceted and multidimensional nature of formal institutions,
despite its use and application of three important facets to firm-level analysis.
Second, the study did not take into account the active role of the sample firms in
shaping their institutional environment. North (1990) suggests that economic players
are not necessarily passive subjects of the 'rules of the games'. When equipped
with adequate strength, economic players have the capacity to challenge and for
cibly change the features of institutions, including the regulatory framework,
economic policies and business development and support programmes. The highly
politicized nature of government administration in the Philippines makes the sys
tem largely malleable to satisfying the demands and interests of powerful clusters
of actors. The two-way interaction between institutions and economic players
like business firms provides an interesting avenue for future investigation.
Third, the measurement of the three formal institutions was based on managerial
perceptions of the effects of institutions on business performance. Although the use
of perceptual measures is widely accepted in the literature, based on the overarching
view that it is the perceived rather than the objective external environment that is acted
upon by the strategic decision makers of firms, the study recognizes that it may be
valuable to examine some objective measures of formal institutions.
Fourth, the study did not measure the extent to which regional differences in
the institutional environment affect business performance, due to the availability
of data. The scope of the present research was limited to highly aggregated re
gional data, which uncovered slight regional differences. However, the Philippines
has a decentralized system of government with a high degree of devolution of
responsibilities to local government units. For instance, the regulatory framework
for business in a Philippine city consists of regulations imposed by both local and
city government such as the local business bureau, and national government agencies
such as the Department of Trade and Industry or the Bureau of Internal Revenue.
For this reason, it will be more informative for future research to investigate how
institutions at the local government level affect business performance. Such analyses
are more likely to provide valuable input into the design of public policies for
regional or local business development.
Fifth, the measure of business performance was limited to sales growth, largely due
to the availability of consistent performance data from the ESU survey. Sales growth
provides at best a narrow view of business performance. Future research may con

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38 South East Asia Research

sider assessing broader sets of performance variables, including commonly

objective measures such as return on assets and return on investment, or perc
strategic measures such as overall business growth relative to the industry av
A final limitation of the study relates to its specific focus on formal institu
only. It is well known that formal institutions operate alongside informal in
tions. Because formal and informal institutions lie on a continuum (North, 1
their functions, operations and effects on macro- and micro-economic phe
ena are likely to overlap, contradict, reinforce or substitute one for the othe
study's focus on a specific set of formal institutions fails to take into accoun
possible confounding impact of informal institutions such as cultural norms
tices, business norms and industry-based practices. For instance, the infam
cultural attribute of pakikisama as well as utang na loob, or debt of gratitud
cultural norms that influence personal and business relations. Complex soci
lationships that thrive on reciprocal expectations highlight both business-to-busin
and business-to-politics relationships (Hodder, 2000). How utang na loob
informal institution intersects with the practices of granting and returning favo
bribery, red tape and corruption is beyond the scope of the current study
represents an interesting avenue for future research.
The current study highlights the importance of institutions in understan
how and why formal institutions matter to the performance of firms in the con
of a developing economy in South East Asia. The institutional environment
fines the business environment of firms and determines the kind of business
endeavours that are deemed acceptable and worthy of institutional support. The
findings confirm the critical role of government in providing an institutional en
vironment that is conducive to business development and growth. The findings
provide strong empirical support for the theory that institution building may be
one of the effective ways of promoting or supporting the vibrant economic growth
and development of the business sector. The findings also provide a strong case
for future regional economic policy to focus on institutional reforms in order to
improve the efficiency of institutions such as rule of law, regulatory quality and
financial environment at the national and local levels.

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