The effect of informal competition on registered firms’ credit constraints: Global evidence, channels, and the roles of productivity and financial development

This paper contributes to the literature on the effects of informal firms on the operations of registered firms at three levels. First, we provide the first global evidence on the causal effect of competition from informal firms – referred to as informal competition – on the credit constraints faced by registered firms. Using a large firm-level dataset from the World Bank Enterprise Surveys, covering 145 countries and over 141,000 observations, and employing the instrumental variable method to address the endogeneity of informal competition, we find that registered firms competing against informal firms are significantly more likely to be credit-constrained than those that do not. This result holds after controlling for economic development, financial development, economic conditions, and the institutional environment across different countries, regardless of firm size and sector, and it remains robust across a variety of robustness tests. Evidence from Sub-Saharan Africa and Latin America and the Caribbean indicates that the effect of informal competition is stronger in these regions than in the rest of the world. Second, we show that the impact of informal competition diminishes with higher financial development and firm productivity. Third, we demonstrate that self-financing capacity, capacity utilization, and informal payments are key channels through which informal competition exacerbates credit constraints for registered firms.