PESTLE Analysis

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Rethinking the Impact of Regulation on Small Businesses John Kitching

Kingston University

Introduction: Regulation as a Business and Policy ‘Problem’

For more than 30 years, regulation has been perceived as an important problem for policy-

makers in the UK, Europe, USA and beyond. Laws governing employment, health and

safety, and the environment have attracted the opprobrium of business owners and their

representative organisations, politicians and the media. Policy-makers have sought to

develop regulatory policies that minimise the burdens such laws impose on business,

particularly small firms, while ensuring fair, competitive markets and safeguarding

employees, consumers and the environment.

Academic interest has both followed practitioner and policy concern, and to some extent,

perpetuated it. International organisations frequently report on the issue of regulation.

The World Bank issues an annual ranking of virtually all nations with regard to the ease of

doing business, which is largely a commentary on each country’s regulatory framework and

the support it lends to business (World Bank 2014). OECD has developed an index for

assessing national approaches to employment regulation (OECD 2013). The World

Economic Forum Competitiveness report issues country rankings with regard to the burden

of government regulation and many other features of the regulatory environment, for

instance, property rights, intellectual property protection and the efficiency of the legal

framework in settling disputes and in challenging regulations (World Economic Forum

2014).

A large number of cross-national surveys have investigated the links between regulation and

macro-level indices such as business start-up rates (e.g. Djankov et al. 2002; Urbano and

Alvarez 2014) These surveys conventionally take some index of regulatory quantity/quality

provided by the World Bank, Heritage Foundation or similar organisation and correlate it

with measures of start-up. Typically, although not universally, studies find negative

relationships between regulation and macro-level outcomes. Such studies implicitly assume

that regulation impacts individual firms in an homogenous way or are unable to specify the

mechanisms through which regulation produces particular effects at the micro-level.

The eight papers included in this VSI reflect the substantial interest in regulatory issues and

their impacts on small businesses. This brief introduction sets the scene for the papers, all

published previously in ISBJ, by summarising their principal arguments and framing them in

terms of larger framework for thinking about not only how regulation impacts businesses

but also how it shapes wider market processes.

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Compliance Costs – and Benefits?

Studies have conventionally focused on business owner experiences of regulation-handling

and the presumed costs of compliance. Surveys of business owners commonly identify

regulation as a major obstacle to growth or success (BIS 2013). More sophisticated studies

estimate the costs of compliance and make the important point that smaller enterprises find

it more costly or difficult to comply with regulations because they are unable to spread the

costs across a wider base. As small firms typically lack market power, or possess the

resources to withstand serious cost or demand shocks, the compliance costs of regulation

are often perceived as imposing an opportunity cost on resource-constrained small firms,

diverting their limited resources, time and energy to the ‘unproductive’ task of meeting

statutory requirements. Policy-makers have responded by looking to reduce the

administrative burden of regulation in a variety of ways.

Chittenden et al. (2005) review the literature on the compliance costs incurred by small

firms in relation to tax regulation in four countries – UK, USA, Australia and New Zealand.

This paper does two things. One, it identifies the costs of complying with regulation as

important burdens to which small firms are disproportionately exposed; and, two, it

recognises the difficulties of developing accurate and convincing measures that are

comparable across international borders. The disproportionate costs borne by small firms

relative to large companies is confirmed for all four countries. Lack of understanding of

regulatory requirements, frequent change and high fixed costs were evident in all four

jurisdictions. Although compliance costs are widely regarded as important, there is no

consensus regarding the extent of such costs for conceptual and methodological reasons.

Differences in the definition of compliance costs, and variations in methods used to

calculate them, the time periods covered and variable data quality mean that it is difficult to

compare the results of different studies across international borders.

Two studies examine the same regulation from the vantage point of businesses in two

different industry sectors. The National Minimum Wage (NMW) was introduced in the UK in

1999 amid a flurry of claims by critics that it would lead to serious unemployment among

low-paid groups and push businesses relying low-paid labour out of the market. Supporters,

in contrast, insisted that it might lead to business benefits as firms streamlined and

formalised operations. Druker et al. (2005) investigate the effects of the introduction and

first uprating of the NMW on hairdressing businesses; in particular, the authors consider

whether the NMW constituted a ‘regulatory shock’, influencing organisational change. They

found that the advent of the NMW did not act as a shock, encouraging firms either to adopt

a more formalised approach to employment or to move ‘downmarket’, with greater

pressure on employees or on family members associated with the business. The NMW was

one factor among many impacting on the way in which salon owners evaluated and

positioned their business. Distinct types of employer response were identified, indicating

that regulation generates a variety of impacts on firms, including non-compliance; much

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depends on existing practices, the precise demands made by specific regulations and wider

market conditions. The authors conclude that employer responses can be best understood

as reflections of existing management strategy and practices rather than a trigger to adopt

new approaches.

Morris et al. (2005) explore the consequences of minimum wage legislation for training and

other non-pay benefits on small businesses in the UK equestrian sector. Contrary to

the conventional wisdom regarding the negative effects of minimum wages on smaller

firms, a sizeable proportion of respondents were favourably inclined to such measures,

particularly the more successful firms. Some employers offset the cost of increased wage

bills arising from the NMW through readjustment of their compensation packages, and

specifically a curtailment of benefits in kind, either prior to or post the NMW, although the

financial impact on these firms was not significant. The debate concerning the impact of

regulation on small firms has tended to focus on issues such as employment, health and

safety and environmental law. Eierle (2008) extends the scope of research into regulatory

issues by focusing on statutory financial reporting requirements by investigating the

statutory financial reporting obligations of small firms (GmbHs) in Austria. This article

analyses small firm compliance with statutory filing requirements and their take-up of filing

concessions and revealed preferences for filing options. Take-up of filing concessions differs

strongly between small and medium-sized GmbHs, suggesting that some medium-sized

GmbHs expect net benefits from voluntary disclosures, whereas small GmbHs tend to value

the costs arising from voluntary disclosures more highly than the benefits associated with

them.

Prior studies treat regulation principally as a static and negative influence, thereby

neglecting the full range of regulatory effects on business performance. Regulation

generates contradictory effects, in part, directly through small firm responses to the

regulations that place obligations on them and indirectly, via the responses of the various

stakeholders with whom small firms interact and whose actions affect them. Stakeholders

are a diverse group of market and non-market agents and organisations including suppliers,

customers, competitors, infrastructure providers and regulatory authorities. These

stakeholders are also regulated entities whose behaviour is moulded by the legislative rules

to which they are subject.

Expanding our Conception of Regulatory Impacts

Kitching et al. (2013a) propose a broader framework within which to study the dynamic,

multi-stranded influence of regulation on small business activity and performance. This

approach situates small firms at the centre of network of stakeholder relationships, all of

whom are regulated entities – including suppliers, customers, competitors, infrastructure

providers and regulatory authorities. From the standpoint of any individual business,

regulation produces effects directly and indirectly. Direct effects flow from small

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firms' adaptations to the regulatory requirements to which they are subject, and indirectly

via the influence regulation exerts through small firms’ relationships with the stakeholders

with whom they interact. There is no uniform ‘small business effect’; it depends on how

small firms and their stakeholders choose to adapt their behaviour to the regulatory

framework. Rather than treat regulation as imposing uniform constraints on businesses,

variable effects of regulation are to be expected. Regulation enables business to act as well

as constrains their activity and performance, generating contradictory effects. For instance,

those firms best placed to cope with new consumer protection laws might find it easier to

find and retain customers. Similarly, regulation providing stronger protection for investors

and creditors might better support capital markets and facilitate the supply of finance to

small firms.

Carpentier and Surat (2012) examine the effects of securities market regulations in Canada

on new venture seeking to list. These rules prohibit certain kinds of venture from listing;

they may be permissive or stringent. The authors argue that the quality of firms, their post-

listing operating performance and strategy, and their fate largely support the opinion that

strong listing requirements are essential to prevent the emergence of a ‘lemon market’.

Such a market would likely impact adversely on well-resourced, listed firms because

investors are unable to distinguish higher- and lower-quality businesses and, in

consequence, withdraw from the market, reducing investment and impeding economic

development. In short, by imposing stricter regulations on listing, limiting entry by poorer-

quality firms, regulators might be better able to support the market by encouraging

investors to invest. Such regulations thereby affect firms directly, by permitting or denying

listing, and indirectly by encouraging or discouraging investment.

Cook et al. (2012) investigate UK regulation governing bankruptcy and its impacts on small

companies. An effective bankruptcy regime, the authors aver, should facilitate the speedy

reallocation of resources tied up in SMEs that are not viable, while at the same time

facilitating the rehabilitation and recovery of SMEs that are viable but experiencing

temporary financial difficulties. Getting the balance right hinges on the ability to

discriminate between firms that ought to be liquidated and those that can be rehabilitated.

The authors explore how one aspect of the regime, the Company Voluntary

Arrangement procedure, impacts companies deemed viable and unviable. The authors claim

the procedure allows the problems of bankrupt SMEs to be addressed, resulting in good

rates of business survival, and orderly liquidation in those cases where the firm cannot be

saved. Thus CVAs can help to avoid failure or, if not, mitigate its effects. The key point is

that the regulatory framework impacts the survival of small firms. This, in turn,

facilitates the preservation of employment and debt recovery by creditors. This helps to

avoid a ‘domino effect’ where the failure of one firm can lead to the failure of its suppliers.

This powerfully illustrates the myriad ways in which regulation generates a range of effects

for distressed firms and for the creditors and employees they interact with.

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Drawing on interview and survey data from a study of preparers and users of small company

abbreviated accounts, Kitching et al. (2013b) develop the conceptualisation of regulation as

a dynamic force generating contradictory consequences. Specifically, the paper specifies

the mechanisms through which regulation influences performance directly and indirectly.

Filing abbreviated accounts enables small company preparers to retain a high degree of

confidentiality over the financial information they are required to disclose publicly while, at

the same time, influencing a diverse range of accounts users and stakeholders. These

include credit reference agencies, customers and trade creditors whose decisions to provide

or withhold vital resources such as credit ratings, credit and new business opportunities may

be influenced by the decisions to file abbreviated accounts - all of which impact the

preparer’s activity and performance. All of these are effects of regulation governing

statutory financial disclosure. Business owners may or may not be aware of the indirect

effects of regulation.

Together these eight studies expand our knowledge of the impact of regulation on small

business activity and performance by illustrating the diversity of regulation impacting upon

small businesses and the range of effects it can generate. Future studies should seek to add

to developing further our understanding of the multiple, diverse ways regulation impacts

small firms and the effects of small firms’ adaptations on other stakeholders.

References

Carpentier, C. and Suret, J-M. 2012. Entrepreneurial equity financing and

securities regulation: An empirical analysis. International Small Business Journal 30, 1, 41-64.

Chittenden, F., Kauser, S. and Poutziouris, P. 2005. Tax regulation and small business in the

USA, UK, Australia and New Zealand. International Small Business Journal 21, 1, 93-115.

Cook, G., Pandit, N., and Milman, D. 2012. A resource-based analysis of bankruptcy law,

SMEs and corporate recovery. International Small Business Journal 30, 3, 275-293.

Department for Business, Innovation and Skills (BIS) (2013b) Small Business Survey 2012:

SME Employers, online at:

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/193555/b

is-13-p74-small-business-survey-2012-sme-employers.pdf

Djankov. S., La Porta, R., Lopez-de-Silanes, F. and Shleifer, A. 2002. The regulation of entry.

Quarterly Journal of Economics 117(1): 1-37.

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Druker, J., White, G. and Stanworth, C. 2005. Coping with wage regulation: implementing

the national minimum wage in hairdressing businesses. International Small Business Journal

23, 1, 5-25.

Eierle, B. 2008. Filing practice of small and medium-sized companies: Empirical findings from

Austria. International Small Business Journal 26, 4, 491-528.

Kitching, J., Hart, M. and Wilson, N. 2013. Burden or benefit? Regulation as a dynamic

influence on small business performance. International Small Business Journal, published

online, July 4.

Kitching, J., Kašperová, E. and Collis, J. 2013. The contradictory consequences of regulation:

The influence of filing abbreviated accounts on UK small company performance.

International Small Business Journal, published online, October 10.

Morris, D., Collier, T. and Wood, G. 2005. Effects of minimum wage legislation: Some

evidence from small enterprises in the UK. International Small Business Journal 23, 2, 191-

209.

OECD. 2013. Protecting jobs, enhancing flexibility: A new look at employment protection

legislation. In: OECD Employment Outlook 2013. OECD Publishing: Paris.

Urbano, D. and Alvarez, C. 2014. Institutional dimensions and entrepreneurial activity: an

international study. Small Business Economics 42, 4, 703-716.

World Bank (2014) Doing Business 2015: Going Beyond Efficiency, online at:

http://www.doingbusiness.org/reports/global-reports/doing-business-2015

World Economic Forum (2014) The Global Competitiveness Report 2014-2015, online at:

http://www3.weforum.org/docs/WEF_GlobalCompetitivenessReport_2014-15.pdf