How aspirations interact to influence informal firms’ decision to formalize

Abstract

Whether to formalize or not is a key decision for informal firms. We explore behavioral antecedents of this decision, arguing it is subject to financial and legitimacy aspirations of informal firms. Drawing on the institutional and behavioral theory of the firm literatures, we suggest that informal firms’ under (over) performance on financial and legitimacy aspirations are both independently and jointly associated with risk-seeking (risk-avoiding) behavior. We explore these effects through conducting three experimental vignette studies in a cluster informal firms in Ghana. The findings indicate that informal firms formalize when financial performance and perceived legitimacy is above aspiration level, yet do not do so when financial performance and perceived legitimacy is below aspiration. We also find that perceived legitimacy relative to aspiration positively moderates the effect of financial performance on informal firms’ decision to formalize.