American Journal of Industrial and Business Management, 2013, 3, 1-11 Published Online October 2013 (
Institutions and the Regulation of Business—
An International Firm-Level Study of Regulatory
Compliance Costs
Gjalt de Jong*, Roderick Kloeze
University of Groningen, Groningen, The Netherlands.
Email: *
Received August 27th, 2013; revised September 23rd, 2013; accepted September 28th, 2013
Copyright © 2013 Gjalt de Jong, Roderick Kloeze. This is an open access article distributed under the Creative Commons Attribution
License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.
Prior work has established the negative effects of many regulations on business and policy.These negative effects have
been a key driver for many of the so-called better regulation programmes. Despite all efforts, however, deregulation
programmes have had inconclusive results and their success remains the subject of ongoing debate. We suggest that the
public policy efforts have largely overlooked a business perspective of regulation and its institutional determinants. We
argue that the institutional determinants of regulation include the regulation stock, the quality of regulation and the pre-
dictability of regulation application. This study is among the first to examine the impact of these institutional determi-
nants on regulatory compliance costs for firms using a unique dataset from companies in OECD countries. Our results
convincingly support our approach to the study of regulation.
Keywords: Better Regulation; Compliance Costs; Regulation Stock; Regulation Quality; Regulation Predictability;
OECD Countries
1. Introduction
Low economic growth and high levels of national debt
have increased the interest of governments in structural
reforms to boost competitiveness and reduce unemploy-
ment. One aspect that often appears in these discussions
is cutting red tape, that is, limiting the negative conse-
quences of regulation for business. The drive to reduce
red tape actually precedes the current economic difficul-
ties and has received wide attention, especially in Europe
[1]. In the US the passing of the Sarbanes-Oxley Act
following the Enron scandal also sparked interest in the
costs and benefits of government regulation [2,3]. De-
spite all efforts, however, the success of regulation re-
ducing policies is still the subject of ongoing debate. In
this study we delve deeper into the institutional founda-
tions of regulation. We argue that an institutional focus
employinga firm-level perspective is a useful approach to
the policy debate. We add to existing research by demon
strating that from a business perspective, regulation
causes compliance costs due to the institutional setting
within which a company operates: the stock, quality and
predictability of regulation.
Our study focuses on the firm-level compliance costs
of government regulation. Assessing the situation, Weg-
rich [1] and Helm [4] conclude that while the volume of
the regulation research stream is substantial and the theo-
ries on regulation abundant, current conceptualizations
and measures of regulation remain inadequate. Accord-
ingly, the regulation research domain is broad, but it has
not yet reached maturity and there is a need to reexamine
conventional wisdom about regulation. The commonly
held view that regulation constrains entrepreneurship and
limits welfare has induced policymakers to review their
regulatory practices. Today, a reduction in regulatory
requirements is on the policy agenda of almost all Euro-
pean countries and international organizations, which is
exemplified by the growth in so-called “better regulation
programmes” [5]. Despite these programmes, concerns
remain that regulation is still negatively impacting firm
activities significantly and that deregulation programmes
have largely failed [6].
In line with public administration research [7-9], we
suggest that firm-level regulation costs are determined by
the institutional setting: the stock of existing regulations,
*Corresponding author.
Copyright © 2013 SciRes. AJIBM
Institutions and the Regulation of Business—An International Firm-Level Study of Regulatory Compliance Costs
its quality and its predictability. As convincingly argued
in the business literature, managers of private firms form
cognitive maps based on perceived information and
events, which subsequently impact on a firm’s strategic
decisions. We therefore propose that effective policy
measures need to account for firms’ perspective of regu-
lation costs and its institutional determinants. We test our
hypotheses on a large sample of small and medium sized
enterprises from OECD countries [10]. Our research con-
text is relevant because firms in these countries are in-
creasingly exposed to regulation by governments and
international organizations such as the European Union.
The outline of this paper is as follows. We begin by re-
viewing the research that serves as the foundation for our
hypotheses. We discuss definitions, measures and the
consequences of red tape in public administration and
public policy. Next, building on this theoretical back-
ground, we formulate our hypotheses about the institu-
tional drivers of regulatory compliance costs. Then we
introduce this paper’s research methodology, addressing
issues related to our measurement of the variables. Fol-
lowing that, we present our empirical findings. Finally,
we conclude by discussing limitations and offering a
reflection on opportunities for future research.
2. Literature Review
The research tradition in public administration and public
policy offers useful insights for the development of our
hypotheses and the empirical part of our study. Both
adopt the organization as the unit of analysis: the former
focuses on government organizations, while the latter
concentrates on private companies. When reviewing this
literature, at least three conclusions emerge.
First, red tape (i.e., the negative consequences of re-
gulation) is best conceptualized from a firm’s perspective.
Rosenfeld [11] offered one of the first definitions of red
tape as “guidelines, procedures, forms and government
intervention that are perceived as excessive, unwieldy, or
pointless in relationship to decision-making or imple-
mentation of decisions” ([11]: 603). This definition sets
out two oft-repeated important characteristics of red tape:
red tape as excessive regulation and red tape as a percep-
tion or impression. Public administration research has
refined Rosenfeld’s definition following substantial pro-
gress in the empirical study of red tape [12,13]. With
variations, the definitions largely align with Bozeman’s
[7] conceptualization of red tape as “rules, regulations,
and procedures that remain in force and entail a compli-
ance burden for the organization but have no efficacy for
the rules’ functional object” ([7]: 283). Red tape is de-
fined as those rules that serve no purpose at all. It is dif-
ferent from formalization and rules that may have bene-
fits (“white tape”). In a similar vein, we argue that the
cost of government regulation is best analyzed from a
firm’s perspective. This offers a better reflection of the
regulatory constraints faced by companies, as well as the
degree to which these constraints serve no purpose [13].
This aligns with Feeney and Bozeman’s [14] conclusions,
who observe that there is an emerging consensus that red
tape matters for organizations and this affects firm deci-
sions and behavior in complicated ways.
Second, firm-level data collected by means of surveys
permit managers to respond not just to the number of
rules and procedures they face, but also to what degree
they are oppressive or frustrating [8,13]. Business impact
studies have generated various measurements for the
costs of regulation, enabling the study of the antecedents
and consequences of regulation from an international
perspective. For example, the World Bank’s “Doing
Business” indicators investigate the degree and indirect
effects of regulation from a cost accountancy perspective
[2,15,16]. The Standard Cost Method (SCM) quantifies
the total costs of administrative procedures [2]. Djankov
et al. [17] show that the differences in regulation costs
across countries are substantial and that they hamper the
entry of new firms and foreign direct investment. This
research tradition is based on the institutional view,
which argues that economic growth and wealth ultima-
tely depend on a country’s institutional framework [18].
North [19] defines these institutions as the “rules of the
game” and formal regulation make up a large part of the
institutional framework [20].
Third, business impact studies and public administra-
tion research also offer insights for the foundations of red
tape. If red tape does not serve an organizational purpose
and is in effect pointless, then why does red tape exist?
Why do organizations and governments not simply eli-
minate pointless rules and regulations to set the organiza-
tion or the business community free? Bozeman [21] of-
fers an initial explanation as to why red tape exists in the
first place: rules that are viewed as pointless by some
may be treasured by others. Bozeman [21] also distin-
guishes two sources of red tape: “rules born bad” and
“good rules gone bad”. The former result from inade-
quate comprehension, self-aggrandizement and over-con-
trol. The latter come about through rule drift, rule en-
tropy, change in functional object and misapplication.
These explanations all relate to instances where intrinsi-
cally good rules are applied in ways not originally in-
tended or to rules whose meaning is lost over time due to
inertia or a changing environment.
In a similar vein, Bozeman [21] discusses how politi-
cal processes can cause rules to be born bad or go bad,
with special attention to the influence of the US Congress.
One of the causes of red tape is political compromise.
The result of political compromise is often vaguely
worded regulation intended not to inflame important
Copyright © 2013 SciRes. AJIBM
Institutions and the Regulation of Business—An International Firm-Level Study of Regulatory Compliance Costs 3
constituencies or interest groups. It is then left to the bu-
reaucracy to refine the language, often leading to regula-
tion which includes unnecessarily many exceptions and
caveats, and which goes beyond its originally intended
scope. The political process itself also tends to lead to
excessive demand for regulation. Interest groups demand
regulation to protect or enhance their interests. These
groups obtain the benefits of successfully lobbied regula-
tion and, since the costs are borne by the entire popula-
tion, the private benefits they obtain exceed their private
costs [4]. This process causes the level of regulation to
exceed what is socially desirable, and the majority of
firms will view regulation as excessive and thus as red
tape. Finally, excessive regulation is also the result of
risk aversion and patronage. Politicians are generally
blamed for adverse incidents through a failure to prevent
them by means of regulation. They are less often blamed
for unnecessary regulation. The result is that risk-averse
politicians have an incentive to supply excessive levels
of regulation or to require excessive enforcement from
the bureaucracy. Politicians also have an incentive to
supply regulations that benefit groups that are important
during elections. Hence, the political process provides an
institutional setting where there is excessive demand for
and supply of regulation, resulting in increasing “exter-
nal” red tape for private firms and “internal” red tape for
government organizations.
3. Hypotheses
Public administration research and business impact stud-
ies offer three antecedents of rule production that we will
use to explain regulatory compliance costs. The existing
stock of regulation is our first institutional determinant.
This aligns with the observation that the stock of regula-
tion is ever increasing, resulting in ever-increasing legal
requirements and regulation costs for companies to bear.
The design of regulation is our second institutional de-
terminant. The inherent characteristics of the political
process explain the production of regulation that is of
low quality. The result of compromise can be regulation
that is vaguely worded or ambiguous. It is then left to the
bureaucracy to refine and implement such regulation, the
result of which will be regulation with unnecessarily
many exceptions and caveats [4]. The predictability of
the enforcement of regulation is our third institutional
determinant. Regulation aligns with uncertainty, de-
pending on how rules need to be applied by firms. Am-
biguous regulation resulting from political processes
[4,17] can result in different interpretations. As a result,
the application of rules can differ across firms and sec-
3.1. The Existing Stock of Regulation
Various studies following Djankov et al. [17] show that
the costs of administrative procedures can be substantial
[16]. The average number procedural steps needed to
start a business in the sample of Djankov et al. [17] was
10.48, taking at least 47.40 business days. The costs of
these procedures were estimated at an average of 47.08%
of per capita GDP. These costs slow the rate of new
business entry [22]. The existing stock of regulation is a
determinant of compliance costs, as the compliance with
existing rules is a legal requirement on firms. Feeney and
Bozeman [14], in a study of internal red tape, found that
those respondents who felt that the focal organization
had too many rules also perceived higher levels of or-
ganizational and contractual red tape. There are two ex-
planations for this. First, if the number of rules that need
to be complied with is higher, the number of rules felt to
be excessive or obsolete and their share of the overall
population of rules will also be larger. Second, the more
rules a manager needs to comply with, the more likely a
manager will be to consider this to be a frustrating proc-
ess resulting in a general opinion that all rules are point-
less or excessive—rules end up being considered as
causing red tape even when strictly speaking they do not
[13]. Taking the above into account, we formulate our
first hypothesis:
Hypothesis 1 (H1): The larger the existing stock of
regulation, the larger the compliance costs of regulation.
3.2. The Quality of Regulation Design
The second institutional variable in our study concerns
the quality of regulation design. This variable encom-
passes several dimensions of quality, such as the ease of
understanding rules and procedures, whether or not it is
clear which agency to contact and whether the rules are
designed to achieve their objective as effectively as pos-
sible. One of the main criticisms of both the World Bank
and the SCM measurements of the costs of regulation is
that these treat all regulation as inherently negative and
do not account for the design of regulation in the first
place [6,15]. Radaelli [5] argues that “[t]he concept of
quality has now become a fundamental component of
regulatory reform and regulatory management in a large
number of countries” ([5]: 271). Furthermore, DeHart-
Davis [23] found that well-designed rules are less likely
to be considered as “red tape” and more likely as “green”
or “white” tape. Hence, if regulation is well designed, the
firm-level negative effects of regulation will be lower.
Additionally, the discussion of “rules bornbad” [21]
shows that the design of regulation is a key determinant
of red tape. These are all reasons why low-quality regu-
lation increases the company’s costs of regulation. Better
quality should reduce the costs of regulation for various
reasons. First, if rules are easy to understand and it is
clear whoin government to contact about them, the time
spent by business in complying with regulation is re-
Copyright © 2013 SciRes. AJIBM
Institutions and the Regulation of Business—An International Firm-Level Study of Regulatory Compliance Costs
duced. Moreover, rules that are easy to understand re-
duce the inclination to seek and the need for outside legal
expertise. To put it differently: regulation with mediocre
design increases the costs of “transacting” with the gov-
ernment. Since compliance with regulation is a “transac-
tion” that cannot be legally avoided, it raises the costs of
regulation. This leads to the following hypothesis:
Hypothesis 2 (H2): A higher quality of regulation de-
sign lowers the compliance costs of regulation.
3.3. Predictability of Regulation Application
The final institutional variable of our study concerns the
predictability of the application of existing regulation.
Intuitively, if regulation is applied consistently and is
therefore predictable, the costs of regulatory compliance
for a company should be lower. The consistent applica-
tion of regulation means that companies, for example,
will know what forms to complete and how. This reduces
regulatory uncertainty. Lower uncertainty means firms
will be less likely to hire outside expertise in complying
with regulation. Further, the chance of litigation as a re-
sult of not complying with regulation is reduced. Bertelli
and Whitford [24] find that rules to be of better quality in
terms of protecting market mechanisms, if an independ-
ent regulator enforces them. Independent regulators can
apply rules and regulation more consistently and pre-
dictably than regulators who are under political pressure.
Consistency of application enhances the predictability of
enforcement of regulation and is one of the characteris-
tics of green tape identified by DeHart-Davis [23]. As
with regulation quality, the costs of “transacting” with
the government decreases if regulation application and
enforcement is more predictable. Transaction cost eco-
nomics argues that a transaction characterized by high
uncertainty should either be internalized or there should
be unilateral adaptation [25]. By definition, however, a
transaction with a regulatory body cannot be internalized.
Therefore, the increased transaction costs due to incon-
sistent and unpredictable adaptation of regulation have to
be borne by the firm. This leads to the following hy-
Hypothesis 3 (H3): The more predictably that regula-
tion is enforced, the lower the compliance costs of regu-
4.1. Data and Sample
The data used in this study derives from the OECD [10]
study of regulation. The database presents survey-based
information from nearly 8000 small and medium sized
firms in 11 OECD countries. It offers information with
respect to three areas of regulation. The first area is em-
ployment regulation, which includes hiring and firing
employees, complying with health and safety standards,
workers rights, consulting with worker councils or un-
ions, statistical reporting of employment-related data,
administering employment-related or payroll taxes, so-
cial security and pensions, or other mandatory employee
benefits such as maternity leave and sick leave. These
second area is environment regulation, which includes
licenses, permits, planning and environmental impact
assessments; complying with emission/discharge and
hazardous substance requirements, process or product
quality standards, pollution control and product regula-
tions; environmental reporting and testing, record-keep-
ing and day-to-day administrative requirements related to
the environment, such as environmental levies and taxes;
and eco-labelling of products or processes. The third area
is tax regulation, which includes business profits tax/
corporate income tax, other taxes on capital and assets
(e.g. dividend tax, property tax), sales taxes (e.g. VAT,
general sales taxes), and tax deduction requests such as
PAYE income taxes. These areas of regulation cover the
most important national and international business rules
imposed by governments and international organizations.
The focus of the survey was on firms that employ 500
employees or less. The choice of these firms as the unit
of analysis is appropriate for two main reasons. First, it
has been argued that small and medium sized firms are
more exposed to regulation than their larger counterparts.
The performance and strategic decision-making behav-
iour of small and medium sized firms is more sensitive to
regulation than large firms. Second, large firms experi-
ence greater difficulty in responding to a regulation sur-
vey as no single person or department is responsible for
compliance with all regulation to which a large firm is
exposed. Large firms also have international activities,
further complicating the measurement of regulation.
The survey was distributed by mail in 11 OECD coun-
tries: Australia, Austria, Belgium, Finland, Iceland,
Mexico, Norway, New Zealand, Portugal, Spain and
Sweden. Each firm in the sample received a single ques-
tionnaire on either labour, environmental or tax regula-
tion. No single respondent thus provided information on
all areas of regulation. The overall response rate of 40%
was satisfactory, with response rates ranging from a high
of 78% in Australia, to a low of 18% in Mexico and Por-
tugal, respectively. We pooled the firm-level information
in one database and used country dummies to control for
international differences in costs of regulation. This pro-
cedure ensures a sufficient number of observations to
obtain reliable estimates of our hypothesized relation-
4.2. Measurements: Dependent Variable
Our measure of regulation costs aligns with the standard
cost method. The SCM measurement of regulation costs
Copyright © 2013 SciRes. AJIBM
Institutions and the Regulation of Business—An International Firm-Level Study of Regulatory Compliance Costs 5
accounts for different cost components of regulation. The
compliance costs of regulation for a firm are determined
by a) the number of hours spent by staff and management
(“Estimate the number of hours spent in an average month
by staff and management in your business complying with
regulations”), b) expenditure on computers and software
(“Estimate your annual computer or software expenditure
which is principally used to comply with regulations”),
and c) the expenditure on hiring outside expertise (“How
much money does your business spend during an average
month on hiring outside services to comply with re-
gulations”). To obtain yearly estimates and to obtain con-
sistency within the second item, we multiplied the first
and the third items by twelve. Further, in line with the
SCM method, the first item was multiplied by the hourly
labour costs per country (firm-level data for hourly labour
costs was not available). The three different components
of regulatory compliance costs were aggregated in an
overall measurement of regulation costs. We used the
logarithm of these costs to obtain a normally distributed
measurement of our dependent variable.
4.3. Measurements: Independent Variables
We use a composition of two survey items to obtain our
measurement of the existing stock of regulation (see
Djankov et al. [17] for a similar approach). The first item
is a count of the number of government decisions that the
company had to comply with (“During the past year, how
many separate decisions or permits did your business
request from a government to comply with regulations?”).
However, some rules are more complex and thus need
more time and attention to comply with than others. A
single count of regulations would insufficiently account
for differences in complexity per regulation. We therefore
used a second item to correct for this. The second item
measures the degree to which it is feasible to comply fully
with all relevant regulations, despite their number
(“Regardless the number of regulations, is it still feasible
to comply with them fully?”). The first item is a con-
tinuous variable and the responses range between 0 and
300. We multiplied this item by the inverse of the second
item and used the resulting weighted scale as our measure-
ment for the stock of regulation that a firm faces. This
means that the number of rules and procedures in the stock
of regulation will be weighted lower, the more feasible it
is to comply with them.
We use respondents’ evaluation of three statements to
measure the quality of regulatory design: “regulations are
easy to understand”, “regulations achieve their objectives
as simply as possible”, and “regulations are consistent
with one another”. Each was measured on a four-point
Likert scale, with categories ranging from 1 = “agree
fully” to 4 = “disagree fully”. These items directly relate
to Bozeman’s [21] conceptualization of red tape and to
the characteristics of high quality regulation [4,5]. A
factor analysis confirmed the uni-dimensionality of the
three-item scale. The Cronbach’s alpha of 0.71 is above
the threshold value of 0.70 and is therefore satisfactory.
We combined the three items into an overall index of
regulatory design quality.
We used the respondents’ evaluation of the following
five statements to measure the consistency and predict-
ability of regulations, introduced by “thinking about your
contacts with government offices to obtain decisions or
permissions on regulations, to what extent to you agree
or disagree with the following statements”: “officials
give definite answers”, “it is clear who is responsible for
decisions”, “the process for appeals and complaints is
clear”, “decisions are consistent and predictable over
time and among similar businesses”, “additional or un-
expected payments are not required”, and “you get the
same view no matter who you contact”. Each was meas-
ured on a four-point Likert scale, with categories ranging
from 1 = “agree fully” to 4 = “disagree fully”. The items
directly relate to the requirements of consistent regula-
tion [5,15,17]. A factor analysis confirmed the uni-di-
mensionality of the five-item scale. The Cronbach’s al-
pha of 0.72 is above the threshold value of 0.70 and is
therefore satisfactory. We combined the five items into
an overall index of regulation consistency.
4.4. Control Variables
We entered various control variables when we tested the
hypothesized relationships. The first control variable is
the size of the firm. It is known that the compliance cost
of regulation is usually a fixed cost, meaning that the
burden is smaller for a large firm than for a small firm
[2,26]. In fact, it is suggested that compliance costs are
the highest for medium sized firms and the smallest for
very small or very large firms. We therefore include firm
size and the squared term of firm size in our model to
account for the inverted U-shaped relationship between
firm size and compliance cost. The number of employees
measures firm size. The second control variable is the
age of the firm. Compliance costs vary with the age of
the company in its overall lifecycle. Older companies
will have learned how to deal with bureaucratic proce-
dures. They are therefore less likely to bear the negative
effects of regulation and may have developed methods
and procedures to efficiently deal with regulation [9].
The age of the company is measured by an ordinal meas-
ure ranging from 1 to 3, with 1 indicating firms that are
less than two years old, 2 indicating firms between two
and five years old, and 3 firms older than five years old.
The third control variable is a dummy variable that
measures whether or not a foreign company owns the
firm. Foreign ownership could mean that the firm ex-
periences more compliance costs because it has to com-
Copyright © 2013 SciRes. AJIBM
Institutions and the Regulation of Business—An International Firm-Level Study of Regulatory Compliance Costs
Copyright © 2013 SciRes. AJIBM
ply with particular host country regulation that does not
apply to the home country. Fourth, we control for the
company’s sector. Regulation differs across sectors
within a country. Thefirms operate in 16 different sectors.
We added 15 dummy variables to account for sector dif-
ferences. Fifth, the firms offered information for each of
the three main regulation areas (i.e., employment, envi-
ronment and tax regulations). Differences in regulation
areas could exist and firmscouldconsider regulatory com-
pliance costs in certain areas to be higher than in others.
We include regulation area dummies to control for this.
Finally, we include country dummies to control for
country-specific differences in regulation costs that are
not captured by the independent variables in our model.
5. Empirical Results
5.1. Main Findings
Means, standard deviations and correlations are provided
in Table 1. In preparation for the regression analyses, we
performed the usual tests to obtain reliable estimates.
These tests show that non-normality is not an issue. We
tested for possible biases caused by collinearity among
variables by calculating the variance inflation factor (VIF)
for each of the regression coefficients. Calculations of
VIF ranged from a low of 1.1 to a high of 1.5. The VIF
values were well below the cut-off value of 10 [27]. The
pretests indicate that heteroscedasticity might be present
in the data. We therefore estimated our model with ro-
bust standard errors, which is the usual solution for this
[27]. Table 2 presents the regression results.
We ran a two-step hierarchical regression: that is, the
three regulation dimensions were added in Model 2 to
Model 1 with control variables. The dependent variable
is a logarithm of compliance costs so the coefficients
denote percentage changes. The various fit parameters
show that our full model fit the data better. The R2 im-
proves from 47 percent in Model 1 to 49 percent in
Model 2 (F = 92.48 with p < 0.001 and F = 93.23 with p
< 0.001 for Models 1 and 2, respectively). Taken to-
gether, our results offer strong support for two of our
three hypotheses and modest support for the other. Table
2 shows that the existing stock of regulation has a posi-
tive and strongly significant effect on compliance costs
(β = 0.021, with p < 0.001). Hypothesis 1 is thus con-
firmed. The magnitude of the coefficient of the regula-
tion stock variable is also significant. Depending on the
ease of compliance, on average, each extra rule increases
the company’s costs of regulatory compliance by be-
tween 0.53% and 2.1% (if the number of rules and pro-
cedures that a firm has to comply with is not adjusted for
the feasibility of compliance, the results are nearly iden-
tical). The average firm in our sample faces compliance
costs of approximately USD 380,000 per year. One extra
rule increases regulatory compliance costs by approxi-
mately USD 2000 if the ease of compliance is at its
highest level (a score of 4) and by approximately USD
8000 if the ease of compliance is at its lowest level (a
score of 1).
Hypothesis 2, predicting that a higher quality of re-
gulation design will reduce the company’s costs of re-
gulatory compliance, is also confirmed. The coefficient is
strongly significant and the sign is negative, as expected
(β = 0.124 with p < 0.001). The size of the coefficient
also is large, here estimated at 12.4%. The scale of this
variable ranges from 3 to 12: everything else being equal,
the compliance costs of regulation for a firm that faces
the lowest quality of regulation design (a score of 3) is
112 percent higher than that of a firm that faces the
highest quality of regulation design (a score of 12). For
the average firm this means a difference of almost USD
425,000. Hypothesis 3, predicting that a greater predict-
ability of regulation application will lower the compli-
ance costs of regulation, is also confirmed. The coeffi-
cient receives moderate support and is negative, as ex-
pected (β = 0.031 with p < 0.05). The size effect of the
coefficient is somewhat smaller than that of the quality
variable, but at 3.1% it is still substantial. The regulation
predictability variable ranges from 5 to 20; everything
else being equal, the difference in the cost of regulatory
Table 1. Correlations, means and SDs(a).
Mean SD 1 2 3 4 5 6 7 8
Regulation Costs (log) 2.66 8.20 1.000
Regulation Stock 5.02 12.03 0.127 1.000
Regulation Quality 6.37 1.88 0.027 0.143 1.000
Regulation Predictability 11.10 2.70 0.035 0.064 0.473 1.000
Firm Size 67.18 104.63 0.161 0.101 0.011 0.110 1.000
Firm Size Squared 2.87 0.39 0.088 0.068 0.002 0.089 0.898 1.000
Firm Age 2.87 0.39 0.031 0.024 0.054 0.054 0.070 0.035 1.000
Foreign Ownership 0.13 0.33 0.124 0.082 0.031 0.051 0.226 0.142 0.000 1.000
Notes: (a)Paired correlations of the main variables.
Institutions and the Regulation of Business—An International Firm-Level Study of Regulatory Compliance Costs 7
Table 2. The determinants of perceived regulatory compliance costs(a).
Model 1 Model 2
Regulatory Compliance Costs Regulatory Compliance Costs
Regulation Stock 0.021***
Regulation Quality 0.124***
Regulation Predictability 0.031*
Firm Size 0.008*** 0.008***
(0.001) (0.001)
Firm Size Squared 0.000*** 0.000***
(0) (0)
Firm Age 0.133 0.109
(0.084) (0.083)
Foreign Ownership 0.309** 0.284**
(0.104) (0.102)
Constant 11.906*** 13.025***
(0.467) (0.473)
Observations 2990 2990
R-squared 0.47 0.49
Adjusted R-squared 0.46 0.49
F-value 92.48*** 93.23***
Notes: (a)†p < 0.10, *p < 0.05, **p < 0.01, ***p < 0.001. Robust standard errors in parentheses. Sector, regulation area and country dummies are included in the
compliance from the lowest to the highest quality is
46.5%. For the average firm, this means a difference of
almost USD 177,000.
Our results for regulation hold, whilst controlling for a
large number of alternative antecedents that may deter-
mine a company’s compliance costs. With regard to the
control variables, one result is worth mentioning. The
size of the firm (measured by the number of employees)
is a significant predictor of the compliance costs of regu-
lation. Larger firms face higher costs of compliance than
smaller firms. This effect diminishes somewhat as firms
grow larger, but not by much (the coefficient for the
square of number of employees is relatively small). This
aligns with the firms included in this sample, which all
have 500 employees or less. Nonetheless, a non-monotic
relationship between firm size and regulation costs ap-
5.2. Robustness Analysis
We conducted further analyses to assess the robustness
of our results. The results were largely consistent with
the initial results in each of these supplemental analyses.
First, we disaggregated the data in the three different
regulatory areas that are included in our study. These
results support the conclusion that the existing regulation
stockand the quality of regulation design are important
determinants of a company’s compliance costs. However,
the estimated parameter coefficient for regulation pre-
dictability is only significant in the domain of tax regula-
tion. Apparently, unpredictability in the application of
regulation is an important matter of concern for tax
regulation. Intuitively, this makes sense: for many com-
panies, compliance with taxation rules will be of the ut-
most importance, given the penalties involved for not
meeting regulatory requirements in this area. Firms will
be strongly inclined to align with tax regulation. The
unpredictability of application is therefore likely to be a
greater source of concern with regard to taxation, where
unintended violations of rules can have more serious
consequences than in other areas of regulation. Second,
we disaggregated compliance costs into its underlying
cost components. All of our hypotheses were recon-
firmed. We also found that the regulatory structure is
particularly important to the costs of external support,
and less so to ICT expenses. Software or ICT costs are
Copyright © 2013 SciRes. AJIBM
Institutions and the Regulation of Business—An International Firm-Level Study of Regulatory Compliance Costs
usually incidental investments: it is likely that they are
made in response to structural issues rather than in re-
sponse to issues that can change from year to year. Third,
we estimated our models using generalized least squares
(GLS). GLS is another method that corrects for het-
eroskedasticity, by weighting the least squares errors so
that they become homoskedastic [27]. This did not affect
the results at all. Hence, the regression studies and the
robustness analyses are strongly convincing and are con-
sistent with our institutional explanation of regulatory
compliance costs for firms.
6. Recommendations and Limitations
Over time, each country has developed its own coun-
try-specific regulatory infrastructure. This results in sub-
stantial cross-country differences in average compliance
costs for firms. For example, firms in Spain and Portugal
face regulatory compliance costs 240 times as large as
those in New Zealand. Previous research has established
that such differences can explain differentials in national
economic outcomes [22,28]. Large regulatory burdens
and restrictive regulation are among the most important
causes of the economic under-performance and stagna-
tion of Mediterranean economies compared to other
Our study provides evidence in favour of the hypothe-
sis that an increase in the existing stock of regulation
increases the compliance costs of regulation for firms.
The increase in regulatory compliance costs is greatest if
firms consider the regulatory burden to already be so
large that it is no longer feasible to comply with all regu-
lation. However, even when it is feasible to comply with
all regulation, an increase in the number of rules and
procedures faced by firms leads to an increase in com-
pliance costs of about 0.5%. Therefore, all regulation
leads to costs and each new rule or procedure increases
the administrative burden faced by firms. The regulatory
compliance costs identified in this study are substantial
and potentially underestimated. A firm that makes ICT
investments to comply with regulation cannot use these
resources for alternative and perhaps more productive
processes. Employees spending time on meeting regula-
tory requirements cannot perform alternative tasks. Our
results are an indication to policymakers that any rule
they design and implement will involve costs for those
they apply to.
The results with regard to the quality of design are also
robust. Whereas it is debatable whether a large stock of
regulation is beneficial or not, there is less ambiguity
with regard to the quality of regulation. An increase in
the quality of regulation lowers compliance costs and is
of direct benefit to society. The effect is substantial: each
point increase on our scale of regulation quality (ranging
from 3 to 12) decreases the compliance costs of regula-
tion by 10% to 12%. The benefits to society will perhaps
be somewhat smaller than those to individual firms be-
cause the process of drafting high quality regulation can
be long and costly. However, given the fact that low
quality regulation impacts all firms and that the reduction
in costs is large, the net effect is likely to be beneficial.
The robustness tests have shown that the effects of regu-
lation quality are especially strong for ICT investments.
The implication is that an improvement in regulation
quality will free resources that firms can use for alterna-
tive investments, which in turn can have economic bene-
fits for the firm and for the country.
The results with regard to the predictability of regula-
tion application also lead to interesting conclusions. The
results indicate that a reduction in unpredictability leads
to a reduction in the compliance costs of regulation for
firms. The result of a reduction in unpredictability is thus
a gain to business, at the costs of extra legislative re-
sources. On balance, this again is likely to offer net so-
cial gains, albeit with beneficial effects that are smaller
than those of an increase in regulation quality. The bene-
fits firms accrue are approximately 2% to 3% for each
point increase on our regulation predictability scale
(ranging from 5 to 20). We found that the effects of regu-
lation predictability mainly materialize in tax regulation.
A country with high tax regulation compliance costs
should focus on the improvement of regulation applica-
tion in this domain first.
This study advances the public policy literature by us-
ing data to investigate compliance costs at the firm level,
in a cross-country setting. The use of firm-level data is
well established in public administration research for the
study of internal red tape and the effects thereof on or-
ganizational outcomes. Regulation in business impact
studies is generally studied using country-level data on
the number of rules that firms have to comply with (ac-
cording to the official rule book). This study therefore
expands the latter line of research by examining actual
compliance costs and the actual number of rules faced by
firms. Not all firms have to comply with all regulations.
Compliance and enforcement may be spotty, so that the
actual number of rules that need to be complied with
differs from what an analysis of existing legislation
would suggest. Previous country studies implicitly as-
sume that regulation is the same for all firms in a given
country. The data used here show wide variations in
regulation costs within countries as well as between
This study adds two qualitative dimensions to the
regulation debate: namely, regulation quality and regula-
tion application predictability. These are not included, at
least not explicitly, in previous work on regulation [15].
The present study considers regulation as a multi-dimen-
sional concept. The results show that our dimensions
Copyright © 2013 SciRes. AJIBM
Institutions and the Regulation of Business—An International Firm-Level Study of Regulatory Compliance Costs 9
have a significant and substantial impact on the compli-
ance costs faced by firms. Ignoring such factors will thus
misinform the policymakers who design measures aimed
at reducing the costs of regulation.
6.1. Policy Recommendations and Managerial
This study has implications for policymakers and man-
agers. The first implication follows directly from the ob-
servation that quality and predictability are determinants
of the costs of compliance for companies in addition to
the stock of regulation. Policymakers who want to reduce
regulation costs for firms are advised to primarily con-
sider the design and application of the rules they imple-
ment, for two reasons. First, policymakers who introduce
new regulation should be aware that even well-intended
regulations with social benefits can result in high costs
for firms. New regulations can result in a net social loss
if they are poorly designed or inadequately applied. Fur-
ther, new rules are often created in response to incidents.
Policymakers anticipating incidents with new regulation,
often only consider the benefits of these new rules inas-
much as they prevent the recurrence of the initial incident.
Regulation is often implemented following incidents that
never recur. In such cases, the costs of regulation easily
exceed the envisioned benefits. The Sarbanes-Oxley Act
is an example of such a case. Our results are therefore an
appeal to abstain from incident politics. The design of
regulation in incident situations is likely to be of poor
quality due to the short time horizons of policymakers in
such situations. Incident politics will also result in ad hoc
regulation without a coherent view of all the regulation
already imposed upon firms.
Second, for those policymakers seeking to reduce the
compliance costs for firms of existing regulation, the
return on political capital is likely to be higher in terms
of improving regulation quality or regulation predictabil-
ity than of reducing the stock of regulation. As Kaufman
[29] has argued: “[O]ne person’s red tape may be an-
other’s treasured safeguard” ([29]: 4). Every rule or pro-
cedure that is removed will meet opposition from one
constituency or another. Improvements in quality and
predictability will be largely uncontroversial. A policy-
maker with limited time and resources can therefore have
a greater impact on compliance costs for firms by im-
proving quality and predictability rather than by remov-
ing rules from the stock of regulation.
For managers, the implications in part parallel those
for policymakers. The efforts to influence policymakers
could focus on improving regulation quality and regula-
tion predictability alongside and in addition to regular
lobbying activity to reduce or prevent new regulation.
The implications for managers also mirror those of poli-
cymakers in the design and application of internal bu-
reaucracy. Our study focuses on regulatory compliance
costs. The constituent parts of this external red tape
(regulation costs, stock, quality and predictability) can
also apply to internal red tape with similar causal rela-
tionships. Finally, our results show that the costs of
regulation vary between countries, resulting in different
rates of return of foreign direct investment. Our results
also indicate that foreign firms face higher compliance
costs of regulation than domestic firms. These compli-
ance costs of regulation for foreign firms directly con-
tribute to the so-called liabilities of foreignness. For
managers making foreign direct investment decisions, the
compliance costs of regulation should be an important
criterion in choosing a new host country.
6.2. Limitations and Future Research
Regulation studies have their limitations and our study is
no exception. These limitations offer opportunities for
future research. A first limitation concerns our measure-
ment of bureaucracy by means of regulatory compliance
costs. As Bozeman [7] has argued, bureaucracy and regu-
lation detail are distinct concepts and should not be con-
fused. Our data does not enable the measurement of
“net” effects of regulation: an ideal measure of “net”
effects of regulation would account for all the costs and
benefits of regulation, ultimately measuring only the
regulation that is meaningless and unnecessary. Future
research could replicate this study using measurements
that account for the compliance costs of pointless or use-
less rules. Another limitation of our empirical study con-
cerns country coverage. The sample is relatively large for
a questionnaire-based study of regulation. The observa-
tions include countries ranging from Southern Europe
and Latin America to Scandinavia and more An-
glo-Saxon regions. Nonetheless, we do not know if our
results and conclusions also hold for non-OECD coun-
tries. Future research could replicate our study with data
from Asian countries or for countries with weak institu-
tional infrastructures such as Russia. The final limitation
of our empirical study is the cross-sectional nature of the
database. A panel dataset would enable longitudinal
analyses and in so doing, the study of whether regulatory
compliance costs and their institutional determinants
vary over time.
New data collection would also enable the study of
other institutional determinants of compliance costs, such
as the accountability of the agencies responsible for
regulation, the degree of regulation enforcement and the
speed of regulation introduction. For example, if govern-
ment agencies were accountable for regulation produc-
tion or regulation enforcement, this would improve both
regulation quality and regulation predictability, reducing
Copyright © 2013 SciRes. AJIBM
Institutions and the Regulation of Business—An International Firm-Level Study of Regulatory Compliance Costs
the regulatory compliance costs for firms. Stronger re-
gulation enforcement will increase regulatory compliance
costs because firms will ensure that they comply with all
the regulations they face. The speed at which proposed
regulation is introduced could reduce regulatory compli-
ance costs because regulation uncertainty for firms would
thereby be reduced, preventing unnecessary investments
in ICT or external expertise required to anticipate am-
biguous regulation situations. Another avenue for future
research concerns the costs of compliance due to industry
standards (such as ISO certification) or self-regulation. A
study of these compliance costs could be valuable for
two reasons. First, self-regulation often substitutes for
national regulation, potentially reducing the overall re-
gulatory compliance costs for firms. Second, the deter-
minants and effects of industry standards or self-regu-
lation can differ from government regulation.
7. Conclusion
In conclusion, regulation dominates world business and a
thorough understanding of its determinants remains cen-
tral to public administration and policy research. With
the above limitations acknowledged, we are confident
that this study makes an important contribution to this
line of research by shedding light on the murky world of
the institutional regulatory environment, and adding to
our understanding of how the relationships between the
various dimensions of the regulatory environment and
compliance costs vary.
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