Company Law Reform in a Post-'Doing Business' World

Some days ago, the World Bank discontinued the Doing Business (DB) report. For nearly twenty years, the DB’s annual report was one of the main drivers of business law reform worldwide, and a top data provider for empirical studies in the field. Although recurrent criticism of its methodology and growing concern for data irregularities omened the DB’s demise, its actual consummation creates a vacuum in the comparative analysis of business law. A pressing question that the DB propagated and now leaves unanswered is: how (if at all) may company law promote entrepreneurship?

My recent paper, ‘Simplified Corporations and Entrepreneurship’, published in the Journal of Corporate Law Studies, directly addresses this question. Based on a critical review of the DB’s legacy, the paper proposes an alternative approach to design and evaluate company law incentives to entrepreneurship, and uses it to examine simplified corporations, one of the most radical of such incentives of the past two decades.

The Legacy of the Doing Business in Company Law

The DB’s ‘Starting a Business’ index, a dominant component of the annual report, ranked countries based on the costs, time, and procedures required to register a limited liability company. The underlying rationale is that, for most entrepreneurs, those requirements operate as a barrier to formally enter the market. Hence, countries with less ‘regulation of entry’ were placed at the top of the ranking. In tandem, the DB collected and published data on the annual number of newly registered companies per country, under its ‘Entrepreneurship Database’. These data were first used by World Bank’s researchers to explore the extent to which less ‘red tape’ regulation may lead to more new operating firms (here a list of papers), and subsequently became one of the most widely used datasets in cross-country empirical research on entrepreneurship (eg, Global Innovation Index).

The DB’s user-friendly framework and the persuasiveness of its unprecedentedly large database unleashed a global competition to deregulate entry requirements. Since 2005, it reportedly influenced close to 4,000 legal reforms worldwide, many of which were explicitly tailored to improve countries’ ranking. Despite the DB’s success in harmonizing registration requirements, rates of newly registered business remained variant, even by its own measures. This mismatch was an indication that the DB’s assessment of company law and entrepreneurship might have been inadequate. Moreover, it suggested that company law reforms following its formula and empirical studies using its datasets were potentially flawed as well.

To help disentangling this issue, my paper identifies two relevant limitations of the DB. First, the Starting a Business oversimplified account of the quality of the law. The index focused on registration requirements, many of which are context-dependent and, in any case, are not uniformly significant (see, eg, the evidence reported here and here). Hence, reducing the regulation of entry is not per se good company law reform. The second limitation is in how the Entrepreneurship Database measured the annual number of newly registered firms per country. The database does not contain information about all new businesses, but only about those registered as limited liability companies (or the most common legal entity form), operating in the country’s largest city, with at least five employees, a minimum paid-in capital, among other precise characteristics that resemble a mid-sized industrial firm more than a startup, as ironically noted by Dan Awrey in a recent tweet. Thus, the DB’s database on new businesses is unsuitable to account for startup activity or entrepreneurship, let alone measure the impact of company law incentives on them.

An Alternative Approach to Develop Company Law Incentives

My recent paper proposes an alternative approach to design and evaluate company law incentives to entrepreneurship, reassessing both shortcomings. First, instead of focusing on procedural requirements as the main drivers of firm formation, I suggest considering substantive aspects of the law that might influence the behavior of entrepreneurs, such as limits on single ownership or on the issue of classes of shares. Second, rather than taking a static and quite restricted bundle of criteria of what counts as a ‘new business’, I suggest considering all new registrations and assess how changes in the characteristics and rights granted by various legal entities might influence entrepreneurs’ choices. In other words, broadening the scope of what could be ‘good company law’ and ‘new business’, to evaluate how substantive reforms may impact entrepreneurs’ behavior across time.

Following this approach, I examined simplified corporations (SCs), legal forms specifically tailored to stimulate entrepreneurial activity in Chile and Colombia. Introduced in 2007 and 2008, respectively, these new corporate forms not only offered entrepreneurs reduced registration and operation rules, but also single ownership and the ability to issue classes of shares. These two features, which were outside the scope of the DB framework and remain unavailable in many jurisdictions, could improve entrepreneurs’ ability to access external finance. SCs also inspired developments elsewhere, with the Colombian reform even serving as a regional model under the OAS, and an international benchmark for UNCITRAL (see 2014 Yearbook, 539-600). An empirical examination of SC could, thus, shed light on how to design and evaluate company law incentives to entrepreneurship in a post-DB world.

Lessons for a Post-Doing Business World

The study offers three insights on how company law may contribute to entrepreneurship:

• Reducing entry requirements is insufficient to boost firm registrations. The results of differences-in-differences tests show that, despite major deregulation of entry requirements, neither reform increased the overall number of newly registered entities, and, in fact, the Chilean reform had the opposite effect.
• Company law can influence entrepreneurs’ legal entity preferences. An analysis of annual registrations by legal entities reveals that SCs became the preferred mode of incorporation for new entrepreneurs in both countries shortly after their introduction. In Colombia, that effect took only one year.
• Simple legal design matters. In Chile, SCs were introduced through an overreaching and complex law, with inter alia incentives for established businesses and amendments to various regulations. Such complex legal design likely contributed to the short-term decline in new registrations and delayed the law’s impact on entrepreneurs’ choices. In contrast, Colombia dedicated a separate and accessible statute exclusively to its SC, which contributed to directing entrepreneurs toward the new entity quickly.

Overall, the paper corroborates the view that the DB framework, which focused on how procedural requirements influenced the registration of mid-size industrial firms, was inadequate to assess the relationship between company law and entrepreneurship. The reported findings also demonstrate that company law reform can influence entrepreneurs’ preferences, and that simple legal design can accelerate that process.

To conclude, the DB’s official discontinuity is an invitation to reassess the design and evaluation of company law incentives to entrepreneurship. Reforms should not be exclusively about registration requirements but about meaningfully supporting startups’ founders; for example, directing them towards entities that expand their ability to access external finance.

Alvaro Pereira is a Lecturer in Commercial, Corporate, and Banking Law at the University of Leeds School of Law.