Organized Crime and Its Effect on New Businesses

Boarded-up restaurant seen from street
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Organized crime is social problem in many parts of the world, including both developing and developed countries. It has thrived under globalization and continues to impact people’s lives, draining economies and governments of resources. In our study in Journal of Management, my co-author Stav Fainshmidt and I considered how organized crime might affect strategic decisions for new ventures. We wanted to understand how new businesses in particular might be influenced by prevalent organized crime because they are among the smallest and most fragile organizations.

When organized crime is common in a country, it means that extortion is widely practiced. Criminals engage in extortion rackets wherein they repeatedly demand money, property, or favors from people, particularly business owners. Because the business costs of extortion are significant, it makes sense that business owners would want to avoid these costs. Our findings using a sample of over 8,000 entrepreneurs operating in 39 different countries show that when organized crime is prevalent, entrepreneurs are more likely to choose not to register their business with legal authorities. Rather, they prefer to operate in the shadows of the gray market so that they are harder for criminals to find and extort. This is particularly true for entrepreneurs who are sole owners of the business and those who lack other options for employment because their lack of resources makes them easy targets. However, firms that sell novel products or services as well those that have more foreign sales are more resilient to extortion and therefore more likely to be legally registered even if organized crime is prevalent because these types of firms are harder or riskier for criminals to extort.

Our study highlights extortion as a unique institutional pressure that should be considered alongside other types of institutions, such as laws, regulations, and cultural norms. However, it is distinct from these because it is a “shadow institution,” or one that is common but not widely accepted. Because organized crime uses violence to reinforce extortion, people are forced to bow to the pressure even though they may disagree with the practice of paying criminals. Such shadow institutions may be common and important determinants of organizational decisions, but management scholars have not explored their influence very much.

In a time when many governments around the world are trying to boost formalization of their economies so that more people register their businesses and pay taxes, it is important to consider the influence of organized crime. Programs or changes to policies that encourage the legal registration of business will likely be less effective if organized crime creates a sense of fear in business owners. Governments should therefore try to reduce the influence of organized crime if they want their policies promoting formalization to be successful.

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Mark R. Mallon

Mark R. Mallon is an assistant professor in the Department of Management at the University of North Carolina Greensboro.

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