# **I. INTRODUCTION**

Which is more important for businesses’ investment decisions – the magnitude of the regulatory burden placed upon them or the consistency with which regulations are enforced? On the one hand, a large body of work built on Ronald Coase’s (1960) theory of transaction costs suggests that excessive regulation can serve as a barrier to investment. From this perspective, high levels of regulation complicate the ability of firms to enter and exit markets, while also seriously hampering factor allocation of both capital and labor (c.f. Cooper and Haltiwanger 2006, Bentolila and Bertola 1990, Joyanovich 1982, Hopenhayen 1992, Erickson and Pakes 1998). On the other hand, an emerging body of work has pointed to regulatory uncertainty – uncertainty about how regulation will change or be enforced – as a key barrier to investment. This literature builds on the intuition that firms invest based on expected returns, which are discounted as the probability of negative shocks increases net costs (Pindyck 1991, Dixit and Pindyck 1994). Work on regulatory uncertainty argues that a lack of predictability in regulation and its enforcement increases the risks of negative shocks, thus decreasing firms’ incentives to invest.

Thus far, the literatures on regulatory burdens and regulatory uncertainty have remained separate, making it difficult to understand which has a more profound influence on firms’ investment decisions. More problematically, however, much of the literature on regulation has focused on formal, written regulations and institutions. For example, work on regulatory uncertainty has used proxy measures such as the number of antitrust cases brought over time (Bittlingmayer 2001), the number of offices responsible for permitting (Feiock and Jeong 2002), history of passage and repeal of regulation (Fabrizio 2012), retroactive changes in investment regulation (Lyons and Mayo 2005), and survey responses on the anticipated direction of policy (Barrodale 2010; Engau and Hoffmann 2009). Although some work relies on measures that may capture informal institutions ( _c.f._ Beazer 2012), most recent work has simplified uncertainty theoretically by simply looking at “overall uncertainty”, a broad measure that captures many channels, including informal ones, but evades important questions about the sources of uncertainty(c.f. Kang et al. 2014; Baker et al. 2015; Gulen and Ion 2015). This paper attempts to bridge these perspectives by joining a recent group of papers examining regulatory uncertainty arising from informal institutions and practices, which has so far gone underexplored in the literature.

We begin from the premise that a key source of regulatory uncertainty is _the distance between expectations given de jure regulation and de facto practice_ .<sup>_1_</sup> The further the gap between these two, the less certainty firms have regarding applications of the law and the weaker incentives to invest. We then proceed to argue that unpredictable informal practices surrounding regulation are one important, but underexplored, way in which firms’ expectations can differ from practice. In this paper, we focus on the predictability of two types of informal practice: corruption and state-led attacks on private property.

First, we argue that one source of regulatory uncertainty is corruption, which creates a gap between de facto practices and de jure policy that can be bridged with bribes. Existing work has been ambiguous about the relationship between regulatory uncertainty and corruption (c.f. Triesman 2007), since it is empirically unclear if corruption serves as an unexpected cost of business (Mauro 1995) or a predictable means of cutting through burdensome regulation or attracting state attention (Leff 1964; Slinko et al. 2005). In this paper, however, we draw a distinction between differences in _levels_ of relatively well-ordered (and often centralized) and therefore predictable corruption – a predictable component of the cost of doing business – and _variation in experiences with corruption_ , which often results from decentralized, unconstrained (a.k.a. “administrative”) corruption and the

> 1 The former is measured by the 2012 Doing Business in Russia’s Regions data set, and the latter by the 2012 EBRDWorld Bank Business Environment and Enterprise Performance Survey (BEEPS) for Russian regions.

2