**Institutions** The ES database contains both perception as well as quantitative information regarding the costs of doing business experienced by firms for a large number of countries. The perception indicators are often used to examine the effects of the business environment, but present a number of possible limitations. The main concern is that perception data are subject to measurement errors since they are likely to be affected by observed and unobserved firm and country specific factors. For example, they might simply reflect “individual differences in the degree of optimism or pessimism of the managers” and/or experience or performance of the establishment (Aterido et al., 2011). In view of this, we prefer quantitative measures, where managers are asked to specify the specific costs incurred when doing business, over perception data for our analysis.<sup>23</sup>

We construct an index of the quality of institutions based on the objective measures from the ES.

Financial friction is often thought to be an important source of misallocation, particularly in countries with poorly-functioning financial market. It can severely harm aggregate TFP by preventing the optimal adjustment of factor inputs. A recent study by Buera et al. (2011) has shown that a substantial portion of the variation in aggregate productivity across countries may be accounted for by resource misallocation due to imperfect financial markets. The ES dataset contains a number of questions in regard to access to finance. Specifically, the survey asked firms to indicate whether the establishment has ‘access to finance’ as well as the actual ‘cost of financing’.<sup>24</sup> We define the quality of the financial institution as the ease for establishments to get external financing. More specifically, we measure the financial friction as the percentage of establishments in the each region that do not have a line of credit or loan from a institution.

Another possible driver of misallocation is uneven implementation of regulations which allows unproductive firms to enter and survive easily. The ES dataset contains a large number of measures of the extent of regulation and red-tape induced costs. We use the share of _senior managers’ time that is used in dealing with government officials_ as our measure of regulation (Red-tape), as used in (Hallward-Driemeier et al., 2010; Li et al., 2011).

It is also plausible that the quality of infrastructure may have a differential effect on the operation of firms within industries. Poor-quality infrastructure is often considered to be a major bottleneck for performance of firms in SSA countries. However, the effects of poor infrastructure are _not uniform_ across establishments. For example, the same extent of power outages may cause less damage to large firms because they might insure themselves against outages by purchasing generators or otherwise substituting away from electricity (Aterido et al., 2011; Allcott et al., 2015). We measure the extent of infrastructure bottlenecks by the proportion of annual sales lost due to power outages ( _Electricity_ ).

Finally, the high level of resource misallocation could also reflect that firms in our sample countries face severe corruption costs. The ES contains information on the occurrence of bribe requests as well as the amount of the informal payments to ‘get things done’ with regard to customs, taxes, licenses, regulations, other public services.<sup>25</sup> To measure the extent of corruption, we use the average percentage of sales spent on informal payments made to get things done.

> 23Note that Kalemli-Ozcan and Sorensen (2012) use subjective firm responses as measures of the business environment to examine the cost of capital misallocation in Africa.

> 24The specific questions are “Does this establishment currently have a line of credit or loan from a financial institution? and What is the rate of interest of this most recent line of credit or loan?”, respectively.

> 25The survey questions are: In any of these inspections was a gift or informal payment requested? If so, what percent of total annual sales is paid in informal payments?

27