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Abstract
This study evaluates the factors affecting small businesses in developing countries. This dissertation focuses on formal institutions as important factors in the external environment of small firms. Macro level and micro level institution theories are used as the theoretical framework to explain how formal institutions affect small businesses in developing economies. A systematic literature review reveals three elements of formal institutions playing an important role in the small business sector. Taking in to consideration the large size of informal sector in developing economies, this study uses a quantitative method and the data from 112 developing economies to test three hypotheses. Results from the regression analysis show a significant and negative effect for two out of three variables i.e. accessibility of formal financial resources and flexibility of government regulations. Therefore, access to credit and flexible regulations negatively impact the number of small businesses in developing countries. This study, however, does not find a significant relation between the rule of law and small businesses. This research provides insights that the distinct characteristics of small business sector in developing countries changes the nature of relation between this sector and the formal institutions. As a result, the theories suggested for the developed economies are not applicable to the developing countries in this regard.