Competition from informal firms and product innovation in EU candidate countries: A bounded rationality approach

This study extends the literature that has investigated firms' readiness to confront competition from informal (unregistered) firms by responding through intensified product innovation activities. Drawing on the bounded rationality perspective, we unravel new insights into the relationship between the threat from informal competitors and product innovation by identifying two external contingencies (intellectual property rights protection and regulatory quality) and two internal contingencies (export intensity and top manager's sector experience). In this way, the study acknowledges the immense differences that exist across developing markets, focusing on post-communist societies characterized with a medium level of economic development, limited market size, and weak institutional development. An empirical prototype of this type of context is exemplified in EU candidate countries. Therefore, our model estimates the effect of the threat from informal competitors on product innovation by testing firm-level data from five countries with EU candidate status. Our findings show that direct and positive relationship between the threat from informal competitors and product innovation is strengthened when: 1) intellectual property rights protection is weaker, 2) regulatory quality is higher, 3) the firm is an intesive exporter, and 4) the firm's top managers have less experience. •This study investigates firms' responses to competition from informal firms through product innovation activities.•We unravel new insights into this relationship by analyzing two external and two internal contingencies.•We use the sample of 1419 firms from five EU candidate countries.•Informal competition increases product innovation when IPR protection is weaker and regulatory quality is higher.•We identify factors that steer firm's decision to enhance/rationalize product innovation responses to informal competitors.•Also, it increases when the firm is an extensive exporter and the firm’s top managers have less sector experience.