Informal and Formal Organization in New Institutional Economics

Exchanges are governed by a set of formal institutions (contracts, incentives, authority) and informal institutions (norms, routines, political processes) which are deeply intertwined. However, for the most part, informal institutions are treated as exogenous forces changing the benefits to use alternative formal structures, and formal institutions are treated as mere functional substitutes of informal elements governing exchanges. As a result, scholars have not sufficiently explored the interactions between formal and informal institutions. We contend that the failure to integrate these concepts into a common theory has led to faulty reasoning and incomplete theories of economic organizations. In this paper, we highlight three potential areas of research exploring the interplay between formal and informal institutions: first, whether formal institutions support (complement) or undermine (substitute for) the contributions of informal institutions; second, how vacillation in formal organizational modes allows managers to efficiently alter the trajectory of informal institutions; and third, how certain informal institutions can lead to hierarchical failure, thereby requiring managers to constrain the boundaries of the firm.