Does institutional quality affect the relationship between income inequality and entrepreneurial activity?

PurposeThis study examines whether institutional quality affects the relationship between income inequality and entrepreneurial activity. The authors specifically examine whether the greasing or sanding effect holds for the relationship between income inequality and entrepreneurship, while moderating for institutional quality. The greasing effects suggest that income inequality can promote entrepreneurial activity, while the sanding effects disincentivise it.Design/methodology/approachThe authors examine this relationship using a sample of 100 advanced and developing countries from 2006 to 2018 using a dynamic panel estimator to control endogeneity and simultaneity. Additionally, the authors include an interaction term to estimate the marginal effects of income inequality, while moderating for institutional quality. Furthermore, the authors differentiate between six measures of institutional quality.FindingsOverall, the authors find that institutional quality and income inequality have a positive and significant impact on entrepreneurial activity. However, when moderating for institutional quality, the findings show that the marginal impact of income inequality is negative for countries with low levels of institutional quality. The authors show that the rule of law and government effectiveness are effective moderators in terms of magnitude. Furthermore, the authors find that the sanding effect of income inequality is observed in developing economies, even when moderating for institutional quality.Research limitations/implicationsThe major limitation lies in the estimation of entrepreneurial activity, which is measured using new business formation. While this is commonly used, it focuses on formal entrepreneurial activities and overlooks the informal economy.Originality/valueThis study provides new empirical evidence on whether institutional quality can moderate and explain the puzzling link between entrepreneurial activity and income inequality.