Abstract We explore behavioral antecedents of firm formalization in times of extreme uncertainty. We argue that informal firms' propensity to formalize is subject to their financial and informal legitimacy aspirations. Drawing on the behavioral theory of the firm and threat rigidity hypothesis literatures, we suggest that informal firms' over (under) performance on financial and legitimacy aspirations are both independently and jointly associated with the risk-seeking (risk-avoiding) behavior associated with formalization. We explore these effects by conducting three experimental vignette studies in a cluster of informal firms a few months into the Covid-19 pandemic in Ghana. The findings indicate that informal firms are more likely willing to adopt higher levels of formalization in the face of uncertainty when financial performance and legitimacy are above aspiration level, yet do not do so when financial performance and perceived legitimacy are below aspiration. We also find that owners/managers of informal firms showed a differential preference for the different levels of formalization based on the interaction between financial performance and legitimacy relative to aspiration.
Keywords: Behavioral theory of the firm, informal firms, formalization, legitimacy, Covid-19 pandemic.