Regulatory Employment Thresholds and Firm Size Distortions: Evidence from Ecuador

This study examines whether size-contingent employment regulations are associated with distortions in firm size distribution and whether such patterns are more consistent with productivity-based selection or with broader constraints on firm scaling. Using 2024 census data covering 86,758 formal firms in Ecuador, we combine bunching analysis, regression discontinuity design (RDD), and logistic regression to analyze firm responses at the 10- and 50-employee thresholds. We document significant bunching below the 50-employee threshold, consistent with an economically meaningful implicit regulatory tax on firm scaling. However, RDD estimates reveal no productivity discontinuity at the cutoff, indicating that the observed threshold effects are more consistent with broad-based scaling constraints than with selective filtering of low-productivity firms. Sectoral analyses show a consistent pattern of bunching across technologically diverse industries, supporting an institutional rather than technological interpretation. Conditional on threshold proximity, firm crossing is more strongly associated with sales growth than with productivity advantages. By distinguishing between compositional avoidance and local crossing, the study sheds new light on the puzzle of absent productivity selection. These findings provide the first rigorous evidence of regulatory threshold effects in Ecuador and show how size-based regulations may distort firm scaling and contribute to allocative inefficiencies.