I can't comment on what happens in small airlines as I've never been in one, but I did used to run a small business and, as you quite rightly suggest, in that environment a recommended person saves a sh*tload of advertising, interviewing and hassle - much of which a small business can't afford, and hasn't got time for. The legalities are, perhaps, a nicety, but it's very unlikely anyone will ever take a detailed interest in the exact employment procedures of an operation that only hires one new pilot every third century, so they do what they want.
However, from your posts, the vast majority of you want to work for a shiny jet airline as soon as you possibly can. These are big businesses, and they have to dot the 'i's and cross the 't's in everything they do. As WWW says, personal recommendations must not carry a disproportionate amount of weight, and can never override the minimum standards and qualifications required by the airline.
I repeat what I said before: the majority of jet airline pilot jobs are acquired with no inside contact or recommendation. Luck is by far and away the most important qualification you need.
Scroggs