Agency Theory and Franchising: Some Empirical Results

Abstract

Franchising involves shared contracts entered into bytwo independent firms. This study analyzes franchising using agency theory.Various models are considered, including pure risk-sharing, one-sidedmoral-hazard, two-sided moral-hazard, and capital market imperfection. Theimpacts of these various models on royalty rate, franchise fee, and proportionof franchised stores are examined. Data used in this analysis were collected in1986 from 548 franchisors located in the United States, primarily fromEntrepreneur Magazine's 1986 Franchise 500 and the U.S. Department ofCommerce's Franchising in the Economy. These franchisors were involved infast-food restaurants, business aids and services, construction andmaintenance, and nonfood retailing. Franchisors' propensity to franchise increases with greater geographicaldispersion and increases in the importance of the franchisee's inputs. Thisalso leads to contracts that provide more residual claimancy rights tofranchisees. The two-sided moral hazard model is best supported by thisanalysis. Generally, the models considered were found to be better atdeciphering the extent to which franchisors choose to franchise than atdeciphering the terms of the franchise contracts. (SRD)

Keywords: Residual claims, Franchises, Moral hazard problem, Risk management, Capital, Agency theory, Royalties, Firm financing, Contracts & agreements, Retail industry