Agency Theory and Franchising: Some Empirical Results

Abstract

This article provides an empirical assessment of various agency-theoretic explanations for franchising, including risk sharing, one-sided moral hazard, and two-sided moral hazard. The empirical models use proxies for factors such as risk, moral hazard, and franchisors' need for capital to explain both franchisors' decisions about the terms of their contracts (royalty rates and up-front franchise fees) and the extent to which they use franchising. In this article, I exploit several new sources of data on franchising to construct a cross section of 548 franchisors involved in various business activities in the United States in 1986. The data are most consistent with a model based on two-sided moral hazard. The empirical models are also more successful at explaining the extent to which franchisors choose to franchise stores than at explaining the terms of franchise contracts. Finally, contrary to the predictions of several theoretical models, I find that royalty rates and franchise fees are not negatively related.