The Behavioral Law and Economics of Franchise Tying Contracts
College of Law and Business - Ramat Gan Law School
January 7, 2010
Rutgers Law Journal, Vol. 41, p. 527, 2010
The traditional law-and-economics analysis suggests that the per se illegality rule that governs franchise tying contracts is inefficient. Legal economists particularly argue that a per se illegal standard fails to account for the enhancement in efficiency that a franchise tying contract provides. One central improvement in efficiency that a franchise tying contract creates, according to legal economists, is a decrease in the franchisor's monitoring costs. Particularly, by requiring a franchisee to purchase products directly from the franchisor, a tying contract reduces the costs that the franchisor will have to incur in order to monitor the quality of products sold by the franchisee to customers.
Building upon a noteworthy body of empirical research, this article will argue that the traditional law-and-economics analysis is incomplete. Although a franchise tying contract may reduce product quality-related monitoring costs, it is also likely to significantly increase other monitoring costs.
More specifically, this article will argue that a centralized franchise tying relationship is likely to continually constrain the franchisee's autonomy. Consequently, the tying relationship is likely to decrease the franchisee's satisfaction with the relationship. The emotional experience of decreased satisfaction is likely to promote aggressive retaliatory behavior, which may take the form of franchisee opportunistic behavior. Ultimately, a centralized tying relationship will increase the likelihood that the franchisee will take three central types of opportunistic actions towards the franchisor: manipulate information, shirk the contractual obligation to provide adequate customer service and shirk the contractual obligation to maintain cleanliness standards in the entire franchise unit. These potential opportunistic actions, as they accumulate, are likely to significantly increase the franchisor's information, customer-service and cleanliness-related monitoring costs, thereby off-setting the product-quality monitoring cost savings arguably generated by a franchise tying contract.
Number of Pages in PDF File: 25
Keywords: Franchise, Tying
JEL Classification: K21
Date posted: January 10, 2010 ; Last revised: September 8, 2011