The Economics of Franchise Contracts

29 Pages Posted: 10 Jul 2011 Last revised: 26 Sep 2014

See all articles by Benjamin Klein

Benjamin Klein

University of California, Los Angeles (UCLA) - Department of Economics; Compass Lexecon

Date Written: October 1, 1995

Abstract

An incentive problem exists in franchise relationships because of the failure of franchisees to take account of franchisor profit. Franchise contracts ameliorate this malincentive not by specifying a proxy for desired franchisee performance, but by creating a premium stream that facilitates a self-enforcing agreement. The structure of credible commitments within this self-enforcing arrangement is elucidated, with initial franchisee investments shown to serve no performance guaranteeing purpose. Franchisors do not demand large initial lump sum payments from franchisees because doing so makes it more difficult to terminate franchisees for nonperformance. Franchisors use vertical integration when the premium necessary to assure franchisee performance is large.

JEL Classification: D23

Suggested Citation

Klein, Benjamin, The Economics of Franchise Contracts (October 1, 1995). Journal of Corporate Finance, Vol. 2, No. 1, 1995. Available at SSRN: https://ssrn.com/abstract=1872215

Benjamin Klein (Contact Author)

University of California, Los Angeles (UCLA) - Department of Economics ( email )

1999 Avenue of the Stars
Suite 1150
Los Angeles, CA 90067-4628
United States
310-728-2025 (Phone)
310-728-2070 (Fax)

HOME PAGE: http://www.econ.ucla.edu/people/Faculty/Klein.html

Compass Lexecon ( email )

1999 Avenue of the Stars
Suite 1150
Los Angeles, CA 90067-4628
United States
310-728-2025 (Phone)
310-728-2070 (Fax)

HOME PAGE: http://www.compasslexecon.com/professionals/bio?id=152

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