Specific Investments in Franchisor-Franchisee Relationships: A Model

Abstract

Transaction cost theory has largely considered specific investments as exogenous, leading to calls for studying them as endogenous decisions. We examine firms’ specific investment decisions through a game-theoretic model of bilateral, sequential decisions in an extant franchisor-franchisee relationship with information asymmetry. Our model shows specific investments can directly increase channel revenues and function as tools to credibly communicate demand information. Specifically, under certain conditions, it is optimal for a franchisor to make a specific investment even when it is not reciprocated by the franchisee. Here, the investment does not directly increase exchange value but only acts as a money-burning signal.