In-House and Arm's Length: Productivity Heterogeneity and Variation in Organizational Form

Abstract

This paper analyzes how firms are organized in the U.S. hotel management industry. For most hotel brands, properties with intermediate room occupancy rates are relatively more likely to be managed by company employees rather than by independent franchisees. Properties with the lowest and the highest occupancy rates tend to be managed by franchisees, at arm's length from the hotel chain. This variation in organizational form is consistent with a model in which the incentives embodied in management contracts vary with property-level productivity. We infer that most hotel chains franchise low productivity relationships to keep property-level fixed costs low and franchise the most productive relationships to create high powered incentives for franchisees. Franchisees of high-productivity properties work harder than the managers of both chain-managed properties and low-productivity franchises because the performance incentives in franchise contracts are proportional to hotel revenues and complement the incentives arising from having control over the property.

Keywords: Firm Heterogeneity, firm structure, Incomplete Contracts, Outsourcing

JEL Classification: D22, D23, F12, L23