Incomplete Contracts and Opportunism in Franchising

22 Pages Posted: 5 Jun 2006

See all articles by Jonathan Klick

Jonathan Klick

University of Pennsylvania Carey Law School; Erasmus School of Law; PERC - Property and Environment Research Center

Bruce H. Kobayashi

George Mason University - Antonin Scalia Law School

Larry E. Ribstein

University of Illinois College of Law (deceased); PERC - Property and Environment Research Center

Date Written: June 1, 2006

Abstract

Economic theorists argue that broad termination rights allow franchisors to police opportunism on the part of franchisees which have an incentive to free ride on the franchised trademark. However, in principle, these termination rights could generate another form of opportunism as franchisors then have an incentive to skim establishments that prove to be particularly profitable. We use the adoption of state franchise termination laws to determine which form of opportunism is more important on the margin. Using panel data on fast food establishments, we find that laws restricting franchisor termination rights lead to a reduction in franchising, and this reduction is not offset by the concomitant increase in franchisor-operated establishments. We also examine state employment rates in industries characterized by high rates of franchising relative to other industries where franchising is rare, finding that employment in franchise industries drops, as a proportion of total employment, by about 7 percent when states enact restrictions on franchisor termination rights. Both sets of results imply that the potential for franchisee opportunism is stronger, and restrictions on termination rights are likely to reduce joint surplus among franchisors and franchisees.

Keywords: Franchise, Termination, Labor, Opportunistic Behavior, Corporate Law

JEL Classification: D21, D23, D86, G38, K12, K22, L14, L15, L21, L22

Suggested Citation

Klick, Jonathan and Kobayashi, Bruce H. and Ribstein, Larry Edward, Incomplete Contracts and Opportunism in Franchising (June 1, 2006). Available at SSRN: https://ssrn.com/abstract=906158 or http://dx.doi.org/10.2139/ssrn.906158

Jonathan Klick (Contact Author)

University of Pennsylvania Carey Law School ( email )

3501 Sansom Street
Philadelphia, PA 19104
United States
2157463455 (Phone)

Erasmus School of Law ( email )

3000 DR Rotterdam
Netherlands

PERC - Property and Environment Research Center

2048 Analysis Drive
Suite A
Bozeman, MT 59718
United States

Bruce H. Kobayashi

George Mason University - Antonin Scalia Law School ( email )

3301 Fairfax Drive
Arlington, VA 22201
United States
703-993-8034 (Phone)
703-993-8088 (Fax)

HOME PAGE: http://mason.gmu.edu/~bkobayas

Larry Edward Ribstein

University of Illinois College of Law (deceased)

PERC - Property and Environment Research Center

2048 Analysis Drive
Suite A
Bozeman, MT 59718
United States

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