Abstract
This article studies whether producers' up-front investments can help sustain relations with business partners. The initial investment combined with the business partner's threat to terminate the contract before it expires can generate a bonding mechanism that precludes the producer from behaving opportunistically. I test this view using franchise contract data and a natural experiment. In practice, the franchisor (business partner) determines how much a franchisee (producer) needs to invest up-front. I show that franchisors affected by the passing of a law that restricts their ability to terminate misbehaving franchisees ask their franchisees for higher up-front investments. This result is particularly large for small franchise systems, as franchisees' investments are less redeployable in case of contract termination. The data suggest that contractual up-front investments can be used to sustain business relations.
Original language | English |
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Pages (from-to) | 187-212 |
Number of pages | 26 |
Journal | Journal of Law, Economics, and Organization |
Volume | 31 |
Issue number | 1 |
DOIs | |
State | Published - 1 Mar 2015 |
Bibliographical note
Publisher Copyright:© The Author 2013. Published by Oxford University Press on behalf of Yale University. All rights reserved.
Keywords
- Agency