Bonding through investments: Evidence from franchising

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5 Scopus citations

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 languageEnglish
Pages (from-to)187-212
Number of pages26
JournalJournal of Law, Economics, and Organization
Volume31
Issue number1
DOIs
StatePublished - 1 Mar 2015

Bibliographical note

Funding Information:
Financial assistance shows little within-franchisor variation. Actually, both the 10th and the 90th percentile show no change in financial assistance. There are only 81 cases in which a franchisor withdrew her financial assistance; whereas in 84 cases it started offering it. Franchisors located in Arkansas, California, Illinois, and Nebraska account for 21 cases of fran-chisors withdrawing their financial assistance and for 13 cases of fran-chisors who started offering it.

Publisher Copyright:
© The Author 2013. Published by Oxford University Press on behalf of Yale University. All rights reserved.

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