Contract Duration: Evidence from Franchising

Abstract

Economists generally view standard franchise contracts as efficient, while franchisee advocates view them as exploitive. Consistent with the economic view, we find that contract duration is positively and significantly related to the franchisee's physical and human capital investments (which are often firm specific). In contrast to assertions by franchisee advocates, we find that these relations exist in subsamples containing only the most established franchisors (as measured by size and experience) and that larger, more experienced franchisors tend to offer longer-term contracts than do newer franchisors. Our evidence also suggests that there is learning across firms about optimal contract terms.

Provisions to Be Negotiated in Franchise Contracts: The Case of Spanish Chains

“…However, we find that the opposite occurs in practice, withEmpirically, this uniformity is observed in the establishment of financial conditions (Dnes, 1992;Lafontaine, 1992;Sen, 1993). It has also been observed that franchise agreements remain stable over time and that franchisors do not significantly change contractual terms, especially financial provisions (Lafontaine, 1992;Brickley et al, 2006).…”

“…Although few studies have explored this issue, either in the franchising field or in other contexts (Brickley et al, 2006;Crocker & Masten, 1988;Joskow, 1987;Vá zquez, 2007), we can clearly distinguish three major factors that affect the duration of the franchise contract: asset-specific investments, experience and the likelihood of opportunistic behavior by the franchisee. First, it is believed that the greater the investment by the franchisee in franchise-specific assets to launch the business is, the longer the contract duration should be; in this way, the franchisee is protected from the opportunistic behavior by the franchisor to expropriate the quasi rents generated by these assets.…”

“…On the one hand, franchisees prefer long-term contracts because this provides sufficient time to recoup their investments, many of which are specific to the relationship and would therefore generate hold-up problems (Klein et al, 1978;Williamson, 1985). On the other hand, long-term contracts limit the ability of the franchisor to implement necessary changes in the franchise system and to rescind contracts with inferior franchisees without engaging in costly litigation (Brickley et al, 2006;Crocker & Masten, 1988) (Note 2). Thus, the optimal duration of the contract must reflect a balance between the cost of negotiating the terms of the contract and the risk of being tied to an inflexible agreement for a lengthy period of time (Crocker & Masten, 1988).…”

“…First, it is believed that the greater the investment by the franchisee in franchise-specific assets to launch the business is, the longer the contract duration should be; in this way, the franchisee is protected from the opportunistic behavior by the franchisor to expropriate the quasi rents generated by these assets. In addition, long-term contracts provide adequate time for the franchisee to recoup its investments (Joskow, 1987;Brickley et al, 2006). It has also been observed that there is a positive relationship between the franchisor's experience in franchising and the duration of the contract (Brickley et al, 2006).…”

“…This means that not all companies are equally able to write contractual provisions to deal with potential opportunism (Argyres & Mayer, 2007): companies without these capabilities are not able to design such detailed contracts (Solí s-Rodrí guez & Gonzá lez-Dí az, 2015). 1990), contract duration (Brickley, Misra, & Van Horn, 2006;Vá zquez, 2007), sales prices (Lafontaine, 1999;Lafontaine & Slade, 2001;Muris, Scheffman, & Spiller, 1992;Shepard, 1993), contract termination and renewal (Arruñada, Garicano, & Vá zquez, 2001;Brickley, Dark, & Weisbach, 1991), territorial exclusivity (Brickley, 1999) or tying (Shane, 2001). …”