Brand Licensing: What Drives Royalty Rates?

Abstract

In brand licensing, the brand owner (the licensor) grants another firm (the licensee) the right to use the brand. This differs from franchising, in which a contractual arrangement between a franchisor and a franchisee exists to run a business based on the franchisor's business model. Brand licensing helps generate revenues and protect the brand from misappropriation. In such contractual arrangements, agency theory suggests that when parties to the contract engage in moral hazard (i.e., opportunistic behavior), suboptimal outcomes may result. The authors examine how concerns of moral hazard affect royalty rate, a popular form of compensation in brand licensing. From an agency theory perspective, they discuss how market and contract characteristics influence the risk of moral hazard and shape royalty rates in international brand licensing. The results obtained using data from international licensing contracts indicate that a country's intellectual property rights protection enables licensees to benefit from lower royalty rates and market size enables licensors to demand higher royalty rates. The authors also examine impact of other contract characteristics, such as contract duration and exclusivity, on royalty rate. The results imply that concerns of opportunistic behavior on the part of both the licensor and the licensee influence royalty rates.