Capturing Value by Overcoming Entitlement Constraints: Evidence from franchise System Acquisitions

Abstract

In studying the determinants of successful acquisitions, strategy scholars emphasize the roles of relatedness, complementarity and innovation opportunities, while finance scholars emphasize the reduction of agency costs. In this paper, we investigate an understudied mechanism: overcoming entitlement constraints. We maintain that in franchising systems, prior commitments and psychological contracts between franchisors and franchisees limit franchisors' ability to capture (and possibly create) additional value from the system by changing written contract terms. The reason is that such terms act as reference points by which franchisees determine whether franchisors have undermined their entitlements. If franchisees perceive that their entitlements are being undermined, they retaliate by underperforming, hurting franchisor profits. New owners, however, are less subject to such retaliation, because they did not make such prior commitments. This difference creates gains from trade through an acquisition. We provide empirical evidence consistent with this theory from a sample of 186 acquisitions of franchise systems.