Differences in contract design between successful and less successful franchises

Abstract

The aim of this paper is to identify differences in contract design between successful and less successful franchise chains. Comparing contracts from both groups of companies, we observe, on the one hand, that (1) franchise contracts are unbalanced irrespective of the chain’s success: contracts cover franchisees’ obligations more than franchisors’ obligations. On the other hand, we find that (2) contracts in successful franchise chains are more complete (i.e. cover a larger number of contingencies) than the less successful ones and (3) this difference lies in the contingencies regarding franchisees’ obligations, which are more fully covered in the contracts of more successful chains. More specifically, within the contingencies regarding franchisees’ obligations, (4) successful chains restrict the franchisee decision rights more frequently on day-to-day business operations than on financial conditions or post-contractual contingencies. These findings can be explained because successful chains are more sensitive to franchisees’ opportunistic behavior, because they have learned how to manage and solve any potential conflicts, or because of differences in bargaining power. Finally (5) franchisors’ obligations are not statistically different between groups, which we interpret as evidence that relational contracting mechanisms do not substitute formalization.