Franchise Fees and Royalties: Theory and Empirical Results

Abstract

This is the first econometric study that explores which franchisors in Japan require royalties, what determines the royalty rates of those that require sales-based royalties, and what determines their franchise-fee amounts. Our findings are broadly consistent with the standard principal-agent view of franchise contracts, in which royalties heighten franchisor performance incentives. From an analysis of a broad sample of 278 franchisors in Japan, in 2001, we find that franchise contracts are more likely to include royalties if franchisor performance incentives are more valuable. The same conditions are associated with higher sales-based royalty rates and higher franchise-fee amounts.