Retail contracting and costly monitoring: Theory and evidence

Abstract

We reconcile seemingly conflicting hypotheses and evidence that surface in the principal-agent literature. Specifically, we examine the literature that deals with the effect of costly monitoring on retail-organizational form. Our principal-agent model of the optimal relationship between up and downstream firms allows the principal to garner two types of imperfect signals of agent effort: sales data and behavior data. The model yields predictions that we confront with the econometric evidence, which comes from both franchising and sales-force-compensation literatures. We find that, when variation in the informativeness and in the cost of increasing the informativeness of both signals is considered, the evidence is consistent with the theory.