The Role of Royalty Rates in Determining Monitoring Costs of Restaurant Franchise Contracts

Abstract

The purpose of this research is to examine determinants of royalty rates in restaurant franchising from a monitoring costs perspective utilizing agency theory. The primary hypothesis of the study is that agency costs associated with monitoring franchisees are inversely related to royalty rates levied by the franchisor. Agency problems specifically related to monitoring costs of franchise contracts are identified. An empirical model for monitoring costs in relation to royalty rates is developed to test a series of hypotheses. Empirical evidence largely supports the primary hypothesis that when the franchisor perceives monitoring activities are difficult and/or costly, the franchisor tends to lower royalty rates to induce the franchisee's efforts.