Franchisee Associations as Sources of Bargaining Power? Some Evidence

• Author: Nicholas Argyres,Janet Bercovitz
• Date: 01 October 2015
• Published date: 01 October 2015
• DOI: http://doi.org/10.1111/jems.12111

Franchisee Associations as Sources of Bargaining

Power? Some Evidence

NICHOLAS ARGYRES

Olin Business School, Washington University in St. Louis

One Brookings Drive, Campus Box 1133, St. Louis, MO 63130

argyres@wustl.edu

JANET BERCOVITZ

College of Business

University of Illinois at Urbana-Champaign

1206 South Sixth Street, Champaign, IL 61820

jbercov@illinois.edu

The empirical literature in economics and strategy on contract structure, including on franchise

contract structure, has been largely based on agency and transaction cost theories. The effects

of bargaining power have been much less studied. This paper considers the role of independent

franchisee associations in franchising relationships as a means to test for the presence of bargain-

ing power effects. We find that the presence or absence of a franchisee association is significantly

related to each of three key contractual and relationship characteristics: contract duration, non-

compete stringency, and terminations/nonrenewals. This suggests that bargaining power should

be accounted for in studies of contract structure and relationship outcomes.

1. Introduction

The empirical literature in economics and strategy on contracting, and on franchise

contracting in particular, has been largely guided by either the agency model or by

transaction cost economics. These efficiency-oriented theories have been shown to ex-

plain critical categories of contract structure, such as contract duration, payment terms,

equity participation, and restrictions of various kinds.1Very few studies, however, have

examined the impact of bargaining power on contract structure in general, or franchise

contracting in particular.2Yet understanding the role of bargaining power in contracting

is critical for understanding the strategies of contracting firms.

In this paper, we explore the relationships between the existence of independent

franchisee associations and: (1) key terms of business format franchise contracts, and

(2) termination of franchisees. Independent franchisee associations are self-organized

groups of franchisees belonging to the same franchise system that are not sponsored

by the franchisor. (In contrast, franchisee advisory councils consist of representatives of

We are grateful to the American Association of Franchisees & Dealers (AAFD) for data on franchisee asso-

ciations used in the paper, and to Bob Purvin and Peter Hanson, for valuable conversations. We also thank

Dan Elfenbein, Kyle Mayer,Lamar Pierce, St `

ephane Saussier,and participants the International Society for the

New Institutional Economics and Atlanta Competitive Advantage conferences. Finally, we thank an editor

and two anonymous reviewers for many helpful comments.

1. Examples include: Joskow (1985, 1987), Masten and Crocker (1985), Crocker and Masten (1988),

Lafontaine (1992), Lafontaine and Slade (1997), Brickley (1999), Arru˜

nada et al. (2001), Brickley et al. (2006).

2. Exceptions include Michael (2000) for franchising, and Lerner and Merges (1998) for contracts in

biotechnology.

C2015 Wiley Periodicals, Inc.

Journal of Economics & Management Strategy, Volume24, Number 4, Winter 2015, 811–832

812 Journal of Economics & Management Strategy

franchisees chosen by the franchisor.) We study whether independent franchisee asso-

ciations provide a vehicle for the exercise of franchisee bargaining power by examining

whether franchise systems in which franchisee associations are active feature contract

terms and/or termination outcomes that favor franchisees. To our knowledge, no other

empirical study has considered the role of independent franchisee associations in fran-

chising relationships.

A pure efficiency perspective would suggest that each key term in a franchise

contract is determined by agency or transaction cost considerations. The predictions of

a bargaining power perspective would be less specific, suggesting that some provisions

might be impacted by such power, and some might not, depending on the relative

bargaining power of the parties.3For example, franchisees may gain enough bargaining

power, or choose to employ bargaining power, to affect certain provisions in their favor,

but not others. In addition, beyond affecting contractual provisions, bargaining power

might also have effects on actions taken by a franchisor that serve its interest at the

expense of a franchisee, or vice versa. Findings such as these could indicate the presence

of bargaining power, and therefore signal a need to augment theoretical approaches

common in economics and strategy.

We study the relationshipbetween bargaining power – as proxied by the existence

of an independent franchisee organization – and two contractual provisions that, accord-

ing to industry publications and trade groups, are of significant interest to franchisees:

contract duration and franchisor rights to restrict competition from former franchisees.

We also study its relationship with franchisor actions (termination and non–renewal of

franchisees) that can severely harm franchisees’ interests.

We proceed by briefly reviewing the literature on franchise contracting. We then

provide background on independent franchisee associations and underlying sources of

franchisee bargaining power. We develop our hypotheses regarding the impact of these

bargaining power considerations on contract duration and the stringency of noncompete

clauses, as well as franchisor termination behavior. Next, we describe our data and

methods, present and discuss our results, and offer directions for future research.

2. Efficiency of Franchise Contracts

Business format franchising is an organizational form in which a franchisor licenses

a franchisee the right to use the trademarked brand name owned by the franchisor. In

addition to the brand name, franchisees adopt the franchisor’s “business format,” which

can include selling specified products, using specified signage and operating methods,

purchasing specified inputs from the franchisor, etc. Franchisees typically pay the fran-

chisor an upfront fixed fee for the rights to the format, as well as a royalty calculated as

a percentage of the franchisee’s revenues. Franchisees also invest in franchisor-specific

property improvement and advertising campaigns, as well as in training that is largely

franchisor-specific.

Business format franchising offers potential franchisees an opportunity to purchase

and run a proven business of which he/she is the sole owner, or “residual claimant.”

This residual claimant status implies that the franchisee is highly financially motivated

to exert effort in the running of the business – more financially motivated than if the

franchisee were instead an employee of a company-owned outlet. The franchisor benefits

3. This kind of general prediction can be found, for example, in Aghion and Tirole (1994).