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Moral Hazard, Asset Specificity, Implicit Bonding, and Compensation: The Case of Franchising

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  • Wimmer, Bradley S
  • Garen, John E

Abstract

In franchising, many of the elements of moral hazard models merge. Issues of two-sided moral hazard, bonding, and asset specificity all play a role. The authors extend the literature by considering how asset specificity creates an implicit bond and affects incentive pay. This approach implies that, if one party posts a larger bond, this improves their incentives and allows enhancement of the other party's incentives through a larger residual income claim. The authors' empirical work supports this approach. For example, reductions in the specificity of the franchisee's investment due to leasing lowers the royalty rate and raises the franchise fee. Copyright 1997 by Oxford University Press.

Suggested Citation

  • Wimmer, Bradley S & Garen, John E, 1997. "Moral Hazard, Asset Specificity, Implicit Bonding, and Compensation: The Case of Franchising," Economic Inquiry, Western Economic Association International, vol. 35(3), pages 544-554, July.
  • Handle: RePEc:oup:ecinqu:v:35:y:1997:i:3:p:544-54
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    Citations

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    Cited by:

    1. Richard S. Brown, 2017. "Franchisor market power and control rights in franchise systems: the case of Major League Baseball versus the Los Angeles Dodgers," Service Business, Springer;Pan-Pacific Business Association, vol. 11(1), pages 1-21, March.
    2. Windsperger, Josef, 2001. "The fee structure in franchising: a property rights view," Economics Letters, Elsevier, vol. 73(2), pages 219-226, November.
    3. repec:spr:infosf:v:2:y:2000:i:1:d:10.1023_a:1010054222086 is not listed on IDEAS
    4. Josef Windsperger, 2013. "The governance of franchising networks," Chapters,in: Handbook of Economic Organization, chapter 27 Edward Elgar Publishing.
    5. Dur, Robert & Non, Arjan & Roelfsema, Hein, 2010. "Reciprocity and incentive pay in the workplace," Journal of Economic Psychology, Elsevier, vol. 31(4), pages 676-686, August.
    6. Affuso, L., 2000. "Intra-Firm Retail Contracting: Survey Evidence from the UK'," Cambridge Working Papers in Economics 0022, Faculty of Economics, University of Cambridge.
    7. George Hendrikse & Patrick Hippmann & Josef Windsperger, 2015. "Trust, transaction costs and contractual incompleteness in franchising," Small Business Economics, Springer, vol. 44(4), pages 867-888, April.
    8. Francine Lafontaine & Margaret E. Slade, 1998. "Incentive Contracting and the Franchise Decision," NBER Working Papers 6544, National Bureau of Economic Research, Inc.
    9. Masayoshi Maruyama & Yu Yamashita, 2012. "Franchise Fees and Royalties: Theory and Empirical Results," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 40(3), pages 167-189, May.
    10. Josef Windsperger, 2003. "Complementarities and Substitutabilities in Franchise Contracting: Some Results from the German Franchise Sector," Journal of Management & Governance, Springer;Accademia Italiana di Economia Aziendale (AIDEA), vol. 7(3), pages 291-313, September.
    11. Eugênio José Silva Bitti & Cintya Lanchimba & Muriel Fadairo, 2017. "Franchisors'choice between royalties and fixed fees evidence from Brazil," Working Papers 1731, Groupe d'Analyse et de Théorie Economique Lyon St-Étienne (GATE Lyon St-Étienne), Université de Lyon.
    12. repec:ehu:cuader:24429 is not listed on IDEAS
    13. Eugênio José Silva Bitti & Cintya Lanchimba & Muriel Fadairo, 2017. "Franchisors' choice between royalties and fixed fees evidence from Brazil," Working Papers halshs-01618054, HAL.

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