Making New Franchise Systems Work

Posted: 17 Nov 2009

See all articles by Scott Shane

Scott Shane

Case Western Reserve University - Department of Economics

Date Written: 1998

Abstract

While controlling for firm age and size, the effect of franchisor policies on the survival of new franchise systems over time is examined, the effects of franchisor policies to manage moral hazard, adverse selection, and holdup are compared, and it is shown that the survival of new franchise systems is explained by agency cost economizing and that scholars need not invoke resource constraint theory to explain new franchisors' behavior. Nine testable hypotheses are presented about franchise system survival that provide an empirical test to overcome the problems of previous cross-sectional research and demonstrates the validity of agency theory. The hypotheses are: (1) new franchise systems which permit passive ownership of franchised outlets are more likely to fail than are other new franchise systems; (2) new franchise systems which require higher levels of franchisee cash involvement are less likely to fail than are other franchise systems; (3) new franchise systems which require franchisees to have experience are less likely to fail than are other new franchise systems; (4) new franchise systems which have higher royalty rates are less likely to fail than are other new franchise systems; (5) new franchise systems which are geographically concentrated are less likely to fail than are other new franchise systems; (6) new franchise systems which are more complex are more likely to fail than are other new franchise systems; (7) new franchise systems which employ master franchising are more likely to fail than are other new franchise systems; and (9) new franchise systems which have higher levels of total investment are more likely to fail than are other new franchise systems. Data regarding 157 new franchisors established in the United State between 1981 and 1983 were taken from the Sourcebook of Franchise Opportunities. Six of the nine hypotheses receive support from the results: Failure is less likely for higher levels of franchisee cash investment, requiring that franchisees have experience, and geographic concentration. Failure is more likely when passive ownership is permitted, the franchise system is more complex, and when master franchising is used. Overall, results indicate that franchise systems structured to economize on agency costs are more likely to survive. (SFL)

Keywords: Agency costs, Contracts & agreements, Firm age, Firm size, Firm survival, Franchises, Firm ownership, Firm control, Access to capital, Experience

Suggested Citation

Shane, Scott A., Making New Franchise Systems Work (1998). University of Illinois at Urbana-Champaign's Academy for Entrepreneurial Leadership Historical Research Reference in Entrepreneurship, Available at SSRN: https://ssrn.com/abstract=1505894

Scott A. Shane (Contact Author)

Case Western Reserve University - Department of Economics ( email )

Cleveland, OH 44106
United States

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