Skip to main content
SpringerLink
Log in

Entrepreneurial orientation, risk and incentives: the case of franchising

  • Published:
Small Business Economics Aims and scope Submit manuscript

Abstract

The standard principal-agent model predicts a trade-off in contract design between the protection against risk and incentive motivations. Distinguishing two types of risks, we show that, contrary to this traditional view, the relationship between risk and incentives can be positive. In franchise contracting, this implies that the royalty rate decreases with the risk faced by the franchisee on the local market. Using a unique panel dataset combining French franchise and financial data, we address this issue empirically, alongside performance outcomes. The data support the hypothesis of a negative relationship between risk and the royalty rate, which contradicts the prediction of the standard agency theory. Furthermore, our estimations provide evidence that chain performance increases with an adjusted royalty rate. This paper has important implications for contract design, showing that with increasing local market uncertainty and low-risk aversion, franchisors should reduce the royalty rate.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1
Fig. 2

Similar content being viewed by others

Notes

  1. A good discussion on the interest of this method is offered by Rubin (1996).

  2. A high liquidity indicator means that the company does not suffer liquidity risk. However, it can also suggest that the firm does not invest enough.

  3. Considering that low PCOs are associated with less risk in company-owned outlets and with more risk in franchised outlets.

  4. The results of all the specification tests are available upon request.

  5. Note that the result of the comparison of estimations based on the observed royalty rate and estimations based on the predicted royalty rate is intuitively the same as deviations from the predicted royalty rate. For technical reasons, we do not directly include the deviations from the predicted royalty rate as regressor. The Topel and Murphy methodology indeed requires performing the second step with the prediction (from the first step), not with a deviation.

  6. The upfont fee is divided by 10,000

References

  • Ackerberg, D. A., & Botticini, M. (2002). Endogenous matching and the empirical determinants of contract form. Journal of Political Economy, 110, 564–591.

    Article  Google Scholar 

  • Agrawal, D., & Lal, R. (1995). Contractual arrangements in franchising: an empirical investigation. Journal of Marketing Research, 32, 213–221.

    Article  Google Scholar 

  • Allen, D. & Lueck, D. (1995). Risk preferences and the economics of contracts. The American Economic Review, 85(2), 447–451.

  • Antel, R., & Demski, J. S. (1988). The controllability principle in responsibility accounting. The Accounting Review 63, 700 – 718

  • Aysun U., Bouvet F. Hofler R. (2014). An alternative measure of structural unemployment, economic modelling http://www.Sciencedirect.Com/science/journal/02649993, 38, 592–603.

  • Baker, G. P., & Jorgensen, B. (2003). Volatility, noise and incentives, mimeo. Harvard University and Columbia University.

  • Barthélemy, J. (2011). Agency and institutional influences on franchising decisions. Journal of Business Venturing, 26, 93–103.

    Article  Google Scholar 

  • Bhattacharyya, S., & Lafontaine, F. (1995). Double-sided moral hazard and the nature of share contracts. RAND Journal of Economics, 26, 761–781.

    Article  Google Scholar 

  • Blair, R., & Lafontaine, F. (2005). The economics of franchising. Cambridge: Cambridge University Press.

    Book  Google Scholar 

  • Bolton, P., Dewatripont, M. (2005). Contract theory. MIT Press.

  • Breusch, T., & Pagan, A. (1980). The Lagrange multiplier test and its applications to model specification in econometrics. Review of Economic Studies, 47, 239–253.

    Article  Google Scholar 

  • Brickley, J. (2002). Royalty rates and upfront fees in share contracts: evidence from franchising. Journal of Law, Economics and Organization, 18, 511–535.

    Article  Google Scholar 

  • Castrogiovanni, G. J., Justis, R. T., & Julian, S. D. (1993). Franchise failure rates: an assessment of magnitude and influencing factors. Journal of Small Business Management, 31(2), 105–114.

    Google Scholar 

  • Cheng, T., Ing, C., & Yu, S. (2015). Toward optimal model averaging in regression models with time series errors. Journal of Econometrics, 189, 321–334.

    Article  Google Scholar 

  • Combs, J., Ketchen, D., Shook, C. L., & Short, J. C. (2011). Antecedents and consequencies of franchising: past accomplishments and future challenges. Journal of Management, 37, 99–126.

    Article  Google Scholar 

  • Coughlan, A. T., & Narasimhan, C. (1992). An empirical analysis of sales-force compensation plans. Journal of Business, 65, 93–121.

    Article  Google Scholar 

  • De Varo, J., & Kurtulus, F. (2010). An empirical analysis of risk, incentives and the delegation of worker authority. Industrial and Labor Relations Review, 64, 641–661.

    Article  Google Scholar 

  • Dnes, A. W. (1992). ‘Unfair’ contractual practices and hostages in franchise contracts. Journal of Institutional and Theoretical Economics, 148, 484–504.

    Google Scholar 

  • El Akremi, A., Perrigot, R., & Piot-Lepetit, I. (2015). Examining the driver of franchised chains performance through the lens of the dynamic capabilities approach. Journal of Small Business Management, 53, 145–165.

    Article  Google Scholar 

  • Fadairo, M. (2013). Why include royalties in distribution contracts? Evidence from France. International Journal of Retail and Distribution Management, 41, 566–583.

    Article  Google Scholar 

  • Foss, N., & Laursen, K. (2005). Performance pay, delegation, and multitasking under uncertainty and innovativeness: an empirical investigation. Journal of Economic Behavior and Organization, 58, 246–276.

    Article  Google Scholar 

  • Fung, M. K. (2013). A trade-off between non-fundamental risk and incentives. Review of Quantitative Finance and Accounting, 41, 29–51.

    Article  Google Scholar 

  • Garen, J. E. (1994). Executive compensation and principal-agent theory. Journal of Political Economy, 102, 1175–1199.

    Article  Google Scholar 

  • Ghosh, M., & John, G. (2000). Experimental evidence for agency models of salesforce compensation. Marketing Science, 19, 348–365.

    Article  Google Scholar 

  • Greene, W. (2000). Econometric analysis. Prentice-Hall International, 3th edition.

  • Hardin, J. (2002). The robust variance estimator for two-stage models. Stata Journal, 2, 253–266.

    Google Scholar 

  • Hausman, J. (1978). Specification tests in econometrics. Econometrica, 46, 1251–1271.

    Article  Google Scholar 

  • Heckman, J. (1981). The incidental parameters problem and the problem of initial conditions in estimating a discrete time-discrete data stochastic process. In Structural analysis of discrete data with econometric applications (pp. 179–195). Cambridge, MA: MIT Press.

    Google Scholar 

  • Hole, D. (2006). Calculating Murphy-Topel variance estimates in stata: a simplified procedure. The Stata Journal, 6, 521–529.

    Google Scholar 

  • He, Z., Li, S., Wei, B., & You, J. (2014). Uncertainty, risk, and incentives: theory and evidence. Management Science, 60, 206–226.

    Article  Google Scholar 

  • Joseph, K., & Kalwani, M. U. (1995). The impact of environmental uncertainty on the design of sales force compensation plans. Marketing Letters, 6, 183–197.

    Article  Google Scholar 

  • Kacker, M., Sadeh, F. (2015). The relationship between royalty rates and franchise fees: a meta-analysis, EMNet Conference 2015, Cape Town, South Africa, December 3–5.

  • Kacker, M., Dant, R. P., Emerson, J., & Coughlan, A. T. (2016). How firm strategies impact size of partner-based retail networks: evidence from franchising. Journal of Small Business Management, 54(2), 506–531.

    Article  Google Scholar 

  • Knight, F. H. (1921). Risk, uncertainty, and profit. Boston: Houghton Mifflin.

    Google Scholar 

  • Kosová, R., & Lafontaine, F. (2010). Survival and growth in retail and service industries: evidence from franchised chains. Journal of Industrial Economics, 58(3), 542–578.

    Article  Google Scholar 

  • Krafft, M., Albers, S., & Lal, R. (2004). Relative explanatory power of agency theory and transaction cost analysis in German sales forces. International Journal of Research in Marketing, 21, 265–283.

    Article  Google Scholar 

  • Lal, R. (1990). Improving channel coordination through franchising. Marketing Science, 9, 299–318.

    Article  Google Scholar 

  • Lafontaine, F. (1992). Agency theory and franchising some empirical results. RAND Journal of Economics, 23, 263–283.

    Article  Google Scholar 

  • Lafontaine, F., & Bhattacharyya, S. (1995). The role of risk in franchising. Journal of Corporate Finance, 2, 39–74.

    Article  Google Scholar 

  • Lafontaine, F., & Slade, M. (1997). Retail contracting: theory and practice. Journal of Industrial Economics, 45, 1–15.

    Article  Google Scholar 

  • Lafontaine, F., & Shaw, K. (1999). The dynamics of franchise contracting: evidence from panel data. Journal of Political Economy, 107, 1041–1080.

    Article  Google Scholar 

  • Lafontaine, F., & Shaw, K. (2005). Targeting managerial control: evidence from franchising. RAND Journal of Economics, 36, 131–150.

    Google Scholar 

  • Lafontaine, F., & Slade, M. (2001). Incentive contracting and the franchise decision. In Advances in Business Application of Game Theory: Kluwer Academic Press.

    Google Scholar 

  • Lafontaine, F., & Slade, M. (2014). Incentive and strategic contracting: implications for the franchise decision. In K. Chatterjee & W. Samuelson (Eds.), Game theory and business applications. New York: Springer.

    Google Scholar 

  • Lo, D. H.-F., Ghosh, M., & Lafontaine, F. (2011). The incentive and selection roles of salesforce compensation contracts. Journal of Marketing Research, 48, 781–798.

    Article  Google Scholar 

  • Macho-Stadler, I., & Pérez-Castrillo, D. (2001). An introduction to the economics of information: incentives and contracts‬. Oxford University Press.

  • Martin, R. E. (1988). Franchising and risk management. American Economic Review, 78(5), 954–968.

    Google Scholar 

  • Maruyama, M., & Yamashita, Y. (2012). Franchise fees and royalties: theory and empirical results. Review of Industrial Organization, 40, 167–189.

    Article  Google Scholar 

  • Mathewson, F., & Winter, R. (1985). The economics of franchise contracts. Journal of Law and Economics, 28, 503–526.

    Article  Google Scholar 

  • Michael, S. C., & Combs, J. G. (2008). Entrepreneurial failure: the case of franchisees. Journal of Small Business Management, 46(1), 73–90.

    Article  Google Scholar 

  • Misra, S., Coughlan, A. T., & Narasimhan, C. (2005). Salesforce compensation: an analytical and empirical examination of the agency theoretical approach. Quantitative Marketing and Economics, 3, 5–39.

    Article  Google Scholar 

  • Nagar, V. (2002). Delegation and incentive compensation. The Accounting Review, 77, 379–395.

    Article  Google Scholar 

  • Polo-Redondo, B.-J., & Lucia Palacios, L. (2011). Determinants of firm size in the franchise distribution system: empirical evidence from the Spanish market. European Journal of Marketing, 45(1/2), 170–190.

    Article  Google Scholar 

  • Prendergast, C. (2002a). The tenuous trade-off between risk and incentives. Journal of Political Economy, 110, 1071–1102.

    Article  Google Scholar 

  • Prendergast, C. (2002b). Uncertainty and incentives. Journal of Political Economy, 20, 115–137.

    Google Scholar 

  • Raith, M. (2008). Specific knowledge and performance measurement. The Rand Journal of Economics, 39(4), 1059–1079.

    Article  Google Scholar 

  • Rantakari, H. V. (2008). On the role of uncertainty in the risk-incentives trade-off. The B.E. Journal of Theoretical Economics, 8, 1–23.

    Google Scholar 

  • Rao, H. H. (1971). Uncertainty, entrepreneurship, and sharecropping in India. Journal of Political Economy, 79, 578–595.

    Article  Google Scholar 

  • Rey, P., & Tirole, J. (1986). The logic of vertical restraints. American Economic Review, 76, 921–939.

    Google Scholar 

  • Rubin, P. (1978). The theory of the firm and the structure of the franchise contract. Journal of Law and Economics, 21(1), 223–233.

    Article  Google Scholar 

  • Rubin, D. (1996). Multiple imputation after 18+ years. Journal of the American Statistical Association, 91, 473–489.

    Article  Google Scholar 

  • Salanié, B. (2005). The economics of contracts. MIT Press.

  • Scott, F. (1995). Franchising vs. company ownership as a decision variable of the firm. Review of Industrial Organization, 10, 69–81.

    Article  Google Scholar 

  • Serfes, K. (2005). Risk sharing vs. incentives: contract design under two-sided heterogeneity. Economics Letters, 88, 343–349.

    Article  Google Scholar 

  • Shane, S., Shankar, V., & Aravindakshan, A. (2006). The effects of new franchisor partnering strategies on franchise system size. Management Science, 52, 773–787.

    Article  Google Scholar 

  • Shi, L. (2011). Respondable risk and incentives for CEOs: the role of information-collection and decision-making. Journal of Corporate Finance., 17, 189–205.

    Article  Google Scholar 

  • Umanath, N. S., Ray, M. R., & Campbell, T. L. (1993). The impact of perceived environmental uncertainty and perceived agent effectiveness on the composition of compensation contracts. Management Science, 39, 32–45.

    Article  Google Scholar 

  • Vazquez, L. (2005). Up-front franchise fees and ongoing variable payments as substitutes: an agency perspective. Review of Industrial Organization, 26, 445–460.

    Article  Google Scholar 

  • Windsperger, J. (2001). The fee structure of franchising: a property rights view. Economics Letters, 73, 219–226.

    Article  Google Scholar 

  • Wright, J. (2004). The risk and incentives trade-off in the presence of heterogeneous managers. Journal of Econmics, 83, 209–223.

    Google Scholar 

  • Wulf, J. (2007). Authority, risk, and performance incentives: evidence from division manager positions inside firms. Journal of Industrial Economics, 55, 169–196.

    Article  Google Scholar 

Download references

Author information

Authors and Affiliations

  1. Escuela Politécnica Nacional, Ladron de Guevara, E11-253, Quito, 170517, Ecuador

    Cintya Lanchimba

  2. Univ Lyon, UJM Saint-Etienne, GATE Lyon Saint-Etienne, UMR 5824, 10 Rue Tréfilerie, F-42023, Saint- Etienne, France

    Muriel Fadairo

  3. Austria, Faculty of Business, Economics and Statistics, University of Vienna, Oskar-Morgenstern-Platz 1, 1090, Vienna, Austria

    Josef Windsperger

Authors
  1. Cintya Lanchimba
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Josef Windsperger
    View author publications

    You can also search for this author in PubMed Google Scholar

  3. Muriel Fadairo
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Muriel Fadairo.

Electronic supplementary material

ESM 1

(PDF 145 kb)

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Lanchimba, C., Windsperger, J. & Fadairo, M. Entrepreneurial orientation, risk and incentives: the case of franchising. Small Bus Econ 50, 163–180 (2018). https://doi.org/10.1007/s11187-017-9885-3

Download citation

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11187-017-9885-3

Keywords

JEL Classification

Search

Navigation