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Revenue versus incentive: Theory and empirical analysis of franchise royalties

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  • Maruyama, Masayoshi
  • Yamashita, Yu

Abstract

This paper analyzes royalty rates in franchise contracts, focusing on the two leading hypotheses. We consider whether royalty payments are simply the means for franchisors to acquire revenue from franchisees (revenue hypothesis), or are to preserve incentives for the franchisors to exert appropriate efforts (incentive hypothesis). We propose a new variant of the revenue hypothesis, which is derived from an elementary model of franchise contracts with input sales. We hypothesize that the royalty rate is higher when the total margin ratio of the franchise chain is higher (when the sales revenue ratio is lower). We use OLS to explore data on 118 Japanese franchise chains in 2001 and find evidence supporting this hypothesis, which provides an explanation for higher royalty rates for service-type franchises.

Suggested Citation

  • Maruyama, Masayoshi & Yamashita, Yu, 2014. "Revenue versus incentive: Theory and empirical analysis of franchise royalties," Journal of the Japanese and International Economies, Elsevier, vol. 34(C), pages 154-161.
    • Handle: RePEc:eee:jjieco:v:34:y:2014:i:c:p:154-161
    DOI: 10.1016/j.jjie.2014.06.002
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    More about this item

    Keywords

    Franchising; Royalties; Service; Empirical study;
    All these keywords.

    JEL classification:

    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure
    • L81 - Industrial Organization - - Industry Studies: Services - - - Retail and Wholesale Trade; e-Commerce
    • M21 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics - - - Business Economics
    • M31 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Marketing and Advertising - - - Marketing

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