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Bonding Through Investments: Evidence from Franchising

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  • Giorgo Sertsios

Abstract

This article studies whether producers’ up-front investments can help sustain relations with business partners. The initial investment combined with the business partner’s threat to terminate the contract before it expires can generate a bonding mechanism that precludes the producer from behaving opportunistically. I test this view using franchise contract data and a natural experiment. In practice, the franchisor (business partner) determines how much a franchisee (producer) needs to invest up-front. I show that franchisors affected by the passing of a law that restricts their ability to terminate misbehaving franchisees ask their franchisees for higher up-front investments. This result is particularly large for small franchise systems, as franchisees’ investments are less redeployable in case of contract termination. The data suggest that contractual up-front investments can be used to sustain business relations (JEL L14, K20, M21).

Suggested Citation

  • Giorgo Sertsios, 2015. "Bonding Through Investments: Evidence from Franchising," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 31(1), pages 187-212.
    • Handle: RePEc:oup:jleorg:v:31:y:2015:i:1:p:187-212.
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    File URL: http://hdl.handle.net/10.1093/jleo/ewt014
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    Cited by:

    1. Sertsios, Giorgo, 2020. "Corporate finance, industrial organization, and organizational economics," Journal of Corporate Finance, Elsevier, vol. 64(C).
    2. Renáta Kosová & Giorgo Sertsios, 2018. "An Empirical Analysis of Self-Enforcement Mechanisms: Evidence from Hotel Franchising," Management Science, INFORMS, vol. 64(1), pages 43-63, January.

    More about this item

    JEL classification:

    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
    • K20 - Law and Economics - - Regulation and Business Law - - - General
    • M21 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics - - - Business Economics

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