Asset Specificity and Hold-up in Franchising and Grower Contracts: A Theoretical Rationale for Government Regulation?

There has been much controversy over the merits of government regulation to protect growers and franchisees from hold-up at the hands of integrators and franchisors. Typically, economic argument have discouraged regulation, since direct evidence for hold-up is weak and bargaining should yield second-best efficiency. This paper questions direct tests for hold-up, arguing that hold-up occurs only off the equilibrium path but nevertheless influences equilibrium payoffs as a couterfactual. Moreover, when markets do no clear, bargaining may fail to yield net efficiency. In such circumstances, integrators or franchisors will force excessively high levels of asset specificity onto growers or franchisees. And will insist that these small parties be excessively vulnerable to being dismissed, since such an arrangement shifts the distribution of wealth by alleviating the need for high efficiency wages. Market power aggravates this effect. Nevertheless, misguided regulations may also be detrimental if their dir ect economic effects are not well understood.