On the existence of franchise contracts and some of their implications

• Published in: International journal of industrial organization Vol. 10; no. 4; pp. 567 - 593
• Main Authors: Katz, Barbara G., Joel, Owen
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier B.V 01.12.1992; Elsevier; North-Holland; Elsevier Sequoia S.A
• Series: International Journal of Industrial Organization
• Subjects: Contracts; Economic models; Economic theory; Expected utility; Franchising; Revenue sharing; Studies; Utility functions
• ISSN: 0167-7187; 1873-7986
• DOI: 10.1016/0167-7187(92)90060-C

We characterize the franchising problem as a contractual agreement between a principal and multiple agents. The contract contains a revenue-sharing rule, the level of national expenditures by the franchisor and the number of units to be enfranchised. The franchisor offers the contract to a group of potential agents whose attitudes toward risk and effort differ. The revenue of a franchise unit is determined by decisions of both parties as well as a random perturbation. Under certain conditions, we establish the existence and uniqueness of an expected utility maximizing franchise contract with the property that the royalty payment to the franchisor never exceeds one-half the revenue. We provide an explanation for the use of a common contract and argue that, in reality, it is non-linear. We show that this common, non-linear contract attracts agents deemed desirable by the franchisor.