An Empirical Analysis of Self-Enforcement Mechanisms: Evidence from Hotel Franchising

Abstract

The relational contracts literature suggests that a principal can improve contract self-enforceability by specifying initial requirements that increase the agent's ex-post rents. Initial requirements specified in hotel franchise agreementssize and quality-tier of hoteloffer a unique empirical setting to test this. Using proprietary data on 5,547 new franchised hotels and their revenues, we find that hotels far away from their franchisor's headquarters are larger, more likely to belong to a high-quality tier, and generate higher revenues ex-post. This supports the idea that the agent's ex-post rents can serve as a substitute to the principal's monitoring intensity in the mitigation of agency problems. Our findings shed light on how formal contract terms can influence informal (relational) contracts between business partners.

Boom and Gloom

“…Both franchise agreements and management contracts tend to have long time horizons-usually 20 years, with renewal options-but can be terminated before the contract expires under certain circumstances (see Kosová and Sertsios (2016)). A consumer normally cannot tell whether a branded hotel is operated under a franchise agreement or a management contract.…”

Supersize me? Franchisee size and voluntary compliance with corporate brand‐building initiatives

“…When faced with similar dilemmas such as national advertising campaigns, for instance, franchisees have tended to underinvest (Michael, ). Given that distance hinders monitoring and that, in its absence, franchisees focus on salient measures such as costs or performance at the expense of brand‐building compliance (Holmstrom & Milgrom, ; Kosová & Sertsios, ; Lal, ; Zhang et al, ), we propose the following hypothesis:H2 Franchised outlets farther from corporate headquarters will comply less with voluntary , corporate brand‐building initiatives than franchised outlets closer to corporate headquarters .…”

“…Improved knowledge transfers may facilitate faster and more effective implementation of compliance-based initiatives (Gray et al, 2011), while improved monitoring may focus individuals at the operational level, a necessary component of consistent compliance (Anand et al, 2012). Knowledge transfer and monitoring difficulties also may exacerbate agency problems such as intentional shirking or free riding (Kosová & Sertsios, 2018) by increasing information asymmetry (Kang & Kim, 2008). Perhaps relatedly, geographic distances may also impede franchisors from developing close social ties with franchisees, retarding the efficacy of relational governance mechanisms on steering franchisees' behaviors (Heide, 1994;Heide & John, 1992).…”

“…In this study, we consider two location‐specific factors for which extant research offers mixed indications and theoretical projections: the intensity of an outlet's local competition and its distance from corporate headquarters. Both factors have played prominent roles in developing agency theory in the context of franchising (Kalnins & Lafontaine, ; Kosová & Sertsios, ). We contribute to this literature by examining an important but often overlooked variable, franchisee size, as moderating the effects of competition and distance.…”

Surveying the Economics of Plural Modes of Organization

“…Examples of very different types of hybrid arrangements are purely franchised hotels and the management contracts that are so frequent in the hotel business. The difference between these two types of hybrid arrangements is that in the first case, the parent firm grants the franchisee the right to manage the hotel and use the brand name; while in the second case, "a hotel parent company contracts with a developer or real estate owner and manages/operates the hotel for the sake of the local owner, using its own company employees" (Kosová and Sertsios, 2016).…”