Protection Against the Franchisee´s Opportunistic Behavior in Franchise Contracts

Abstract

This master thesis seeks to examine how safeguards in a franchise contract can contribute to prevent opportunistic behavior from the franchisee. The method used to answer the research questions is an integrated method, where the legal method in interaction with the economic methods and theories contributes to answering the research questions. This method is based on the theoretical framework of strategic contracting, focusing on protecting relationship–specific investments and knowledge exchange against opportunism.

A fictitious franchise contract is utilized as a continuing element in the thesis. The contract will be analyzed based on the legal dogmatic method. In Danish law, there exists no lex specialis, and the contract between the parties is therefore the main source of law between the parties. Furthermore, the incentives for opportunistic behavior from franchisees will take their starting point in the new institutional economics. It is concluded that the franchisee has incentives for opportunistic behavior through the fear of a hold-up situation, the fear of termination and a short contract period in connection with relationship-specific investments. It is also concluded that the franchisee acts in his self-interest as there exists information asymmetry between the parties. In particular, the principal-agent theory is used as a framework to determine the incentive for opportunism, where lack of monitoring gives the franchisee a leeway to seek self-interest.

Implementing hold-up safeguards in the fictitious franchise contract shows that the franchisee gets greater incentives to fulfill the requirements of the franchisor. It is concluded that the contract period of three years gives the franchisee an incentive to opportunistic behavior, and it is therefore argued that this should be expanded. Nevertheless, this solution will not be sufficient to prevent the franchisee from shirking towards the end of the contract period. Nor does it make it more costly for the franchisor to terminate the franchisee. As a solution, the analysis has focused on implementing reciprocal real options. Incorporating real options will also compensate the franchisee for parts of its relationship-specific investments. Finally, the implementation of safeguards will demonstrate commitment and trust from the franchisor, which improves the likelihood of collaboration.