An Extended Transaction Cost Model of Decision Rights Allocation
The Case of Franchising
Nada Mumdziev
Center for Business Studies
University of Vienna
Brunner Strasse 72
A-1210 Vienna, Austria
Email: nada.mumdziev@gmail.com
Josef Windsperger
Center for Business Studies
University of Vienna
Brunner Strasse 72
A-1210 Vienna, Austria
Tel: +43 1 4277 38180, Fax: +43 1 4277 38174
Email: josef.windsperger@univie.ac.at
Abstract
The purpose of this paper is to develop an extended transaction cost approach of decision rights allocation in
franchising networks. Specifically, this study demonstrates that when considering trust in transaction cost theory,
(TCT) supplements the explanation offered by the TCT on the allocation of decision rights in franchising networks.
We found that transaction-specific investments have a positive effect on the allocation of decision rights to
franchisees. These findings imply that franchisors tend to delegate decision rights to franchisees when they are able
to reduce formal control, due to the bonding effect of franchisees’ transaction-specific investments. Contrary to the
traditional transaction cost view and compatible with the incentive view of delegation, we found that behavioural
uncertainty has a positive effect on the allocation of decision rights to franchisees. These findings imply that
franchisors tend to delegate decision rights to franchisees when they encounter difficulties in measuring franchisees’
performance and controlling their behaviour. Furthermore, we found that trust functions as moderator in the
relationships between the transaction cost variables and franchisor’s propensity to delegate the decision making
power to the franchisees. Overall, our study contributes to the literature by constructing and testing an extended
transaction cost model to explain the structure of decision rights in franchising networks.
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1. Introduction
Successful franchise firms govern their contractual relations by efficiently allocating
decision rights between the franchisor and franchisees. Decision rights refer to the use of both
the franchisor’s system-specific assets, such as knowledge and skills in site selection, store
layout, product and brand development, buying and merchandising, and the franchisees’ local
market assets, such as their local market know how in advertising, customer service, quality
control, human resource management and product management (Windsperger 2004; Mumdziev
and Windsperger 2011). This study presents an extended transaction cost analysis on the
allocation of decision rights in franchising networks by considering trust as moderator on the
relationship between the transaction costs variables and franchisee’s fraction of decision rights.
Trust can be defined as the expectation that an exchange partner will not engage in
opportunistic behavior, even in the face of tempting short-term incentives (e.g. Bradach and
Eccles 1989; Mayer et al. 1995). Traditional transaction cost literature has neglected the impact
of trust on inter organisational cooperation (e. g. Williamson 1975, 1985) as it primarily focuses
on transaction cost effects of environmental uncertainty, behavioural uncertainty and transactionspecific investments. However, Williamson acknowledged in a later study (1991) that trust
functions as a shift parameter by influencing the comparative cost of governance. Another
justification for incorporating trust into the TC model comes from the alliance literature, which
shows that trust influences the governance of inter-organisational relationships (e. g. Bradach
and Eccles 1989; Gulati 1995; Zaheer and Venkatraman 1995; Noteboom et al. 1997; Alvarez et
al. 2003; Lui and Ngo 2004; Poppo and Zenger 2002; Gulati and Nickerson 2008; Lazzarini et
al. 2008). The results of this work indicate that trust lowers transaction costs in interorganisational relationships, especially when the opportunism risk is high.
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The role of trust as a moderator has received less attention in the inter-organisational
network literature. Recently, Mellewigt et al. (2007) analyse the moderating role of trust in the
relationship between asset specificity and contractual complexity. They conclude that trust
mitigates opportunism risk and reduces contractual complexity as a control device. Ryu et al.
(2008) test if trust plays a moderating role in the relationship between environmental uncertainty
and the propensity for vertical control in the buyer-supplier relationship. The results confirm that
firms tend to loosen vertical control when they trust their exchange partners. Furthermore,
Hoffmann et al. (2010) analyse the role of trust in the firm’s decisions to vertically integrate or
cooperate. Results confirm both an opportunism-mitigating effect of trust that lowers transaction
costs, and an opportunism independent effect that increases the transaction value of the
cooperation.
Despite the large number of studies on trust in alliances, few studies investigate the role
of trust within the franchising context (Dickey et al. 2007; Cochet et al. 2008; Lopez-Fernandez
and Lopez-Bayon, 2011; Davies et al. 2011). Dickey et al (2007) and investigate the influence of
trust on franchisees’ behavior and attitude toward franchisor. They argue that trust will be
developed as a mechanism of reducing franchisees’ opportunistic behavior in areas that are not
covered by the contract. Cochet et al. (2008) analyse franchisors’ reliance on relational
governance mechanisms (such as trust) to attenuate agency problems which arise from
franchisee autonomy. They found evidence that franchise firms use relational governance to
counterbalance their loss of control associated with allocation of decision autonomy to individual
franchisees. Lopez-Fernandez and Lopez-Bayon (2011) found that trust arising from past
relationships has a positive effect on delegation of decision rights. Davies et al. (2011) construct
and test a relational exchange model that demonstrates how trust affects franchisee compliance.
They show that trust reduces non-compliant opportunistic behaviour. Similar to Dickey et al.
(2007), they show that trust reduces the likelihood of franchisees’ non-compliance with
franchisor’s operational guidelines.
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In this study, we propose an extended transaction cost model of decision rights allocation
in franchising. According to the transaction cost theory, the allocation of decision rights aims at
reducing transaction costs, due to transactional uncertainty and transaction-specific investments.
We demonstrate that considering trust in the TCT model supplements the explanation offered by
TCT on the allocation of decision rights in franchising networks. Trust influences the impact of
transaction cost variables (such as uncertainty and transaction-specific investments) on the
delegation of decision rights, because it alleviates opportunism risk and increases information
sharing between the franchisor and franchisees. Specifically, we argue that trust moderates the
impact of behavioural uncertainty, environmental uncertainty and transaction-specific
investments on the delegation of decision rights to franchisees. We found that behavioural
uncertainty and transaction-specific investments have a positive effect on the allocation of
decision rights to franchisees. These findings imply that franchisors tend to delegate decision
rights to franchisees when they encounter difficulties in measuring franchisees’ performance and
behaviour monitoring. This also is likely to occur when they are able to reduce formal control,
due to the self-enforcing effect of transaction-specific investments. In addition, we found that
trust increases the impact of environmental uncertainty and transaction-specific investments on
the allocation of decision rights to franchisees and decreases the positive relationship between
behavioral uncertainty and delegation of decision rights.
This study contributes to the literature in three important ways. Firstly, we extend the
franchise literature that deals with decision rights in franchising (Arrunada et al. 2001; 2005;
Windsperger 2004; Azevedo 2009; Mumdziev and Windsperger 2011; Lopez-Fernandez, LopezBayon 2011) by developing a transaction cost explanation of the allocation of decision rights.
Secondly, we extend the literature which deals with trust in franchising (Dickey et al. 2007;
Cochet et al. 2008; Lopez-Fernandez and Lopez-Bayon, 2011; Davies et al. 2011) by analyzing
the impact of trust on decision rights allocation between franchise partners. Thirdly, this study
extends the transaction costs literature by testing the role of trust as a moderator between the
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transaction costs variables (uncertainty and transaction-specific investments) and the franchisors’
propensity to allocate decision rights to the franchisees. Adding trust as a moderator has
considerably increased the explanatory power of the TC model. Overall, we extend the TCT by
investigating the moderating role of trust in the relationships between the transaction cost
variables and the franchisor’s propensity to delegate decision rights to the franchisees. This
provides new insight by demonstrating that considering trust in TCT supplements the
explanation offered by TCT on the allocation of decision rights in franchising networks.
The paper is organised as follows: Section two presents the extended transaction cost
model of decision rights allocation in franchising. Section three presents the results of the
empirical analysis. In section four we summarise and discuss the results, and in section five we
draw some conclusions.
2. Research Model and Hypotheses
Our research model consists of three transaction costs determinants: behavioural
uncertainty, environmental uncertainty and transaction-specific investments. We test their effect
on the decision rights allocation to franchisees as a dependent variable. Furthermore, we add
trust in the model. Specifically, we hypothesise that trust moderates the impact of behavioural
uncertainty, environmental uncertainty and transaction-specific investments with regard to the
delegation of decision rights (see Figure 1).
Insert Figure 1
2.1 Behavioural uncertainty, trust and decision rights
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Transaction cost theory views behavioural uncertainty as arising from the difficulties of
accurately monitoring the contractual performance of exchange partners (Williamson 1985).
Anderson and Gatignon (1986) define this concept as internal uncertainty, which exists when the
firm cannot accurately measure agent’s performance. In the application of a TC model to explain
firms’ make-or-cooperate decision, Hoffmann et al. (2010) find that higher performance
measurement difficulties significantly increase the firms’ tendency to vertically integrate.
Behavioural uncertainty increases the risk of opportunism that arises in the form of various
dishonest and detrimental behaviour, such as cheating, shirking or distortion of information. In
order to reduce the risk of franchisee’s opportunistic behaviour, the franchisor exercises greater
control over the transaction partner’s activities (Williamson 1985; Gatignon and Anderson
1988). One way is to impose stronger control by centralising decision making. According to this
traditional transaction cost view (Williamson 1975; Hennart 1991), we expect a negative
relationship between behavioural uncertainty and franchisees’ portion of decision rights.
Therefore, we formulate the following hypothesis:
H1: Franchisees’ portion of residual decision rights is negatively related with franchisors’
perception of behavioural uncertainty.
If a franchisor perceives the franchisee as trustworthy, this will influence his perception of
behavioural uncertainty and hence its propensity to use formal control mechanisms. Trustworthy
franchisees need to be less monitored under high difficulties to measure the performance of the
network partners. As a result, the higher trust as informal control device, the lower the
franchisor’s necessity for hierarchical control by centralising decision making in the case of
performance measurement difficulties becomes. Consequently, we can derive the following
hypothesis:
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H1a: The relationship between behavioural uncertainty and franchisee’s portion of
decision rights is less negative under high trust.
2.2 Environmental uncertainty, trust and decision rights
According to the control view of governance (Williamson 1975), firms will increase their
information-processing capacity if the coordination requirements increase with environmental
uncertainty. Stinchcombe (1990) asserts that organisations implement more elements of
hierarchy when the degree of uncertainty increases. Similarly, Noordewier et al. (1990) show
that environmental uncertainty is positively related with firm’s level of control. Therefore, when
franchisors perceive increased environmental uncertainty (such as market volatility and low
predictability of sales volume), they intend to increase control over operational decisions at the
local markets. We subsequently formulate the following hypothesis:
H2: Franchisees’ portion of residual decision rights is negatively related with
environmental uncertainty.
In high-trust relationships that facilitate information exchange and reduce opportunistic
behaviour between the partners, franchisors will rely more on delegation of decision rights to
franchisees when environmental uncertainty increases. Therefore, the negative effect of
environmental uncertainty on the allocation of decision rights is expected to be lower if
franchisors trust their franchise partners. We formulate the following hypothesis:
H2b: The relationship between environmental uncertainty and the franchisee’s portion of
the decision rights is less negative under high trust.
2. 3 Transaction-specific investments, trust and decision rights
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According to the transaction cost theory, transaction-specific investments increase the
partners’ quasi-rents that can be expropriated by the less dependent partner (Williamson 1985;
Klein 2000). When the transaction-specific investments of the franchisees are high, their quasirents are likely to exceed the potential hold-up gains from opportunistic behaviour. This bonding
effect increases the self-enforcing range of contracts (Klein 1995, 1996). In this situation, the
hostage effect of transaction-specific investments motivates the franchisees to behave
cooperatively in order to realise the relationship-specific quasi-rents (Williamson 1983; Katz
2008).
This incentive effect of transaction-specific investments may influence the allocation of
residual decision rights in the following way: Based on the traditional TC-view, decision rights
are control devices to mitigate opportunism risk. The higher the opportunism risk for the
franchisor, the higher is the degree of control by the headquarters. On the other hand, high
franchisees’ transaction-specific investments result in lower opportunism risk, thereby requiring
a lower level of control by the franchisor. Therefore, the higher the franchisees’ specific
investments, the lower their motivation to behave opportunistically becomes, and the lower the
franchisor’s need to monitor and control the franchisees by centralisation of decision making
becomes, and hence the more residual decision rights are transferred to the franchisees. We can
derive the following hypothesis:
H3: Franchisees’ portion of residual decision rights is positively related with
franchisees’ transaction-specific investments.
Since transaction-specific investments result in high quasi-rents, which in turn increase the
franchisee’s motivation to cooperate, higher trust increases the quasi-rent-generating effect of
transaction-specific investments. Through this, the self-enforcing range of contract increases
(Hwang 2006). In this case, the franchisor reduces hierarchical control by transferring a higher
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fraction of decision rights to the franchisees, compared to a situation with a lower level of trust.
Therefore, we expect that trust will positively interact with the effect of the transaction-specific
investments on the allocation of decision rights to franchisees. In other words, the positive effect
of transaction-specific investments on the allocation of decision rights to the franchisees will be
stronger in a high-trust situation. We formulate following hypothesis:
H3a: The relationship between transaction-specific investments and franchisee’s portion
of the decision rights is more positive under high trust.
3. Empirical Analysis
The empirical data for this study was collected via questionnaire from German franchise
systems. To obtain the list of all franchise systems active in Germany and their contacts, we used
the directory of the German Franchise Federation (DFV) and “Franchise Wirtschaft” (a Bond’s
Franchise Guide type directory published in Germany). The questionnaire was developed in
several steps, refined and discussed within in-depth interviews with franchise experts and
practitioners. Finally, we conducted a pre-test with 20 franchisors in Austria. We used the key
informant approach for the data collection (McKendall and Wagner III, 1997) to choose the
respondents. Most of them were senior managers responsible for the franchise expansion. The
questionnaires were sent to 491 relevant franchise systems. We received 137 completed
questionnaires, which is a response rate of about 28%. The non-response bias was estimated by
comparing early versus late respondents (Armstrong and Overton, 1977). Furthermore, the
respondents were also compared regarding their age, size, advertising fee and royalties to
determine whether non-response was a problem for the data, because these variables were
available in the Franchise Wirtschaft.
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3.1 Measurement
Dependent variable
Decision rights: Based on the measure developed by Windsperger (2004), residual
decision rights are measured by asking franchisors to assess the influence of franchisee’s on the
following decisions: selection of suppliers, procurement of equipment, procurement of inputs,
price decision, product/service offering, advertising decision, recruitment and training on the
outlet level, choice of investment projects and financing of investment projects on the outlet
level, decisions on the introduction of new products in the local market, and the application of
controlling system. The strength of franchisees’ influence on those decisions was assessed on a
seven-point scale (1 = no influence, 7 = very high influence). By averaging the scale values we
constructed a decision index varying between 1 and 7. The higher the index, the higher is the
franchisee's influence on residual decision making, i.e. franchisees’ fraction of decision rights.
Independent variables
Trust: We measure partner-related trust with four items by asking the franchisor to assess
the following items on a 7-point Likert scale: level of confidence between them and their
franchise partners, atmosphere of openness and honesty with their partners, readiness of
franchisees to cooperate when they are trusted and trustworthiness of their franchise partners.
Our indicators focus on the behavioural dimension by conceptualising trust as confidence the
franchisors have on the reliability and integrity of the network partners. All factor loadings
exceeded the threshold of 0.70. Reliability analysis was assessed by Cronbach’s alpha (0.87).
Behavioural uncertainty: Behavioural uncertainty arises from the inability to monitor and
control the performance of the local partners (Rindfleisch and Heide, 1997; Williamson, 1991).
Therefore, we measure behavioural uncertainty by asking respondents to assess the following
items on a 7-point Likert scale: difficulty to measure performance, control behaviour and
difficulty to assess the capabilities and competencies of the local managers (franchisees). Factor
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0
analysis confirmed the underlying construct, with all variables loading above the threshold of
0.70. Cronbach’s alpha is 0.758.
Environmental uncertainty: The measure of environmental uncertainty is based on Celly,
Frazer (1996) and John and Weitz (1988). To measure this construct, we asked respondents to
assess the following items on a 7-point Likert scale: possibility to forecast the local market
development and fluctuations of outlet sales at the local market. Cronbach’s alpha is 0.56 which
is relatively low. However, recent research assigns more significance to maximise validity rather
than internal consistency (John and Benet-Martinez 2000). According to Pedhazur and
Schmelkin (1991), reliabilities above 0.5 can be viewed as acceptable under the condition of
construct validity.
Franchisees’ specific investments: According to the transaction cost theory, the
governance form is influenced by transaction-specific investments of the franchisees (Klein
1995; Williamson 1983). The natural log of franchisees’ initial investments represents
franchisees’ transaction-specific investments.
Control Variables
Sector: This is a dichotomous variable: 0 refers to services franchising and 1 to product
franchising. Due to the different know-how intensity of product and services firm, their impact
on the allocation of decision rights may also differ.
Size: The size of the network was operationalised by the total number of outlets. From the
transaction costs perspective, larger firms have a greater ability to absorb risk and a higher
coordination and control capacity (Erramilli and Rao 1993). Therefore, we expect that larger
franchise firms can realise economies of coordination and monitoring, thereby increasing control
over operational decisions.
3.2 Results
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Descriptive statistics
Table 1a shows the descriptive statistics. The sample of 127 German franchise systems contains
81 “service franchising” and 46 “product franchising” systems. The decision rights (DR)-index
has a minimum value of 2.25 and the maximum of 7. The closer the index value to 7, the
stronger the franchisees’ influence on operational decisions. A mean of 5.13 indicates relatively
high influence of franchisees on the analysed decisions.
Insert Table 1a
The descriptive statistics regarding the components of the dependent variable (decision rightsindex) is specified in Table 1b. The values from 1 to 7 represent the extent to which franchisees
have influence on a particular decision (1 = no influence on the decision; 7 = very high influence
on the decision). Generally, we can divide them into values <5.00 and >5.00. The mean values
which are <5.00 refer to the decisions regarding suppliers, product, equipment and inventory
procurement, innovation of products/services and controlling system. These decisions are closely
related to the business concept (e. g. which product to offer, which inventory or equipment to use
to ensure the quality level, which suppliers will provide final or intermediary products and which
controlling system to use). On the other hand, the decisions such as recruitment, employee
training, advertising and price decisions, as well as investments and financing, are under stronger
influence of the franchisees. This may indicate that franchisees’ local market knowledge and
managerial capabilities play a more important role for these decisions. Table 2 presents the
correlations between the variables used in the regression analysis. None of the correlations seem
to be large enough to indicate concern about multicollinearity (Hair et al. 1995).
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Insert Table 1b
Insert Table 2
Regression results
The hypotheses are tested by applying multiple regression analysis. Results are shown in Table
3. Model 1 includes only the control variables. Model 2 includes the TC variables
(environmental uncertainty, behavioural uncertainty and transaction-specific investments) and
tests H1, H2, and H3. The moderating effect of trust, hypothesised by H1a, H2a, H3a, is tested in
models 3-6.
Insert Table 3
Model 1 shows that the control variables have no significant effects on allocation of decision
rights. Model 2 includes behavioural uncertainty, environmental uncertainty and franchisees’
transaction-specific investments, which then tests the first-order effects on the franchisee’s
portion of decision rights. Behavioural uncertainty has a positive and strongly significant
influence on the delegation of decision rights (ß= 0.486; p < .01). Although the coefficient is
significant, this result does not confirm the transaction cost hypothesis H1. A positive sign of the
coefficient implies that the franchisors actually delegate more decision rights when they
encounter difficulties in measuring franchisees’ performance and controlling his/her behaviour.
This result is compatible with the incentive view of delegation (Aghion and Tirole 1997). Under
higher behavioural uncertainty, the franchisors provide more incentives by delegation of
operational decisions. This result is robust across all tested models. The negative coefficient of
environmental uncertainty is slightly supportive of the hypothesis H2 (ß= -0.209; p <.10). This
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result confirms that franchisors tend to implement more elements of hierarchy, i.e. centralised
decision making, when the degree of external uncertainty increases. The coefficient of initial
investments, representing the effect of franchisee’s transaction-specific investments on the
allocation of decision rights, has the expected positive sign indicating that higher franchisees’
transaction-specific investments will result in more delegation of decision rights. However, the
coefficient is not significant.
In Models 3-6, we use moderated regression analysis (MRA) to examine the moderating
effects of trust on the allocation of decision rights (Sharma et al. 1981). For the analysis, the
scores of the main effects are mean-centered to avoid problems of multicollinearity. The
correlations between the interaction terms and the centered main effect variables do not indicate
any problems with multicollinearity. In addition, all VIF values in our model were below the
value of 2, indicating no problem with multicollinearity (Belsley et al. 1980).
Model 3 tests the moderating effect of trust on the relationship between behavioural
uncertainty and decision rights allocated to franchisees. H1a hypothesised that the negative
relationship between behavioural uncertainty and franchisee’s portion of decision rights will be
subdued under high trust. The interaction coefficient is negative and significant (ß= -0.204, p <
.05) indicating that trust as implicit bond weakens the positive impact of behavioural uncertainty
on the delegation of decision rights. Consequently, under high performance measurement
difficulties, the franchisors have less need to delegate decision rights as formal incentives when
they trust their partners. Furthermore, the results show that both the main effects - behavioural
uncertainty and trust - and their interaction terms are statistically significant. This means that
trust not only interacts with behavioural uncertainty, but also directly impacts the delegation of
decision making to franchisees. Trust is therefore a quasi moderator (Sharma et al. 1981). Its
moderator effect is thus not clear, as each of the interaction components (behavioural uncertainty
and trust) could be interpreted as a moderator. However, TC-theory provides the theoretical
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justification for treating trust as a moderator variable, as the traditional TC-theory neglects the
existence of trust between transaction partners and its effect on the governance choice. 1 The
effect of this interaction term is also confirmed in Model 6, where all interaction terms are
included in the model.
In Model 4 we test H2a, which predicts that trust will weaken the negative effect of
market uncertainty on the allocation of decision rights to franchisees. The interaction coefficient
is positive and strongly significant (ß= 0.272, p<0.01) indicating that - under high trust franchisors reduce control over operational decisions and rely more on franchisees’ decisions
when environmental uncertainty increases. Therefore, the negative effect of environmental
uncertainty becomes weaker by the trust variable. The main effect of the environmental
uncertainty, although negative as expected, is not significant. Similar to Model 3, trust is a quasi
moderator, as its main effect is statistically significant. This indicates that even if the value of
environmental uncertainty were zero, trust would still have a positive effect on the dependent
variable. This moderation effect remains statistically significant in the Model 6 as well.
Model 5 provides results for the hypothesis H3a, which predict a positive moderating
effect of trust on the relationship between franchisees' initial investments and decision rights.
Although positive as expected, the coefficient of the interaction term is not statistically
significant. Finally, Model 6 provides the regression results with all three interaction terms
included in the regression analysis. In this model, all interaction effects are statistically
significant. Contrary to the results in Model 5, the moderating effect of trust on the relationship
between initial investments and decision rights is significant and positive as expected (b= 0.278,
p<0.01). This provides support for hypothesis H3a. Since trust increases the quasi rentgenerating effect of transaction-specific investments, the delegation-increasing effect of higher
transaction-specific investments is higher under high trust. The coefficient of trust as the main
1
According to Sharma et al. (1981), the search for moderator variables should be guided by theory rather than by strict
empiricism and the definition of moderator variable need not be limited to the psychometric definition (which suggests only pure
moderators).
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effect is also positive and strongly significant (ß= 0.329, p<0.01). The adjusted R² reaches 0.440,
indicating that the model explains 44 % of the variance. Overall, the empirical results provide
some support of the transaction cost hypotheses. In addition, the results show that trust as a
moderator has significantly improved the explanatory power of the transaction costs model.
4. Discussion and Implications
This paper presents an extended transaction cost model decision rights allocation in
franchising. Specifically, it investigates the influence of the transaction cost variables
(behavioural uncertainty, environmental uncertainty and transaction-specific investments) as
well as trust as a moderator on the allocation of decision rights to franchisees. The empirical
results from the German franchise sector provide partial support of our TC hypotheses. First, we
find that behavioural uncertainty has a positive effect on the allocation of decision rights to
franchisees. In contrast to our transaction cost interpretation, these findings imply that
franchisors tend to delegate decision rights to franchisees when they encounter difficulties in
monitoring behaviour, and measuring performance of the franchisees. This result is compatible
with the incentive view of delegation (e.g. Aghion and Tirole 1997; Baker et al. 1999). Aghion
and Tirole argue that delegation of decision rights to the agents increases their incentives to
search for and develop projects. Consequently, in a situation of high behavioural uncertainty, the
franchisors provide more formal incentives through delegation instead of tightening control.
Secondly, we find some support for the hypothesis that franchisors transfer less residual decision
rights to the franchisees when they perceive higher environmental uncertainty.
Furthermore, our results provide strong evidence of the moderating role of trust in the
relationships between the transaction cost variables and the franchisees’ fraction of decision
rights. We find that trust reduces the negative impact of environmental uncertainty on
franchisor’s control over operational decisions. In a situation of high environmental uncertainty,
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the franchisors will transfer more decision rights to the franchisees, if they are perceived to be
trustworthy, i.e. believe that they will not take advantage of an uncertain business environment
for short-term opportunistic gains. This result is similar to the findings of Ryu et al. (2008) who
found that trust weakens positive relation between manufacturers’ perception of environmental
uncertainty and their propensity for vertical integration. Furthermore, we find that trust as
implicit bond weakens the impact of behavioural uncertainty on delegation of decision rights.
Therefore, in a high-trust situation, the franchisors have less need for delegating decision rights
as formal incentives. Finally, we find that trust increases the bonding effect of transactionspecific investments, hence strengthening their positive impact on the delegation of decision
rights to franchisees. Interestingly, the results show trust functions as a quasi-moderator, as it has
statistically significant direct and indirect effects on the dependent variable. Although the
moderating effect of trust is significant, a significant main effect of trust is not expected by the
transaction costs theory. This result could be explained from a relational governance perspective.
This view sees trust as a principal mode of informal control (Ring and Van de Ven 1992) which
implies that the franchisor’s reliance on the goodwill and integrity of the network partners (Ring
1996) has a direct impact on the governance choice. Contrary to this view, the role of trust in TC
theory depends on its capacity to reduce the likelihood of opportunistic behaviour by an
exchange partner. Consequently, trust has a moderating role on the impact of the transaction cost
variables on the choice of formal governance (i.e. allocation of decision rights). In conclusion,
our empirical results demonstrate that considering trust in the TC model supplements the
explanation of the allocation of decision rights in franchising offered by the TC theory.
Implications and Limitations
This study has important implications for both researchers and franchisors.
Complementary to the agency-theoretical and property rights perspectives (Arrunada et al., 2001,
2005; Azevedo, 2009; Windsperger 2004), we develop an extended transaction cost explanation
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of the decision rights allocation in franchising networks. Specifically, we extend the transaction
cost theory by considering trust as moderating mechanism between transaction cost variables and
decision rights as formal governance mechanism. We find some support that the transaction cost
variables and trust (as moderating variable) impact the allocation of decision rights between the
franchisor and franchisees. This analysis provides new insight regarding the allocation of
residual decision rights in franchise relationships. Specifically, the moderating role of trust
indicates that trust increases delegation of decision rights to the franchisees, when franchisees’
transaction-specific investments and environmental uncertainty are high. On the other hand, trust
as an implicit bond reduces delegation as formal incentives, especially when it is difficult to
measure franchisees’ performance. Furthermore, our study also contributes to the literature on
the relationship between formal governance and trust. Consistent with the relational governance
view (e. g. Poppo and Zenger, 2002; Lui and Ngo 2004; Yu et al. 2006; Mellewigt et al. 2007),
the findings of this study show that trust is quasi-moderator by directly influencing the allocation
of decision rights.
The results of our study yield practically relevant knowledge for franchisors seeking to
allocate residual decision rights in the franchise system. Based on the incentive view of
delegation, the franchisor should delegate a higher fraction of decision rights to the franchisees
when behaviour control and performance measurement at the local outlet are difficult. On the
other hand, the TC-view suggests that the franchisor should increase control over operational
decisions when the environmental uncertainty is high. By contrast,, the franchisor or franchisormanager has always to consider in their governance decisions that trust-based relationships with
franchisees will increase the efficiency advantages through delegation
Finally, our study has some important limitations: Firstly in our study, the influence of
the variables used in the regression analysis depends on measures based on the franchisors’
evaluation. However, franchisors’ assessment could to some extent deviate from franchisees’
evaluations. To include both perspectives would contribute to the reliability of the measures.
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Secondly, since franchising networks evolve, the role of trust might vary with the relationship
cycle. To grasp the dynamics of trust between the franchise partners a longitudinal design would
be beneficial. A third limitation of this study is that we examined the impact of transaction cost
variables and trust on decision rights, without investigating the performance implications of the
allocation of decision rights for the franchisor. Future research has to investigate the relationship
between the decision rights structure and the efficiency of the franchise systems.
5. Conclusion
Our study offers an extended transaction cost explanation of the allocation of decision
rights in franchising. We demonstrate that considering trust in transaction cost theory
supplements the explanation offered by the transaction cost theory on the allocation of decision
rights in franchising networks. The results indicate that trust moderates the impact of transaction
cost variables on the allocation of decision rights between the franchisor and franchisees.
Overall, we contribute to the franchising literature by constructing and testing an extended
transaction cost model to explain the structure of decision rights in franchising networks.
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APPENDIX
Figure 1 Research Model
Table 1: Descriptive statistics
VARIABLE
Sector
N
Max
Mean
Std. Dev.
1
2,520
155.84
328,42
127
Product franchising
46
Service franchising
81
Size
Min
118
2
2
Franchisees’ specific investments
114
600.00
2,050,000
130.942.4
DR Index
127
2.25
7.00
5.13
0.10
Measurement of performance
127
1
7
3.33
0.140
Control of behavior
127
1
7
4.20
0.136
Assessment of capabilities
127
1
7
3.35
0.139
Market development predictions
127
1
7
3.78
0.145
Outlet sales predictions
127
1
7
4.01
0.160
Cooperation on partnership basis
127
1
7
6.10
0.094
Information exchange between partners
127
1
7
5.38
0.124
Existence of trust between partners
127
1
7
5.83
0.099
Openness and honesty between partners
127
1
7
5.87
0.097
22.819.40
Behavioral uncertainty
Environmental uncertainty
Trust
Table 2: Correlations between regression variables
Decision
rights
Decision rights
Sector
Size
Behavioral Environm. Specific
uncertainty uncertainty investments
Trust
1
Sector
0.038
1
Size
0.160
0.053
1
Behavioral uncertainty
.370**
-0.045
0.071
1
Environmental uncertainty
-0.085
-0.102
0.014
0.129
1
Specific investments
0.021
-0.011
0.088
0.061
- .313**
1
Trust
.357**
0.096
0.045
-0.056
- .365**
0.056
1
** Correlation is significant at the 0.01 level (2-tailed).
* Correlation is significant at the 0.05 level (2-tailed).
2
3
Table 3: Regression results+
MODEL
Dependent variable:
Decision rights index
1
2
3
4
5
6
5.190***
(0.136)
5.141***
(0.133)
5.131***
(0.120)
5.205***
(0.133)
5.168***
(0.122)
5.212***
(0.114)
Sector
+ 0.076
(0.220)
+ 0.191
(0.208)
+ 0.217
(0.189)
+ 0.267
(0.184)
+ 0.150
(0.193)
+ 0.266
(0.178)
Size
+ 0.001
(0.000)
+ 0.000
(0.000)
+ 0.000
(0.000)
+ 0.000
(0.000)
+ 0.000
(0.000)
+ 0.000
(0.000)
Control variables
Constant
Transaction cost hypotheses
+ 0.486***
(0.101)
H1 Behavioral uncertainty
+ 0.568*** + 0.610*** + 0.492*** + 0.619***
(0.096)
(0.094)
(0.096)
(0.092)
H2 Environmental uncertainty
- 0.209*
(0.115)
- 0.107
(0.115)
- 0.107
(0.108)
- 0.043
(0.113)
- 0.209**
(0.110)
H3 Franchisees’ specific investments
+ 0.142
(0.112)
- 0.098
(0.101)
- 0.178*
(0.100)
- 0.095
(0.108)
- 0.088
(0.100)
Moderator effects of Trust
+ 0.474*** + 0.363*** + 0.429*** + 0.329***
(0.099)
(0.097)
(0.101)
(0.099)
Trust
- 0.204**
(0.095)
H1a Trust × Behavioral uncertainty
- 0.166*
(0.095)
+ 0.272***
(0.081)
H2a Trust × Environmental uncertainty
+ 0.054
(0.094)
H3a Trust × Specific investments
N
F-test
R²
Adjusted R²
+
+ 0.345***
(0.090)
116
1.518
0.026
101
6.055***
0.240
0.009
0.200
101
101
101
8.874*** 10.379*** 7.907***
0.396
0.436
0.371
0.353
0.394
0.324
+ 0.278***
(0.098)
101
9.812***
0.490
0.440
Standardized regression coefficients are reported. *** p < .01; ** p < .05; *p < .1;
2
4
APPENDIX: MEASURES OF VARIABLES
Variable
Items
Trust
Please assess the following statements on a scale 1 – 7:
1 = not true at all; 7 = true to the high extent
(1-1)
(1-2)
The cooperation is based on partnership basis
(1-3)
The exchange of information between us and the partners goes beyond the
agreed scope
There is great trust between ourselves and the partners
(1-4)
There is an atmosphere of openness and honesty between us and the partners
Behavioral
uncertainty
Please assess the following statements on a scale 1 – 7:
1 = I do not agree at all; 7 = I fully agree
(2-1)
It is difficult to measure performance of the franchisees.
(2-2)
It is very difficult to control the behavior of the franchisees.
(2-3)
It is very difficult to assess the competencies and capabilities of franchisees.
Environmental
uncertainty
Please assess the following statements on a scale 1 – 7:
1 = I do not agree at all; 7 = I fully agree
(3-1)
It is very difficult to predict the market development at the outlet level
(3-2)
Franchisees’
specific
investment
DR Index
The sales at the outlet level are very fluctuating.
(4-1)
(4-2)
(4-3)
(4-4)
(4-5)
(4-6)
(4-7)
(4-8)
(4-9)
Investment decision
Financing decision
Supplier decision
Recruiting decision
Employees’ training decision
Product/service decision
Resale price decision
Advertising decision
Accounting system decision
Sector
0 = service franchising; 1 = product franchising
Size
Number of franchised and company-owned outlets
Natural log of initial investments (in EUR)
To which extent do franchisees have influence on following decisions?
Scale 1-7 (1 = no influence at all; 7 = to a very high extent)