CONTRACTS, EXTRA-CONTRACTUAL INCENTIVES, AND EX POST BEHAVIORIN FRANCHISE CHANNEL RELATIONSHIPS

Vishal KashyapAssociate Professor of Marketing

310 Smith Hall3718 Ledgewood Avenue

Williams College of Business Xavier University

Cincinnati, OH 45207-1214Ph: (513) 745-3286Fax: (513) 745-3692

e-mail: kashyapv@xavier.edu

Kersi D. AntiaAssistant Professor of Marketing

School of BusinessUniversity of Wisconsin-Madison

975 University AvenueMadison, WI 53706Ph: (608) 263-7720Fax: (608) 262-0394

e-mail: kantia@bus.wisc.edu

Gary L. FrazierRichard and Jarda Hurd Professor of

Distribution ManagementMarshall School of Business

University of Southern CaliforniaLos Angeles, CA 90089

Ph: (213) 740-5032Fax: (213) 740-7828

e-mail: frazier@marshall.usc.edu

May 6, 2023

_____________________________________________________________________________We are grateful for the assistance on data collection provided by Bharat L. Sud, to the participants of the First Erin Anderson Invitational B to B Conference at the Wharton School of Business and of the research seminars at Case Western Reserve University, the University of Minnesota, and the University of Southern California for their feedback. We greatly appreciate the helpful comments of Jan Heide on earlier versions of the manuscript.

CONTRACTS, EXTRA-CONTRACTUAL INCENTIVES, AND EX POST BEHAVIORIN FRANCHISE CHANNEL RELATIONSHIPS

ABSTRACT

Grounded in agency theory, this study examines how franchisors’ ex ante contracts and

extra-contractual incentives influence their ex post monitoring and enforcement efforts, and how

combinations of the ex post governance mechanisms drive franchisee behavior. Integrating three

different archival data sources and a survey of 206 franchisees across eight automotive brands,

we find that franchisor reliance on contractual completeness substitutes to some degree for ex

post behavior monitoring and enforcement efforts, while contractual one-sidedness is associated

with more frequent behavior monitoring, but fewer enforcement efforts. Extra-contractual

incentives, when offered to the franchisee, are associated with higher levels of monitoring and

enforcement. Importantly, different combinations of franchisor monitoring and enforcement

efforts are shown to impact franchisee compliance and opportunism, sometimes with

counterproductive results. Compliance appears facilitated by high levels of behavior and output

monitoring, and output monitoring and enforcement, while reduced by high levels of behavior

monitoring and enforcement. In contrast, franchisee opportunism appears curtailed by a

combination of frequent behavior and output monitoring by the franchisor, but heightened by

franchisor reliance on behavior monitoring and enforcement efforts. The study provides an initial

baseline of understanding on how ex ante governance characteristics and combinations of ex post

governance mechanisms function to facilitate or deter franchisee compliance and opportunism.

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Franchise channel systems enable franchisors to achieve rapid market expansion and

extensive market coverage while leveraging the resources and efforts of associated franchisees

(Coughlan et al. 2007). At the same time, control problems arise in any franchise system.

Franchisors entrust their trademarks and business plans to independent franchisees that vary in

their motivation and ability to adequately represent franchisor offerings (Dahlstrom and Nygaard

1999). To ensure the successful functioning of the franchise system, franchisors must effectively

govern their channel relationships with associated franchisees.

Agency theory provides a useful lens to examine governance mechanisms and their role

in ensuring appropriate agent behavior. Specifically, “…agency theory adopts an ex ante view of

relations between principal and agent. Its emphasis is on precluding or minimizing ex post costs

through an ex ante alignment of incentives” (Bergen, Dutta, and Walker 1992, p. 8), using

appropriately designed contractual terms. In addition to the incentives built into the contract, the

principal may also offer extra-contractual incentives to their agents for additional efforts on

behalf of its brand (Klein and Leffler 1981). Although distinct in their administration (Murry and

Heide 1998), both contractual terms and extra-contractual incentives are designed to provide

agents with an earnings stream that exceeds the short-term gains from shirking or noncompliance

(Klein 1980). Such ex ante governance mechanisms may influence the principal’s need to

undertake ex post monitoring and enforcement (Agrawal and Lal 1995; Antia and Frazier 2001).1

Table 1 provides an overview of empirical studies in marketing focused on formal

governance mechanisms and corresponding agent outcomes in inter-firm relationships. Although

the insights afforded by prior research are impressive, significant research gaps still remain.

First, our understanding of the widely theorized safeguarding role of explicit contracts remains

rudimentary. Despite the development of an impressive body of theoretical work on contracts

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over the last three decades, the relative difficulty of obtaining actual contracts has hindered

empirical studies of the phenomenon. The few studies that have examined contracts empirically

have focused exclusively on understanding the drivers and performance consequences of

contractual completeness2 (Ghosh and John 2005; Lusch and Brown 1996; Mooi and Ghosh

2010). Further, the important role of extra-contractual incentives in bringing about desired agent

behaviors has been all but ignored (for a notable exception, see Murry and Heide 1998).

Second, there is considerable disagreement on the impact of the principal’s ex post

governance efforts on agent behavior. With respect to monitoring, for example, despite strong

expectations of a negative association between monitoring and agent opportunism (Alchian and

Demsetz 1972; Jensen and Meckling 1976), some studies find evidence of an opportunism-

engendering effect (John 1984; Murry and Heide 1998; Crosno and Dahlstrom 2008). The

potential efficacy of enforcement is even less clear because of the limited empirical attention

paid to the phenomenon (Antia and Frazier 2001; Antia, et. al. 2006).

The third critical gap in our understanding of channel governance pertains to the scope of

agent behaviors considered. As evident from Table 1, prior research has focused primarily on

understanding how diverse governance tools relied on by the principal might serve to minimize

agent opportunism. Though necessary, a lack of opportunism represents an insufficient

foundation for strong channel relationships. The health and long-term viability of the franchise

system depends both on franchisor efforts to ensure franchisee compliance with established

policies and procedures, as well as on curbing franchisee opportunism more generally. Clearly,

there is much to be gained from examining both relevant facets of agent responses to the

principal’s governance efforts.

-----Insert Table 1 about here-----

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The objective of this study is to enhance understanding of how alternative (ex ante and ex

post) formal governance mechanisms used by franchisors impact franchisee compliance and

opportunism. Based on agency theory (henceforth, AT), a model is developed that examines how

ex ante deployment of explicit contracts and extra-contractual incentives by franchisors shapes

their ex post monitoring and enforcement efforts. In turn, these ex post governance efforts are

hypothesized to have differential effects on agent compliance and opportunism. We test our

conceptual framework in the context of franchisor-franchisee channel relationships in the US

automotive industry, combining insights from three different archival sources and a survey of

206 franchisees across eight automotive brands.

The present research makes three key contributions to our understanding of channel

governance issues. First, we identify and assess the inter-relationships among an expanded set of

ex ante and ex post governance mechanisms and franchisee behaviors. We not only examine

contractual completeness (e.g., Ghosh and John 2005), but also consider contractual one-

sidedness (e.g., Klein 1980) and extra-contractual incentives as ex ante governance mechanisms

relevant to the principal’s control objectives. These ex ante governance mechanisms are

hypothesized to influence an expanded set of ex post governance mechanisms - behavior and

output monitoring (Heide, Wathne, and Rokkan 2007) and enforcement (Antia and Frazier 2001;

Antia et al 2006). In turn, we link combinations of the ex post governance mechanisms to the

franchisor’s ability to facilitate or deter franchisee compliance and opportunism. Together, our

consideration of multiple facets of governance and agent behaviors yields rich insights into how

franchise channel relationships operate and function.

Our second contribution lies in providing a better understanding of the interrelationships

that exist among multiple ex ante and ex post formal governance mechanisms. In doing so, our

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study is able to inform the critical question of whether ex ante contract characteristics and extra-

contractual incentives serve as substitutes or complements of ex post governance mechanisms.

Our third contribution is to examine how combinations of ex post mechanisms impact

agent behaviors. We build on and significantly extend prior research (Antia et al 2006; Heide,

Wathne, and Rokkan 2007) on the efficacy of the principal’s governance efforts. We take as our

point of departure the widely acknowledged notion that “…Governance mechanisms are often

used simultaneously to take advantage of their differential impacts” (Brown, Dev, and Lee 2000,

p. 54; also see Anderson and Dekker 2005, p. 1737 and Heide Wathne, and Rokkan 2007, p.

431), and show how combinations of the three endogenously determined ex post governance

mechanisms – behavior monitoring, output monitoring, and enforcement – influence levels of

agent compliance and opportunism.

The next section provides an overview of our AT-informed conceptual framework, the

rationale for the particular governance mechanisms and agent behaviors we chose to study, and

our specific hypotheses. This is followed by the description of our empirical context, data

collection and model specification approach, and the results of our model estimation. We

conclude with a discussion of our findings, limitations, and future research directions.

CONCEPTUAL FRAMEWORK

Agency Theory Foundation

In franchise systems, agency relationships are present whenever one firm (the principal)

relies on another firm (the agent) to undertake an action or set of actions on the principal’s

behalf. AT presumes that control problems in principal-agent relationships arise as a

consequence of differences in the goals, information, and risk preferences of the parties (Bergen,

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Dutta, and Walker 1992; Eisenhardt 1989). The focus of AT is on governance mechanisms or

tools that principals use to gain control over agent actions.

Within the AT literature, the two prevalent governance mechanisms are explicit contracts

and monitoring (Bergen, Dutta, and Walker 1992; Eisenhardt 1989). It has been established that

“most of the agency theory literature addresses explicit, formal contracts” (Bergen, Dutta, and

Walker 1992, p. 2). Explicit contracts represent an ex ante mechanism of management control

(Anderson and Dekker 2005). However, explicit contracts are necessarily incomplete, and, “…

even in the presence of mutually agreeable contracts, hazards remain” (Anderson and Dekker

2005, p. 1734). Therefore, along with explicit contracts, ex post monitoring is fundamental to

principals in acquiring more complete information on agent actions and outcomes and aligning

goals (Jensen and Meckling 1976). Franchisor behavior monitoring involves metering franchisee

actions or processes that are expected to produce certain outcomes (Heide, Wathne, and Rokkan

2007). In contrast, franchisor output monitoring reflects metering the visible consequences of

franchisee actions (Heide, Wathne, and Rokkan 2007), such as the franchisee’s market

penetration, overall sales volume, and sales growth.

Furthermore, a presumption in agency theory is that principals will take a full

enforcement approach to agent contract violations. In franchise channel systems, this

presumption is incorrect, because franchisor enforcement responses are likely to vary

significantly in their severity (Antia and Frazier 2001). Therefore, enforcement is a distinct ex

post governance mechanism when AT is applied to franchise systems.

Finally, AT posits that ex ante contracts and ex post monitoring serve to align goals,

thereby helping to motivate agent compliance. It is common, however, for principals to offer

extra-contractual incentives to agents to elicit efforts above and beyond those contractually

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specified (Murry and John 1998). The provision of such extra-contractual incentives is consistent

with the principal’s governance objectives and is also likely to play an important role in shaping

franchisor monitoring and enforcement efforts. We therefore include extra-contractual incentives

among the formal governance mechanisms of interest to us.

Explicit Contracts and Their Key Dimensions

The central contracting problem facing the principal is to offer ex ante contract terms that

induce the agent’s best efforts on behalf of the principal. The literature on contracting identifies

two primary means of achieving this objective: (a) aligning the interests of the principal and

agent and (b) specifying agent obligations on behalf of the principal. The first imperative may be

met by the judicious design of one-sided contracts favoring the principal, the second by

appropriate levels of contractual completeness.

Contractual one-sidedness reflects the degree to which contractual terms offered to

franchisees favor the franchisor (Klein 1980). Strict terms such as unilateral termination and non-

compete covenants, if invoked by the franchisor, serve to threaten the stream of income the

franchisee may expect from being a part of the franchise system (Lal 1990). Franchisees wishing

to avoid punishment and the consequent hardship it entails are more likely to comply with the

principal’s policies and procedures, and are less likely to undertake opportunistic acts.

Relative to one-sidedness, significantly more research attention has focused on

contractual completeness. The common thread underlying the different labels that have been

used to describe this aspect of explicit contracts is the degree to which numerous relevant clauses

are codified in a contract (Ghosh and John 2005; Wuyts and Geyskens 2005). When contractual

completeness is high, the agent’s obligations in the exchange are likely to be better specified,

thereby reducing role ambiguity and the agent’s leeway to undertake non-compliant or

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opportunistic actions (Argyres, Bercovtz, and Mayer 2007). Our choice of these two contractual

characteristics reflects their potential as solutions to the problem of ensuring agents’ best efforts.

Agent Compliance and Opportunism

Compliance reflects the extent to which the franchisee adopts franchisor policies and

procedures in their channel relationship (Dahlstrom and Nygaard 1999). The efficient

functioning of channels, particularly franchise systems, requires individual franchisees to

conform to franchisor stipulated performance obligations (Antia and Frazier 2001). Such

compliance, however, need not preclude opportunism – the tendency on the part of the franchisee

to indulge in “self-interest seeking with guile” (Williamson 1975, p.6).

Low compliance is not synonymous with high opportunism. Franchisees may fail to

comply for a variety of reasons - lack of resources, a poor understanding of the desired behavior,

or a belief that the particular obligation is not appropriate to the local operating conditions - none

of which may be attributed to an intent to deceive. Further, compliance can be relatively high but

opportunism can also exist. For instance, the franchisee may abide with franchisor-issued

guidelines and procedures, yet shirk on other obligations not expressly covered by the franchisor

in documents or communications (Prendergast 1999; Bergen, Dutta, and Walker 1992). Thus,

failure to comply need not be opportunistic; as well, a compliant franchisee could still be

opportunistic. A more complete understanding of the behavioral consequences of the franchisor’s

governance efforts requires an examination of both constructs.

Hypotheses

Explicit contracts and extra-contractual incentives are costly to design and deploy in

franchise systems, as are monitoring and enforcement efforts (Casson 1991). Thus, when the

franchisor incurs ex ante contract and incentive deployment expenses, the addition of ex post

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monitoring and enforcement expenses must be carefully weighed to ensure governance is not

cost-prohibitive (Casson 1991). In addition, if deployed governance mechanisms by the

franchisor, whether ex ante or ex post, are seen as being obtrusive by franchisees, a “reactance”

response from them may be elicited (Brehm 1966). As external pressure from deployment of

franchisor governance mechanisms increases, the reactance response may grow stronger, with

franchisees trying to reestablish their autonomy by acting in a self-serving manner (Fitzsimons

and Lehman 2004; Heide, Wathne, and Rokkan 2007). Governance mechanisms, whether ex ante

or ex post, must be used judiciously as a result.

Proposed Determinants of Monitoring and Enforcement. Contractual completeness is the

degree to which numerous relevant clauses are codified in a contract (Anderson and Dekker

2005; Gong et al. 2007). Contracts “…can range from a simple contract that conveys only the

broad lines of exchange to an explicit contract that specifies as precisely as possible both parties’

responsibilities and remedies for foreseeable contingencies” (Wuyts and Geyskens 2005, p. 103).

By reading and accepting a relatively complete contract, the franchisee gains a greater

awareness of its expected responsibilities in the relationship (Gong et al. 2007; Lusch and Brown

1996). Further, the franchisee’s range of freedom in the exchange is restricted when contractual

completeness is high (Anderson and Dekker 2005). With a heightened awareness of its role and

limits on its actions, the franchisee’s consequent compliance is expected to be higher, and its

ability to undertake opportunistic acts may be reduced (Al Najjar 1995; Gong et al. 2007).

Anticipating greater (lesser) franchisee compliance (opportunism) when contractual

completeness is high, the franchisor may reduce ex post monitoring and enforcement to some

extent because such efforts are not likely required. Of course, all explicit contracts are

incomplete, and franchisees might react in a self-serving manner to contracts that overly restrict

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their decision rights (Arrunada, Garicano, and Vazquez 2001; Ghosh and John 2005). Thus,

increases in contractual completeness beyond a certain point may yield diminishing returns in

economizing on ex post monitoring and enforcement efforts.

When contractual completeness is low, on the other hand, franchisees have fewer

guidelines and more latitude in running their franchises (Crocker and Reynolds 1993). An

incomplete contract can increase the need for renegotiation, thereby increasing the ex post costs

of conducting the relationship (Reuer and Arino 2002). The potential for misaligned expectations

of franchisees is more likely (Argyres, Bercovitz, and Mayer 2007; Klein, Crawford, and

Alchian 1978). As a result, when contractual completeness is low, more franchisor monitoring

and enforcement efforts may be necessary (Coase 1937; Gifford 1999).

H1: Contractual completeness is negatively related to the principal’s (a) behavior monitoring, (b) output monitoring, and (c) enforcement efforts, subject to diminishing returns.

It is also possible, however, that higher levels of contractual completeness are associated

with increased ex post monitoring and enforcement. Such an argument hinges on the existence of

explicit performance standards and obligations. Under conditions of low contractual

completeness, franchisee performance standards and obligations may remain unstated or

inadequately stated for the most part (Ghosh and John 2005). This lack of specificity may

translate to an inability on the part of the franchisor to adequately evaluate franchisee

performance or outcomes against explicit standards.3 As well, the enforcement of vaguely

specified performance obligations makes verification by third parties (for example, the courts)

problematic (Drahozal and Hylton 2003). With increasing contractual completeness, franchisors

may be able to more explicitly specify relevant contingencies and franchisee obligations,

facilitating the use of monitoring and enforcement efforts. The franchisor’s attempts to increase

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contractual completeness are expected to be subject to diminishing returns, however, as beyond a

certain point, further increases in the level of completeness are unlikely to yield commensurate

gains in monitoring or enforcement ability.

H1Alt: Contractual completeness is positively related to the principal’s (a) behavior monitoring, (b) output monitoring, and (c) enforcement efforts, subject to diminishing returns.

Contractual one-sidedness is the degree to which contractual terms offered to franchisees

favor the franchisor (Klein 1980). One-sided contracts act as a screening device, allowing

franchisees to self-select into the system (Blair and Lafontaine 2005). The franchisor may

believe that opportunistic franchisees would not consent to such a contract and enter the

franchise system (Blair and Lafontaine 2005; Klein 1980). Further, when contracts are one-sided,

a self-enforcing contract is in effect. That is, by accepting the contract, the franchisee signals its

intention not only to comply with the franchisor’s policies and procedures, but also avoid

opportunistic acts (Blair and Lafontaine 2005; Ghosh and John 2009). The threat of franchisor

reprisals may induce compliance and limit opportunistic acts of the franchisee (Klein 1980).

Therefore, when contracts are one-sided, the franchisor may not need to frequently monitor

franchisees and undertake severe enforcement actions. If, however, contractual one-sidedness is

pushed to an extreme, it is likely to engender negative franchisee behaviors due to reactance

effects (Brehm 1966). Thus, increases in one-sidedness beyond a certain threshold may yield

diminishing returns in reducing monitoring and enforcement efforts.

H2: Contractual one-sidedness is negatively related to the principal’s (a) behavior monitoring, (b) output monitoring, and (c) enforcement efforts, subject to diminishing returns.

It is also plausible that contractual one-sidedness may lead to increased ex post monitoring

and enforcement. Franchisee reactance is likely to become more pronounced when the franchisee

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is operating under a relatively one-sided contract, in turn leading to reduced compliance and

opportunistic acts occurring as a backlash effect (Clee and Wicklund 1980; Fitzsimons and

Lehman 2004; Wendlandt and Schrader 2007). The use of one-sided contracts may also signal

franchisor distrust in the franchisee, whereby the franchisee’s suspicion of the franchisor’s

motives deepens (Jap and Ganesan 2000). An increased need for monitoring and enforcement

may be present for the franchisor as a result. Finally, certain franchisors may over-engineer their

governance mechanisms and associated safeguards (see Stump and Heide 1996; Reuer and Arino

2002). Franchisors that take the time, trouble, and effort of deploying one-sided contracts may

persist in their safeguarding efforts ex post. Cost prohibitions may be ignored to a certain extent

(Casson 1991). Beyond a certain threshold, however, there are limits to the impact that one-

sidedness will have in fostering ex post monitoring and enforcement.

H2Alt: Contractual one-sidedness is positively related to the principal’s (a) behavior monitoring, (b) output monitoring, and (c) enforcement efforts, subject to diminishing returns.

Extra-contractual incentives refer to the monetary-based payments to franchisees beyond

the explicit contract to motivate specific actions to represent the franchisor’s brand (Gilliland and

Bello 2001). Such incentives are usually deployed to elicit franchisee cooperation with the

franchisors’ specific marketing initiatives. Their use is likely to result in higher levels of

subsequent monitoring and enforcement for two reasons. First, making payments contingent on

the performance of specific tasks or the achievement of specific outcomes requires verification

of task performance or outcome achievement (Prendergast 2000), and for corrective action to be

taken as necessary. While behavior monitoring facilitates the metering of the incentivized tasks,

output monitoring enables the franchisor to meter the incentivized outcomes, and enforcement

allows the franchisor to correct franchisee performance as required (Gilliland 2004). Thus,

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monitoring and enforcement play a key role in the franchisors ensuring that their franchisees

have actually performed the specific activities for which they are being compensated.

Second, incentives themselves may give rise to more insidious franchisee behaviors that

need to be controlled. Specifically, compensation on any subset of tasks may result in a

reallocation of activities toward those that are directly compensated and away from the

uncompensated activities (Holmstrom and Milgrom 1990; Joseph and Thevaranjan 1998).

Anticipating this, franchisors are likely to increasingly rely on ex post governance mechanisms

so as to ensure franchisee compliance with their other performance obligations.

H3: Extra-contractual incentives to franchisees will be positively associated with the principal’s (a) behavior monitoring, (b) output monitoring, and (c) enforcement efforts.

Proposed Determinants of Franchisee Compliance and Opportunism. Prior assessments

of the principal’s governance efforts have tended to focus on the principal’s monitoring efforts

and their efficacy with respect to deterring opportunism, but have yet to reach a consensus on

this important issue. As Heide, Wathne, and Rokkan (2007, p. 425) state, “…whereas some

research suggests that monitoring can serve as a control mechanism that reduces exchange

partner opportunism, there is also evidence showing that monitoring can actually promote such

behavior.” We believe such conflicting evidence is attributable to prior research (1) not

accounting for the endogeneity of behavior and output monitoring and enforcement, (2)

assessing, for the most part, each ex post governance mechanism in isolation, rather than in

combination with each other, and (3) primarily focusing on opportunism as an outcome, thus

providing an incomplete picture of the syndrome of agent behaviors. Having addressed the first

limitation with our earlier hypotheses, we now turn our attention to explicating the likely role

played by combinations of types of monitoring, and enforcement in inducing franchisee

behaviors.

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The crux of our argument is that there are problems associated with the isolated use of

each type of ex post governance mechanism. Behavior monitoring involves franchisor personnel

observing and measuring the activities of franchisee personnel. As such, it is relatively expensive

to implement. Further, because franchisees may prefer engaging in behaviors free of interference

(Deci and Ryan 1985), behavior monitoring is intrusive and vulnerable to franchisee reactance

and ill will. In support of such reasoning, Heide, Wathne, and Rokkan (2007) find that behavior

monitoring is positively related to channel member opportunism.

Although output monitoring is less intrusive and expensive to deploy, the metering of

franchisee outcomes may still have some residual reactance effects (Perrow 1986). Further, with

this approach, franchisees are left to choose how they will reach desired outcomes (Anderson

and Oliver 1987). That is, output monitoring in isolation ignores the actions necessary to reach

such outcomes. This separation of actions and outcomes could lead to franchisee uncertainty and

anxiety, especially when considering factors in the external environment (e.g., local economy)

that cannot be controlled (e.g. Bergen, Dutta, and Walker 1992; Anderson and Oliver 1987;

Eisenhardt 1985). The lack of guidance and direction from the franchisor could lead to

franchisee feelings of unfair treatment, in turn leading to increased opportunistic tendencies and

lower levels of compliance (Gilliland and Manning 2002).

When used in combination, however, behavior monitoring may fill a governance gap that

output monitoring alone cannot address, and vice versa. First, franchisee uncertainty and anxiety

could be reduced when behavior and output monitoring are both at high levels. In such cases, the

franchisor is metering both franchisee actions and outcomes, which should facilitate the

existence of a consistent control system (Anderson and Oliver 1987). Not only is the franchisor

focusing franchisee attention on consequences, but also on the actions necessary to reach those

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consequences. Such direction and guidance is likely to be appreciated by franchisees, enabling

their compliance with channel policies and procedures (Oliver and Anderson 1994). Reactance

responses may be minimized as a result. In addition, when behavior and output are both

monitored, the franchisee is being measured and evaluated on a broader range of performance

criteria. Reasonable performance on some criteria may offset weaker performance on other

criteria in the franchisee’s mind, further reducing anxiety.

Finally, when both types of monitoring occur, the franchisor is gaining important

information on franchisee operations, leading to a possible reduction in information asymmetry

(Heide, Wathne, and Rokkan 2007; Eisenhardt 1985). This could reduce franchisee leeway in

taking opportunistic actions, and induce greater franchisee effort. While this form of control may

offend the franchisee’s sense of autonomy and cause reactance (Brehm 1966; Perrow 1986), the

positives associated with lessening uncertainty and anxiety are likely to offset this effect. Thus,

compliance may be increased and opportunism may be mitigated effectively by using a

combination of monitoring types that addresses both actions and outcomes. Behavior and output

monitoring used together may better mesh franchisor interests with those of the franchisee.

H4: High levels of franchisor behavior and output monitoring are (a) positivelyrelated to compliance, and (b) negatively related to franchisee opportunism.

Enforcement is the severity of a franchisor’s disciplinary response to franchisee

violations of contractual obligations in the franchise system (Antia and Frazier 2001). Problems

exist with the use of enforcement alone as a governance mechanism. A franchisor that takes a

severe enforcement approach in its franchise system sends strong signals of a need for adherence

to contract provisions and consistency in franchisee actions (Antia and Frazier 2001). As a result,

many franchisees are likely to resent such a strict approach and will exhibit a reactance response.

When a franchisee experiences reactance, it may be motivated to regain lost or threatened free

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behaviors through “…whatever methods that are available and appropriate” (Brehm 1966, p. 9),

resulting in lower compliance and greater opportunism.

The combination of behavior monitoring and enforcement is likely to further aggravate

franchisees and heighten their reactance responses. Not only is the franchisor closely metering

franchisee behaviors (i.e., looking over its shoulder), the franchisor is also taking severe

disciplinary actions (i.e., a “stick” approach). As a result, franchisees may try to reestablish their

autonomy by acting in a self-serving manner (Greenberger and Strasser 1986). That is, the

combination of behavior monitoring and enforcement may produce defensive franchisee

behaviors, such as reduced compliance and increased levels of opportunism (Barkema 1995).

Franchisees might attempt to sabotage the brand if the franchisor is too heavy handed in dealing

with them (Brown, Dev, and Lee 2000).

H5: High levels of franchisor behavior monitoring and enforcement are (a)negatively related to compliance, and (b) positively related to franchiseeopportunism.

When output monitoring is high, there is pressure on the franchisee to achieve stipulated

outcomes (Heide, Wathne, and Rokkan 2007). Franchisees are likely to be concerned about how

well they attain these outcomes. As a result, they may be more likely to appreciate the franchisor

heavily defending the integrity of the franchise agreement and its trademarks (Antia and Frazier

2001). Such severe disciplinary actions may provide some protection to the franchisees as they

attempt to reach required financial goals. Reactance effects of franchisees to pressure on

reaching outcomes and severe enforcement responses may be minimized to some extent (Antia et

al. 2006). Together, output monitoring and enforcement may better align both parties’ interests.

H6: High levels of franchisor output monitoring and enforcement behavior are (a)positively related to compliance, and (b) negatively related to franchiseeopportunism.

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RESEARCH METHOD

Study Context and Data Collection

We test our hypotheses in the franchise channel system of the U.S. automotive industry.

Explicit contracts exist between auto manufacturers and their dealers and vary significantly

across different makes. Further, channel governance is a critical managerial issue in this industry

(Kumar, Scheer, and Steenkamp 1995). These factors, along with the availability of rich archival

information, make the automotive industry an appropriate context for our study.

Archival Data. We obtained current franchise contracts from eight franchisors (makes)

doing business in the U.S. market. These eight makes accounted for about 92% of unit sales in

the automotive industry during our observation period. Although the terms offered by each make

significantly varied, individual franchisors offered boilerplate contracts with few, if any,

variations across their franchisees; moreover, the contracts tended to display little variation over

time (Arunada, Garicano, and Vazquez 2001). We measured contractual completeness and one-

sidedness on the basis of a content analysis of these contracts.

Survey Data. We used a random sample of 1,200 automobile franchisees representing the

selected eight makes in locations across the United States and contact information on their

owner-managers. We made telephone calls to each of the 1,200 dealers to solicit participation,

identify qualified respondents, and verify the mailing address. Consistent with recommendations

by Kumar, Stern, and Achrol (1992), we identified the dealer-principal (i.e., owner) or general

manager as the qualified respondent for each franchisee.

After removing dealerships that could not be contacted, had ceased operating, or were

unwilling to participate in the study, we mailed 460 dealerships a questionnaire, a postage-paid

reply envelope, and a customized cover letter soliciting participation. Approximately three weeks

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later, we followed up with telephone calls to dealers who had not yet responded, and resent

surveys to these dealers. A third round of surveys was sent a week later to dealerships that could

not be reached by telephone. The third mailing included a personalized, handwritten note

outlining our research objectives and emphasizing the importance of each survey.

Our data collection effort yielded responses from 237 dealerships across the eight makes

for an effective response rate of 52 percent, which compares favorably to response rates obtained

in prior channels research (cf. Antia and Frazier 2001). Of these, we dropped 31 observations

because of incomplete responses, leaving 206 usable surveys. We compared our final sample

with non-responding dealerships on annual sales volume and found no significant differences.

We also compared early- versus late-responding dealerships across all study variables and again

found no significant differences. To assess informant quality, we asked for self-evaluations of

informant knowledge with respect to their dealership’s relations with the franchisor; the average

level of knowledge reported was 4.1 on a 5-point scale.

Measures

Table 2 provides the descriptive statistics and correlation matrix for the study variables.

-----Insert Table 2 about here-----

Ex Ante Governance. Contractual completeness reflects the extent to which relevant

clauses are clearly codified in a contract (Gong et al. 2007). We followed a three-step procedure

to assess the completeness of each contract (see Ghosh and John 2005 for a similar approach).

The first step was to generate a comprehensive list of clauses covered across the contracts. The

247 clauses elicited by the content analysis dealt with initiation, maintenance, termination, and

post-termination obligations (Heide 1994) required of each party, and represent a superset of the

clauses specified in this research context. Two independent coders evaluated the presence or

19

absence of each clause across each contract; the level of agreement between the coders was .93,

and remaining differences were resolved by discussion. We then counted the number of clauses

specified in each contract and undertook a natural logarithmic transformation to arrive at a score

of contractual completeness for each of the eight makes. The latter transformation reduces

skewness and spread of the distribution, and enables us to test for the hypothesized diminishing

returns to contractual completeness.

We followed a similar approach to measure contractual one-sidedness—the extent to

which contractual terms accepted by the franchisee favor the franchisor (Klein 1980). As before,

two coders independently content-analyzed each of the clauses specified in the contracts. While

analyzing the contracts, the coders checked whether (a) the contractual clause solely favored the

franchisor, and (b) the clause imposed a cost on the franchisee above the normal cost of

supporting the brand, either by constraining behaviors (see clauses 50, 85 in Appendix A) or

inducing behaviors (see clauses 215, 234 in Appendix A). The extent of agreement on what

constituted contractual one-sidedness exceeded .96; the remaining differences were resolved by

discussion. Similar to contractual completeness, we summed the number of clauses in the

franchisor’s favor and undertook the natural logarithmic transformation to arrive at a score of

contractual one-sidedness for each make.4 Appendix A lists some representative clauses featured

across the makes, whether each make specified each clause, and the overall scores of contractual

completeness and one-sidedness for each make.

Extra-contractual incentives refer to the monetary-based payments to franchisees beyond

the explicit contract to motivate specific actions to represent the franchisor’s brand (Gilliland and

Bello 2001). We adapted Gilliland and Bello’s (2001) five-item Likert-type scale, reflecting the

20

provision of extra bonuses and payments by the franchisor to the franchisee for additional efforts

by the latter. The coefficient alpha is .91 for this scale.

Ex Post Governance. We adapted the measures of Niehoff and Moorman (1993), Celly

and Frazier (1996), and Heide, Wathne, and Rokkan (2007) for our study. Behavior monitoring

involves metering the work functions that are expected to produce certain outcomes in the

channel relationship (Heide, Wathne, and Rokkan 2007). The final scale relies on three items

dealing with the degree to which the franchisor (1) checked to see whether the franchisee was

working efficiently, (2) met with the franchisee to monitor its behaviors, and (3) held meetings

with the franchisee to discuss its customer base. The coefficient alpha is .77 for this scale.

Output monitoring involves measuring the visible consequences of a channel member’s

actions (Heide, Wathne, and Rokkan 2007). The final three-item measure focused on the degree

to which the franchisor monitored franchisee results on (1) market penetration of new products,

(2) increasing the customer base in the market, and (3) sales volume. The coefficient alpha is .90.

Enforcement reflects the severity of the disciplinary action undertaken by the franchisor

in response to a franchisee violation of the ex ante contract (Antia and Frazier 2001). We used

the six-item scale proposed by Antia and Frazier (2001) to solicit franchisee perceptions of their

franchisor’s ex post contract enforcement efforts. The coefficient alpha is .88 for the scale.

Behavioral Outcomes. Compliance reflects the extent to which the franchisee adopts

franchisor policies and procedures in their channel relationship (Dahlstrom and Nygaard 1999).

The four items of the measure reflected the degree to which the franchisee complied with

franchisor-related rules and procedures, followed franchisor policies, tried to carry out franchisor

instructions, and followed franchisor guidelines. Coefficient alpha is .95 for the scale.

21

Opportunism reflects self-interest seeking with guile. We derived the seven items for this

measure from those used by Brown, Dev, and Lee (2000) and John (1984), adapted to our

context. The items indicated the extent to which the franchisee had broken promises, overstated

difficulties, altered facts, and held back information. The coefficient alpha is .86 for this scale.

Control Variables. We expect franchisees of high performing brands to be less

opportunistic and more compliant. We therefore controlled for each make’s market share, using

data from Ward’s Automotive Yearbook over a 5-year period immediately preceding the

administration of our survey instrument. Differences in each franchisor’s ability to monitor

individual franchisees were also controlled for by including the distance in miles between each

franchised dealership location and the franchisor’s US headquarters as a regressor (Brickley and

Dark 1987). We also anticipated both behavioral outcomes to be impacted by the dependence of

the franchisee on the franchisor, and thus controlled for each franchisee’s annual sales in

millions of dollars and the number of additional dealerships owned, if any.

Measure Validation

Appendix B displays the individual items measuring each latent construct, with their

loadings and composite reliability statistics and the average variance extracted (Fornell and

Larcker 1981). A confirmatory factor analysis of the latent constructs in our study yields

satisfactory psychometric properties. Although the chi-squared value is significant (χ2 = 558.79,

p < .001, df = 306), other fit statistics (CFI = 0.94; TLI = 0.93 ; RMSEA = 0.07) all meet or

exceed established guidelines (Browne and Cudeck 1992). The items underlying each latent

construct display statistically significant loadings (the lowest t-statistic is 9.07); moreover, the

average variance extracted (AVE) and composite reliability (CR) scores computed for each

22

construct (see Appendix B) exceed benchmark guidelines (Fornell and Larcker 1981), thereby

suggesting strong convergent and discriminant validity.

MODEL SPECIFICATION

Our model specification must account for four key characteristics of the data. First, our

data on 206 franchisees across eight automotive makes violates the assumption of independent

observations; accordingly, we must accommodate the likely correlation among observations

within individual clusters. Second, we expect the three endogenous ex post governance choices –

behavior and output monitoring and enforcement – and the two behavioral outcomes –

compliance and opportunism – to be correlated as well. Ignoring the potential violation of the

assumption of independent observations could result in inflated standard errors and unacceptably

large Type 1 error, whereas accommodating correlated errors among the ex post governance and

behavioral outcomes facilitates more efficient estimates (Cameron and Trivedi 2008). Third, our

hypotheses link ex ante contract characteristics and extra-contractual incentives to ex post

governance characteristics, thereby requiring us to explicitly acknowledge the endogeneity of

each ex post governance effort. Fourth, it is only the pair-wise combinations of the three ex post

characteristics and not their individual main effects that is hypothesized to have a significant

bearing on franchisee compliance and opportunism. We accommodate all the preceding

requirements with a recursive set of five interrelated equations, represented as follows:

BMNij = β10 + β11CCi + β12COSi + β13INCij + ω1 (1)OMNij = β20 + β21CCi + β22COSi + β23INCij + ω2 (2)ENFij = β30 + β31CCi + β32COSi + β33INCij + ω3 (3)COMij = β40 + β41BMNij + β42OMNij + β43ENFij + β44BMNij.OMNij

+ β45BMNij.ENFij + β46OMNij.ENFij + ∑47

411

β Controls+¿ω4 (4)

OPPij = β50 + β51BMNij + β52OMNij + β53ENFij + β54BMNij.OMNij

23

+ β55BMNij.ENFij + β56OMNij.ENFij + ∑57

511

β Controls+¿ω5 (5)

whereCCi = contractual completeness of franchisor i, COSi = contractual one-sidedness of franchisor i, INCij = incentives offered to franchisee j by franchisor i,BMNij = behavior monitoring by franchisor i of franchisee j,OMNij = output monitoring by franchisor i of franchisee j,ENFij = enforcement by franchisor i of franchisee j,COMij = compliance by franchisee j of franchisor i,OPPij = opportunism by franchisee j of franchisor i,

and the variance-covariance matrix Ω ~ MVN(0, σ2).

We estimate equations 1-5 jointly using Roodman’s (2009) conditional mixed process

(CMP) regression technique. CMP is gainfully applied to recursive systems of equations

(equations 1 through 5 form such a recursive set of equations) and uses a seemingly unrelated

regression estimator to maximize a higher order multivariate normal generalization of the

likelihood function. The estimator obtains initial values for the solution space from separate

ordinary least squares estimation of each equation and then makes use of the Monte Carlo

simulation-based GHK algorithm (Geweke 1989; Hajivassiliou and McFadden 1998; Keane

1994) to directly estimate the cumulative higher-order likelihood function. Since Roodman’s

(2009) exposition and the availability of the CMP Stata add-on module, the algorithm has been

used in a wide range of applications across economics (Fletcher and Sindelar 2009), finance

(Cao and Hsu 2010), and management (Lumineau and Henderson 2009). The preceding

specification explicitly accounts for clustered observations, the likely correlation among the ex

post governance mechanisms and between the franchisee compliance and opportunism

outcomes, the endogeneity of each of the ex post governance-related “second stage” regressors,

as well as the six different pairwise multiplicative interactions.5,6

-----Insert Table 3 about here-----

24

The results obtained from the estimated model (see Table 3) provide considerable support

for our hypotheses. Contractual completeness is negatively related to levels of behavior

monitoring (b11 = -1.21, p < .001), but has no impact on output monitoring (b21 = -0.30, n.s.) or

on enforcement (b31 = -0.25, n.s.), providing partial support for H1. As with completeness,

contractual one-sidedness does not appear to impact subsequent levels of output monitoring (b22

= 0.63, n.s.). In contrast to the impact of completeness, however, the deployment of one-sided

contracts leads to increased behavior monitoring (b12 = 1.34, p < .001), consistent with H2Alt(a),

and reduced enforcement (b32 = -1.09, p < .001), consistent with H2(c). We find strong evidence in

support of H3, as the provision of extra-contractual incentives to franchisees is accompanied by

increases in behavior monitoring (b13 = 0.44, p < .001), output monitoring (b23 = 0.23, p <.001),

and enforcement (b33 = 0.11, p < .001).

Assessing the impact of the ex post governance mechanisms on opportunism, we find that

neither output monitoring nor enforcement displays any evidence of inducing compliance when

used by itself (b42 = -0.03, b43 = -0.03, both n.s.). Contrary to our expectation, we do find

evidence of a negative main effect of behavior monitoring on compliance (b41 = -0.62, p < .05).

As expected, none of the three ex post governance efforts appears to significantly impact

franchisee opportunism when used in isolation (b51 = -0.38, b52 = 2.61, b53 = -0.01, all n.s.).

Consistent with H4, we find that a combination of behavior and output monitoring

appears to increase compliance (b44 = 0.12, p < .001) and curb opportunism significantly (b54 = -

0.14, p < .001). Moreover, H5 is supported, as reduced compliance (b45 = -0.06, p < .001) and

increased levels of opportunism (b55 = 0.05, p < .05) are attributable to the combination of

behavior monitoring and enforcement. Finally, we find partial support for H6; although the

combination of output monitoring and enforcement does appear to be associated with greater

25

franchisee compliance (b46 = 0.04, p < .01), there is no evidence of the expected negative effect

of the latter combination on opportunism (b56 = -0.00, n.s.).

With respect to the control variables, we find market share of the make as well as dealer

distance from franchise headquarters to be unrelated to compliance (b47 = 0.00, b48 = 0.00, both

n.s.), but negatively related to opportunism (b57 = -0.02, p < .001; b58 = -0.00, p < .001).

Higher levels of dealership sales are associated with lower compliance (b48 = -0.00, p < .001),

while the ownership of other dealerships appears to increase compliance (b49 = -0.07, p < .05).

However, neither the franchisees’ annual sales volume (b58 = -0.00, n.s.) nor ownership of other

outlets (b59 = -0.05, n.s.) has a significant bearing on opportunism.

To explicate the significant interactions more clearly, we plotted the partial derivative of

the relevant regression equations (Schoonhoven 1981; see Figure 2). All five statistically

significant interactions display evidence of monotonicity. Examining panels 1 and 3 of Figure 2,

we find opportunism (compliance) significantly reduced (increased) only when both types of

monitoring are relied on in conjunction. Panels 2 and 4 of Figure 2 show how the combination of

high behavior monitoring and enforcement is associated with increased (decreased) opportunism

(compliance). In stark contrast, the combination of enforcement and output monitoring (see panel

5 of Figure 2) is seen to increase franchisee compliance. Together, the post hoc probing of the

significant interactions supports the basic foundation of our hypotheses, and provides a useful

representation of the nuances of governance and its effects.

To assess the robustness of our results, we undertook Nickerson, Hamilton, and Wada’s

(2001) GLS regression-based joint estimation of the system of equations 1-5. In contrast to the

direct maximization of the likelihood function conducted by CMP, this method relies on a two-

stage estimation algorithm. In the first stage, the three ex post governance characteristics are

26

simultaneously regressed on ex ante governance characteristics. The predicted values obtained

from the latter first-stage estimation and their pairwise interactions are then used as second-stage

regressors predicting the correlated outcomes of agent compliance and opportunism. The results

of this two-step GLS estimation are displayed in Table 4. Notwithstanding the limitations of this

approach (see footnote 5), the estimates are consistent with those obtained from the CMP

regression.

DISCUSSION

The objective of this research is to provide a better understanding of how formal ex ante

and ex post governance mechanisms of the franchisor impact franchisee compliance and

opportunism. We build on and extend prior research on channel governance by considering

contractual completeness and contractual one-sidedness, as well as extra-contractual incentives

as relevant ex ante governance tools, associating each of these with the ex post governance

mechanisms of behavior monitoring, output monitoring, and enforcement. In turn, we assess how

combinations of ex post governance mechanisms function to facilitate or deter franchisee

compliance and opportunism.

Theoretical Implications

The present research posits and finds supporting evidence for strong linkages between the

deployment of ex ante governance mechanisms and their ex post counterparts. The principal’s

deployment of ex ante contract terms and extra-contractual incentives appears to be

systematically associated with subsequent levels of behavior and output monitoring and

enforcement. In establishing and accounting for the endogeneity of ex post governance, we are

able to inform two key unresolved theoretical questions.

27

Do ex ante governance mechanisms serve as substitutes of or complements to ex post

governance mechanisms? Our assessment of this issue suggests a nuanced picture. Simply put,

the answer depends on the particular ex ante and ex post mechanisms examined. Although

franchisor reliance on contractual completeness is seen to substitute to some degree for ex post

behavior monitoring, contractual one-sidedness is associated with more frequent behavior

monitoring, but fewer enforcement efforts. Interestingly, extra-contractual incentives, when

offered to the franchisee, are unambiguously associated with higher levels of monitoring and

enforcement. Together, these findings imply blanket statements about governance mechanisms

being complements or substitutes to be ill-advised. Rather, a more contingent relationship

between ex ante and ex post governance mechanisms seems to exist. The invariance of the

principal’s output monitoring efforts to ex ante contractual considerations suggests that recent

and ongoing efforts to distinguish between monitoring types (Heide, Wathne, and Rokkan 2007)

appear promising. This leads us to the second key question we help address.

Does greater monitoring lead to or detract from desired agent behaviors? Our

findings suggest that with the notable exception of the compliance-reducing effect of behavior

monitoring, neither type of monitoring has any discernible direct impact on agent compliance

and opportunism. Rather, depending on the particular pairing of the three ex post governance

mechanisms, agent compliance and opportunism may be induced or discouraged. Of the

combinations we assessed, that of behavior and output monitoring appears most potent in its

ability to effectively induce agent compliance and deter opportunism. Enforcement, when paired

with output monitoring, is associated with greater agent compliance, but poses no deterrence to

opportunism. In marked contrast, the combination of enforcement and behavior monitoring is

counterproductive in its inducement of reduced compliance and increased opportunism. Our

28

findings complement prior assessments of combining the distinct facets of monitoring with

micro-level social contracts (Heide, Wathne, and Rokkan 2007), as well as efforts to relate the

severity of enforcement with detection ability (Antia, et al 2006).

Managerial Implications

Our findings provide important insights to managers of firms involved in contractual

relationships, whether franchising or otherwise. No doubt, explicit contract terms do not

represent the entirety of a contractual relationship (Macaulay 1963). However, the fact that

relatively complete contracts substitute for later monitoring and enforcement efforts, that extra-

contractual incentives complement ex post governance, and that one-sided contracts have mixed

effects on subsequent governance suggests that ex ante contract terms and extra-contractual

incentives “set the stage” for ex post governance efforts. In determining the level of ex post

governance, the design and deployment of ex ante governance terms are vital prerequisites to the

development of effective channel relationships.

To those engaged in supervising agent behavior, our findings with respect to the efficacy

of ex post governance mechanisms are perhaps the most helpful. By themselves, monitoring and

enforcement are ineffectual for the most part, and based on the negative association between

behavior monitoring and compliance, can actually be counter-productive. Instead, managers may

bring about agent compliance and reduced opportunism by combining high levels of both types

of monitoring, or by simultaneously relying on high levels of output monitoring and

enforcement. As well, it is worth noting that the combination of behavior monitoring and

enforcement is counter-productive in that it detracts from (induces) compliance (opportunism).

Together, knowledge of the intricacies of ex ante and ex post tools is bound to lead to more

enlightened and effective channel governance efforts.

29

Limitations and Directions for Future Research

This study focuses on formal ex ante and ex post governance mechanisms. We did not

examine the role of norms (Heide, Wathne, and Rokkan 2007), nor assess structural (eg,

ownership) influences (Brown, Dev, and Lee 2000) on agent behaviors. An examination of the

interplay between formal governance mechanisms and norm-, culture-, or ownership-based

counterparts is a promising future research direction.

In much the same manner that ex post governance efforts are endogenously determined,

so are principals’ ex ante governance characteristics. Although cognizant of this, similar to

Ghosh and John (2005), we model only the intervening variables in our conceptual framework

(in our case, the franchisor’s monitoring and enforcement efforts) as endogenous to keep the

model tractable. Future research on the antecedents of contractual characteristics, and how these

characteristics evolve over time, would provide much-needed insights on channel governance.

An additional potentially fruitful avenue for further research relates to the combined

impact of contractual completeness and one-sidedness on ex post governance efforts. Although

we acknowledge the possibility that franchisors may deploy relatively complete and one-sided

contracts, data limitations precluded our ability to assess the impact on agent behaviors of the

potential combination of both contractual characteristics. Research that delves into this aspect of

ex ante governance would add significant value.

30

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TABLE 1EMPIRICAL STUDIES IN MARKETING RELATING GOVERNANCE TO AGENT OUTCOMES

Study Ex Ante Contract Characteristics

Ex Post Monitoring

Ex Post Enforcement

Other Control Mechanisms

Outcome

Achrol and Gundlach (1999)

Contractual safeguards (Content analysis)

No No Relational norms Opportunism

Antia, Bergen, Dutta, and Fisher (2006)

No Yes (no distinction between output monitoring and behavior monitoring)

Yes No Opportunism

Bello and Gilliland (1997)

No Unilateral controls (Process and output control)

No Flexibility, Human Investments

Export performance (strategic, selling, economic)

Brown, Dev, and Lee (2000)

No No No Vertical integration, Specialized investments, Relational norms

Opportunism

Dahlstrom and Nygaard (1999)

No No (Monitoring costs examined as a transaction cost)

No Interfirm cooperation, Formalization,Relational contracting

Opportunism

Ghosh and John (2005)

Contractual incompleteness (Informant reported)

No No Specific investments, End product market strength

End product enhancement, Cost reduction

Gilliland and Manning (2002)

No No No Role Acceptance, Informal Control, Formal Control

Compliance and opportunism

Gundlach, Achrol, and Mentzer (1995)

No No No Commitment, Relational norms

Opportunism

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Heide, Wathne, and Rokkan 2007

No Output monitoring and behavior monitoring. No interactions between the two.

No Microlevel social contracts Opportunism

Jap and Ganesan (2000)

Explicit contracts (Informant reported)

No No Supplier’s and retailer’s specific investments, Relational norms

Supplier performance, Conflict, Relationship satisfaction

Jap and Anderson (2003)

No No No Bilateral idiosyncratic investments, Goal congruence, trust

Opportunism

Jap (2007) No No No Contract value, Number of lots, Partial price visibility, Auction award rule

Opportunism

John (1984) No Surveillance No Formalization, Centralization

Opportunism

Lusch and Brown (1996)

Explicit and Normative Contracts (Informant reported)

No No Relational behavior, Dependence structure, Temporal characteristics

Wholesaler performance

Murry and Heide (1998)

No Yes No Interpersonal Attachments, Incentive Premium, Payment Method

Compliance

Payan and Nevin (2006)

No No No Motivational portion of influence strategies, Request legitimacy, Request imposition, Request importance

Compliance

Payan and McFarland (2005)

No No No Rationality, Recommendations, Requests, Information Exchange, Dependence, Threats, Promises

Compliance

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Rokkan, Heide, and Wathne (2003)

No No No Transaction specific investments, Relationship extendedness, Solidarity norms

Opportunism

Wuyts and Geyskens (2005)

Detailed contract drafting (informant reported)

No No Close partner selection, Network embeddedness, Specialized investments

Opportunism

Present Study Completeness andOne-sidedness (actual contracts coded, not informant reported)

Output monitoring, behavior monitoring, and their combination

By itself and in combination with each type of monitoring.

-Compliance

and opportunism

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TABLE 2DESCRIPTIVE STATISTICS AND CORRELATION MATRIX

Mean (SD) CCS COS INC BMN OMN ENF OPP COM MMS DIS ASD

Ln(Contractual Completeness) (CCS) 4.87 (0.17)

Ln(Contractual Onesidedness) (COS) 3.98 (0.16) .50*

Extra-contractual Incentives (INC) 3.24 (1.60) -.08 -.16*

Behavior Monitoring (BMN) 3.89 (1.40) -.12 .00 .49*

Output Monitoring (OMN) 5.66 (1.22) -.03 .02 .30* .46*

Enforcement (ENF) 4.35 (1.27) -.11 -.18* .16* .18* .22*

Opportunism (OPP) 2.32 (1.09) .03 -.04 .12 .09 -.10 .00

Compliance (COM) 6.03 (0.92) -.03 -.01 .07 .15* .24* .18* -.39*

Market Share (MMS) 23.61 (7.72) .27* -.16* .06 -.05 -.11 .07 .00 -.01

Dealer Distance (DIS) 802.50 (533.98) .19* .21* .06 .18* .14* -.09 -.07 .00 -.12

Annual Dealership Sales (ASD) 56.29 (298.16) .07 .12 .05 -.03 -.01 .06 -.01 -.12 -.01 .01

Additional Dealerships (FOW) 1.72 (1.41) -.12 -.13 .08 .17* .02 .07 -.02 .10 -.02 -.02 .02

* p < 0.05

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TABLE 3CONDITIONAL MIXED PROCESS REGRESSION ESTIMATES

BehaviorMonitoring

Output Monitoring

Enforcement Compliance Opportunism

Coeff. t-value Coeff. t-value Coeff. t-value Coeff. t-value Coeff. t-valueIntercept 2.58 1.88 3.64 2.12* 9.44 10.98*** 5.78 2.46*** -7.82 -0.81Completeness (CC) -1.21 -8.87*** -0.30 -1.00 -0.25 -1.59Onesidedness (COS) 1.34 5.20*** 0.63 1.43 -1.09 -4.24***Extra-contractual Incentives (INC)

0.44 11.42*** 0.23 3.67*** 0.11 2.65***

Behavior Monitoring (BM) -0.62 -1.75* -0.38 -0.29Output Monitoring (OM) -0.03 -0.05 2.61 1.18Enforcement (ENF) -0.03 -0.13 -0.01 -0.01OM*BM 0.12 6.26*** -0.14 -2.57***ENF*BM -0.06 -3.10*** 0.05 2.10*ENF*OM 0.04 2.55** -0.00 -0.06Control VariablesMarket Share (MS)Dealer Distance from HQAnnual Dealership sales (in $M)

0.000.00-0.00

1.070.32

-10.87***

-0.02-0.00-0.00

-4.23***-3.50***

-0.19

Other dealerships owned 0.07 1.96* -0.05 -1.36

* p < .05, ** p < .01, *** p < .001, all one-tailed.

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TABLE 4GLS “TWO STEP” REGRESSION ESTIMATES

BehaviorMonitoring

Output Monitoring

Enforcement Compliance Opportunism

Coeff. t-value Coeff. t-value Coeff. t-value Coeff. t-value Coeff. t-valueIntercept 2.52 0.92 2.69 1.04 10.88 3.82***Completeness (CC) -1.04 -1.83* -0.03 -0.06 -0.45 -0.77Onesidedness (COS) 1.16 1.86* 0.50 0.85 -1.18 -1.83*Extra-contractual Incentives (INC)

0.42 7.49*** 0.27 5.15*** 0.09 1.51

Behavior Monitoring (BM) -0.44 -1.48 0.79 2.59**Output Monitoring (OM) -0.44 -2.03** 0.28 1.27Enforcement (ENF) 0.10 0.49 -0.23 -1.06OM*BM 0.12 2.98*** -0.14 -3.30***ENF*BM -0.06 -1.48 0.04 1.08ENF*OM 0.04 0.99 0.00 0.07Control VariablesMarket Share (MS)Dealer Distance from HQAnnual Dealership sales (in $M)

0.000.00-0.00

0.520.45

-1.96*

-0.00-0.00-0.00

-0.97-2.34**-0.20

Other dealerships owned 0.06 1.43 -0.05 -1.12* p < .05, ** p < .01, *** p < .001, all one-tailed.

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FIGURE 1CONCEPTUAL FRAMEWORK

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FIGURE 2CONTINGENCY EFFECTS

1. Monotonic Effects of Output Monitoring on Opportunism 2. Monotonic Effects of Enforcement on Opportunism

3. Monotonic Effects of Output Monitoring on Compliance 4. Monotonic Effects of Enforcement on Compliance

5. Monotonic Effects of Enforcement on Compliance

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APPENDIX AEX POST CONTRACTUAL CLAUSES

Completeness (Representative Items)

No. Clause Chrysler Ford GMC Honda Nissan Subar

u Toyota Volkswagen

13. Manufacturer support for dealership operations 0 0 0 1 1 0 0 0

14. Manufacturer support for comprehensive advertising and sales promotion 0 0 1 1 1 0 1 0

15. Dealer compensation for labor and parts used to service products under warranty, recall, or product updates 0 1 1 1 3 3 2 0

16. Manufacturer assumes defense of dealer for lawsuits related to manufacturer's products 1 0 3 1 0 0 0 0

17. Manufacturer retains the right to treat dealer orders as nonbinding 1 1 0 1 0 0 0 018. Manufacturer's right to fulfill dealer order in part 1 0 0 1 0 0 0 0

TOTAL CONTRACTUAL COMPLETENESS SCORE 91 144 134 120 172 195 156 195

One-Sidedness (Representative Items)

No. Clause Chrysler Ford GMC Honda Nissan Subaru Toyota Volkswagen3. Approval of premises by manufacturer 1 2 3 1 3 3 3 304. Manufacturer must approve change in dealer ownership 1 0 0 1 1 3 1 08. Manufacturer requires written consent for transfer of current agreement 0 0 0 1 0 0 0 050. Lack of dealer territorial exclusivity 1 4 1 1 4 2 1 085. Dealer's duty to stop selling manufacturer's products after termination 0 0 0 1 1 0 0 0112. Specification and revision of dealer area of primary responsibility 1 0 3 0 0 1 1 0

133. Manufacturer retains the right to disapprove proposed change in ownership 0 2 1 0 0 0 0 0

215. Obligations upon termination 0 6 0 0 0 0 3 0234. Dealer's exclusive facilities for manufacturer 0 0 0 0 0 1 0 0

TOTAL CONTRACTUAL ONE-SIDEDNESS SCORE 46 65 49 63 75 90 66 33

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APPENDIX BMEASURES

* Standardized loadings follow in parentheses for each measurement item, where applicable.______________________________________________________________________________Contract Completeness Natural logarithm of the count of clauses detailing mutual rights and responsibilities (e.g. Anderson and Dekker, 2005).

Contract One-sidedness Natural logarithm of the count of clauses imposing non-trivial obligations on the franchisee (e.g. Anderson and Dekker, 2005).

Extra-contractual Incentives (Gilliland and Bello, 2001)Seven-point scale: 1 = “very little,” and 7 = “very much”; =.91; CR = .92; AVE = 69%

Beyond standard incentives, such as bonuses and discounts, from the franchisor we also receive: 1. Extra incentives to increase our selling effort for their products. (.73)2. Extra dollars for our use in local promotional activities that help promote their product. (.87)3. Extra monetary assistance for targeted events that help promote their product. (.86)4. Extra incentives to work harder in support of their product. (.82)5. Extra incentives to promote their new products. (.85)

Behavior Monitoring (Niehoff and Moorman, 2003)Seven-point scale: 1 = “never,” and 7 = “always”; =.77; CR = .81; AVE = 60%

The franchisor:1. Checks to see if we are working efficiently. (.52)2. Frequently meets with us to discuss behaviors they want us to adopt to meet the franchise goals. (.87)3. Frequently holds meetings to discuss our customer base. (.88)

Output Monitoring (Niehoff and Moorman, 2003 )Seven-point scale: 1 = “never,” and 7 = “always”; =.90; CR = .91; AVE = 76%

The franchisor:1. Monitors our results on market penetration of new products. (.86)2. Monitors our results on increasing the customer base in the market. (.87)3. Monitors our results on sales volume. (.88)

Franchisor Enforcement (Antia and Frazier 2001)Seven-point scale: 1 = “strongly disagree,” and 7 = “strongly agree”; =.88; CR = .87; AVE = 59%

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The franchisor:1. Is firm in its response to contractual violations. (.56)2. Takes tough measures when a particular contractual clause is violated. (.63)3. Takes stern punitive action against franchisees. (.76)4. Imposes the highest level of sanctions when contractual violations occur. (.90)5. Takes severe action against violations. (.91)

Franchisee Compliance (Tyler and Blader 2000)Seven-point scale: 1 = “never,” and 7 = “always”; =.95; CR = .95; AVE = 84%

How often does your organization:1. Comply with franchisor-related rules and procedures? (.95)2. Follow the policies established by your franchisor? (.96)3. Carefully try to carry out the instructions of your franchisor? (.90)4. Carefully follow the franchisor’s guidelines? (.85)

Franchisee Opportunism (Brown, Dev, and Lee 2000)Seven-point scale: 1 = “strongly disagree,” and 7 = “strongly agree”; =.86; CR = .87; AVE = 50%

1. In order to maintain our goals, we occasionally find it necessary to neglect some of our obligations to our headquarters. (.54)

2. We sometimes breach formal agreements for our benefit. (.61)3. We have sometimes promised our franchisor that we would do things,

though we actually had no intention of following through. (.62)4. To get the needed support from our franchisor, we sometimes

overstate the difficulties that our franchise faces. (.78)5. Sometimes we have had to alter the facts slightly in order

to get what we need from our franchisor. (.83)6. On occasion we have had to lie to our franchisor about certain things in order to protect our interests. (.83)7. We sometimes may hold back information that is important to us. (.69)

Control VariablesMarket Performance: The make’s 5-year average market share over the period preceding survey administration, from Ward’s Annual Yearbook.

Dealer Distance from Franchisor’s Headquarters: Distance of dealership from franchisor’s North American headquarters in miles.

Franchisee Annual Sales: Sales in millions of dollars.

Number of additional dealerships owned (if any) by the franchisee.

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ENDNOTES

1 Henceforth, we use the terms “franchisor” and “principal” interchangeably to denote the party offering the contract, and “agent” and “franchisee” to denote the party accepting the offered contract terms.

2 Anderson and Decker (2005) refer to “extensiveness,” Ghosh and John (2005) to “incompleteness,” Lusch and Brown (1996) to “hard contracting,” Mooi and Ghosh (2010) to “specificity,” Reuer and Arino (2007) to “complexity,” and Wuyts and Geyskens (2005) to “detailed contract drafting” to reflect the extent to which a contract specifies all possible contingencies and the associated responses (Gong, et al 2007).3

We gratefully acknowledge the insights of an anonymous reviewer with respect to this point.4

Across all eight contracts examined, we were unable to find a single clause favoring the franchisee. As such, variations in contractual one-sidedness are solely a function of the number of clauses favoring the franchisor. 5

Although multi-level structural equation models (MLSEM) can accommodate the first three characteristics, assessing six multiplicative interactions between latent constructs is currently beyond the capabilities of the numerical integration technique used. A second option using the generalized least squares (GLS) approach proposed by Nickerson, Hamilton, and Wada (2001) does not account for clustered observations. As well, the two-step procedure is statistically inefficient (Heckman 1979), thereby yielding higher Type 1 error rates in small samples. Nevertheless, we discuss the latter approach as an additional test of the robustness of our results. 6

Although we have no a priori expectation regarding the combination of all three ex post governance mechanisms, we did estimate a model testing such a three-way interaction and found it to be a non-significant predictor of compliance and opportunism.