Real options in franchise contracting: an application of transaction cost and real options theory
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Real options in franchise contracting: an application of transaction cost and real options theory Ilir Hajdini1 · Josef Windsperger1
© The Author(s) 2020
Abstract Previous research has not explained the use of real option clause in franchise contracting. The real option clause has two economic functions: To reduce transaction costs by mitigating opportunism risk and to increase strategic rents by exploiting the profit potential from future upside opportunities under uncertainty. We argue that franchisors will more likely use a real option clause (ROC) in franchise contracts under high behavioral uncertainty, high franchisors’ transaction-specific investments relative to franchisees’ and long contract duration. In addition, by combining transaction cost theory and real option theory, our study provides a new explanation for the impact of environmental uncertainty on the use of ROC in franchise networks by showing that there exists a U-shaped relationship between environmental uncertainty and the franchisor’s use of ROC. Overall, the data from German and Swiss franchise systems provide support of the research model. Keywords Transaction cost theory · Real options theory · Explicit call options · Franchising JEL Classification L14 · D86 · D23 There is a room for ROT (real options theory) to improve its integration potential by joining TCE (transaction cost economics)…. (Trigeorgis and Reuer 2017)
* Josef Windsperger [email protected] Ilir Hajdini [email protected] 1
Department of Business Administration, University of Vienna, Oskar‑Morgenstern‑Platz 1, 1090 Vienna, Austria
13
Vol.:(0123456789)
European Journal of Law and Economics
1 Introduction Firms choose different governance structures to safeguard their specific investments and exploit profit opportunities under uncertainty. Previous research has mainly applied transaction cost theory (TCT) to show that hierarchical structures are more efficient to preserve transaction-specific investments in presence of contractual hazards (Williamson 1985, 1991; Gatignon and Anderson 1988; Zhao et al. 2004). A higher level of control facilitates coordination under increasing environmental uncertainty and protects firms’ interests in preserving transactionspecific investments from possible exploitation (Zhao et al. 2004). However, real options theory (ROT) has challenged the transaction cost theory prediction of using hierarchical control in highly uncertain business environments (e. g. Brouthers et al. 2008; Folta 1998; Kogut 1991; Wooster et al. 2016) by viewing environmental uncertainty as an important source of profit opportunities. Hence, under a high level of uncertainty, it is more valuable for the firm to obtain real options, which offer the right to increase equity investments when upside opportunities arise (Trigeorgis and Reuer 2017). In interfirm networks, such as joint ventures and franchise networks, protecting prior investments and exploiting future profit opportunities become more challenging as uncertainties grow due to po
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