Rethinking Franchise Contracts: The Impact of Transactional and Relational Governance Mechanisms on Franchisor Performance

Abstract

The viability of the franchise system depends on franchisors’ ability to design contracts that facilitate the governance of the franchisor–franchisee relationship. Despite its importance, research on the impact of contract design on franchisor performance is limited. This study bridges the gap by integrating research on contracts, transaction cost economics (TCE), and relational governance to examine the influence of contract dimensions on franchise growth. Drawing from TCE, it investigates how transactional contract dimensions—contingency adaptability and franchisees’ roles and responsibilities—are codified in contracts. In addition, unlike prior studies that have focused on non-contractual relational governance, this research explores the embedding of relational norms within the contract. Specifically, I examine the moderating effects of the extent to which relational norms—information exchange and flexibility—are embedded in a legally enforceable contract. This study conducts a comprehensive analysis of the effects of both transactional and relational contract dimensions on franchise growth. To this end, contracts from 332 franchisors were hand-collected and over 200K contract clauses were classified into transactional and relational dimensions using a state-of-the-art machine learning algorithm (bidirectional encoder representations from transformers – BERT). To test the formulated hypotheses, a two-stage residual inclusion Poisson regression model was used. Key findings reveal that contingency adaptability positively influences franchise growth, whereas franchisees’ roles and responsibilities have a detrimental effect. Information exchange enhances the positive impact of contingency adaptability but exacerbates the negative influence of franchisees’ roles and responsibilities. Flexibility, while mitigating the adverse effects of franchisees’ roles and responsibilities, surprisingly reduces the beneficial influence of contingency adaptability on franchise growth. These findings have significant theoretical and practical implications for understanding and optimizing contract design in franchising.