Long-Term Franchise Contracts: A Closer Look at the Hold-Up Problem

TL;DRAbstract

This paper considers the hold-up problem in franchise contracts. Ex ante the franchisee has to invest into specific equipment. Ex post the relationship to the franchisor is governed by asymmetric information about a local demand parameter. A typical result is a combination of underinvestment by the franchisee and distortions of the short-run allocation. The paper investigates the robustness of this result with respect to different model specifications. It is shown that the case of unobservable investment and unlimited franchisee-liability yields a first-best solution whereas all other cases yield underinvestment.

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