This thesis investigates two questions: the determinants of capital structure in franchising and its subsequent impact on the franchise financing decisions; and the efficient governance structure choice in franchising. We posit that firms franchise in order to benefit from the reduced franchisees’ operational risks by limiting the debt level, such that the franchisor can bear more debt and gain tax-deduction benefits. Specific hypotheses are based on various theories like resource-based view, agency theory, signaling theory and classical capital structure theories. We empirically find that as the franchisor requires franchisees to put more equity in the initial investment, the franchisor does bear a higher debt level and gains from tax deductibility of interest expenses. This effect is stronger when more units are franchised. Moreover, we also find evidence supporting our prediction that the franchisee’s leverage is positively linked with franchisor’s maturity. This suggests that as the franchisor imposes a higher level of franchisee’s leverage in order to screen capable franchisees, the franchisor also increases their maturity to reduce bankruptcy risks. This thesis also explores the impact of governance structure on the incentives to invest in specific assets for the franchisor as well as the distributors. Wholly-owned, wholly-franchised, and mixed franchise systems are considered. Circumstances are identified when a dual distribution governance structure uniquely allocates efficient ownership over assets. A necessary condition for the efficiency of a dual distribution governance structure is a positive systemic effect, not the value of the brand name or location (or other) differences between outlets. We find that whether dual distribution benefits are realized in a franchise or a cooperative franchise depends on whether most value is added upstream or downstream.
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