Abstract
This chapter analyzes royalty modes in the franchise arrangements of convenience stores under double-sided moral hazard. In Japan, the majority of franchisors charge margin-based royalties based on gross margin rather than sales-based royalties based on sales. We show that the franchisor can attain the first-best outcome by adopting margin-based royalties under double-sided moral hazard. We consider a case where a franchisee sells two kinds of goods; one is shipped from its franchisor and the other is purchased from another (independent) manufacturer. In this case, the franchisor is completely unable to control the wholesale price of the goods bought from the manufacturer. Therefore, the franchisor cannot achieve the first-best outcome via sales-based royalties under double-sided moral hazard.
Keywords: Double-sided moral hazard, franchise arrangement, franchise contract, franchise fee, joint profits, margin-based royalty, risk neutral, royalty rate, royalty structure, sales-based royalty.
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