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Editor: D. Daniel Sokol
University of Florida
Levin College of Law

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Thursday, January 28, 2010

Monitoring Costs and the Law of Franchise Tying Contracts: A Behavioral Perspective

Posted by D. Daniel Sokol

Uri Benoliel,  Academic Center of Law & Business analyzes Monitoring Costs and the Law of Franchise Tying Contracts: A Behavioral Perspective.

ABSTRACT: Traditional law-and-economics analysis suggests that the per se illegality rule that governs franchise tying contract is inefficient. Legal economists particularly argue that a per se illegal standard fails to account for the enhancement in efficiency that a franchise tying contract provides. One central improvement in efficiency that a franchise tying contract creates, according to legal economists, is a decrease in the franchisor's monitoring costs. Particularly, by requiring from a franchisee to purchase products directly from the franchisor, a tying contract reduces the costs that the franchisor will have to incur in order to monitor the quality of products sold by the franchisee to customers.

Building upon a noteworthy body of empirical research, this article will argue that traditional law-and-economic analysis is incomplete. Although a franchise tying contract may reduce product quality-related monitoring costs, this contract is also likely to significantly increase other monitoring costs.

More specifically, this article will argue that a centralized franchise tying relationship is likely to continually constrain the franchisee's autonomy. Consequently, the tying relationship is likely to decrease the franchisee's satisfaction in the relationship. Such emotional experience of decreased satisfaction is likely to promote aggressive retaliatory behavior. Aggressive retaliatory behavior will take the form of franchisee opportunistic behavior. Ultimately, a centralized tying relationship will increase the likelihood that the franchisee will take three central types of opportunistic actions towards the franchisor: manipulate information, shirk the contractual obligation to provide adequate customer service and shirk the contractual obligation to maintain the entire franchise unit clean. These potential opportunistic actions are likely, accumulatively, to significantly increase the franchisor's information, customer-service and cleanliness-related monitoring costs. Such incrase will off-set the arguable product-quality monitoring cost savings generated by a franchise tying contract.

http://lawprofessors.typepad.com/antitrustprof_blog/2010/01/monitoring-costs-and-the-law-of-franchise-tying-contracts-a-behavioral-perspective-.html

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