'Ugly Princess': Self-Enforcement in Franchising

An intriguing feature of franchising is the simultaneous use of company-owned and franchise units under the same brand name. Furthermore, there is a separation of the ownership and control arrangements in franchise units. The underlying mechanism is the self-enforcement that sustains the long-term franchise relation. We formally model this self-enforcement by taking franchisee's free-riding behavior and the franchisor's opportunistic termination into consideration. We nd that an initial investment with an associate ownership arrangement, that is, franchise arrangement, is an ideal hostage ("ugly princess") for suppressing two-sided opportunistic behavior. By incorporating self-enforcement into the incentive design for a franchising system, we provide explanations for di erent governance structures in franchising as well as adjustments in response to legal constraints on franchise termination.