Acquisitions to Overcome Entitlement Constraints: Evidence from Franchise Systems
The strategy and finance literatures have extensively studied behavioral and social attributes of acquirers that drive acquisition behavior. Less studied are the behavioral and social attributes of targets that invite their acquisition. We maintain that an important such attribute in franchising systems are prior commitments and psychological contracts between franchisors and franchisees that limit franchisors' ability to capture additional value from the system by changing written contract terms. The reason is that such terms act as reference points by which franchisees determine whether franchisors have undermined what they see as their “entitlements”. If franchisees perceive that their entitlements are being undermined, they may retaliate by underperforming or causing trouble, reducing franchisor profits. New owners are less subject to such retaliation, because they did not make such prior commitments. We provide empirical evidence consistent with the importance of entitlement constraints from a matched sample of acquired and non-acquired systems: in the few years following acquisition, acquirers increase franchise, royalty, and marketing fees. Moreover, royalty fees, the largest of these, are increased more in franchise systems in which entitlement constraints bind more tightly; namely, those that emphasize multi-unit franchising.