بدهی های استراتژیک در روابط عمودی : مدارک و شواهد از فرانچایزینگ

In this paper, we examine the strategic use of debt in franchise organizations. We focus on both the franchisee's and the franchisor's capital structures. The primary goal of this study is to examine whether franchisors impose limits on franchisees’ debt levels to be able to increase their own leverage. We find that the franchisor's leverage is significantly related to the maximum leverage allowed for the franchisee. As the franchisor sets an upper limit on the franchisee's debt ratio, the franchisor can raise more debt and therefore seizes tax benefits, since interest payments are tax deductible. We find that this effect is stronger in chains with larger fractions of franchised outlets.

Why do firms franchise? Although this fundamental question has been the subject of considerable theoretical and empirical investigation, little consensus has been reached (Combs and Ketchen, 2003, Combs et al., 2004 and Dant, 1995). In general, the reasons for franchising are based on the resource-based view and organizational economics (Combs and Ketchen, 1999a and Combs and Ketchen, 1999b). The resource-based view suggests that firms use franchising to relieve financial and managerial constraints in order to enhance growth. Oxenfeldt and Kelly (1968) argue that financial constraints induce franchising, since the partial financing by franchisees limits the financing needs of franchisors. However, this view has been refuted by Rubin (1978) and Norton (1995), arguing that franchisee capital is not less expensive than capital from passive sources such as lenders and stockholders. In organizational economics, transaction costs (Williamson 1983) and agency costs (Jensen and Meckling 1976) present motives for franchising. Combs and Ketchen (2003) and Combs, Michael, and Castrogiovanni (2004) argue that the two theories are complementary in explaining franchising structures. In this paper, we introduce a new specific element in the trade-off of costs and benefits of franchising, which is related both to organizational economics and resource scarcity: firms benefit from franchising by being able to increase their debt ratio. A common practice in the franchising business model is that franchisors impose a lower boundary on the franchisees’ personal capital required in the initial total investment. For example, McDonald's requires a minimum of 100,000 dollars of equity investment, which is about 20 percent of the initial total investment, and Subway Restaurants requires franchisees to fund about 43 percent of the total initial investment with their personal capital. Clearly, the equity required by franchisors is an important variable in the contract offered to franchisees. Because of the vertical relation between the franchisor and the franchisee, opportunities for the franchisor may arise to strategically use the debt structures to enhance firm value. De Fraja and Piga (2004) model financing decisions in vertical relations and argue that the upstream party imposes a limit on the downstream party's debt level in order to avoid bankruptcy risk and to secure profits. In this paper, we follow their reasoning. We suggest that organizations using the franchising structure benefit from the opportunity of setting the franchisees’ capital structure in such a way that the franchisor can bear more debt. The higher debt ratio of the franchisor increases value because of the tax deductibility of interest payments (Modigliani and Miller, 1963 and Graham, 2000). Based on the model of De Fraja and Piga (2004), we predict that lower maximum leverage for franchisees induces more leverage for franchisors. In addition, we predict that this effect is stronger when more outlets are franchised. In other words, we propose that the strategic use of the franchisee's maximum debt level may affect the franchisor's capital structure, which will ultimately affect firm value. We empirically test our propositions with data from the Bond's Franchise Guide and COMPUSTAT. We construct a model in which we first estimate the determinants of the maximum debt ratio that is allowed for franchisees. We find that the maximum debt ratio depends on the size of the outlets, on the age of the franchise firm, on arrangements between the franchisor and the franchisee (such as cooperative advertising), and on the type of industry. We then compare the predicted maximum debt ratio, based on firm and industry determinants, with the actual maximum debt ratio. We use the deviation as an explanatory variable in the leverage regression for the franchisor, because this variable measures the constraints on franchisee debt that cannot be explained by firm and industry characteristics. We find evidence supporting our primary prediction that the franchisor's capital structure is interrelated with the franchisee's capital structure. More specifically, we find that the franchisor's leverage is positively related to the deviation of the franchisee's leverage. That is, as the franchisor sets a higher requirement for the franchisee's equity component than expected (lower maximum leverage), the franchisor is able to raise more debt. This evidence is in line with our proposition that the strategic use of the franchisee's capital structure affects the franchisor's decision of financing. Obviously, our argument is an addition to the array of motives for franchising, which currently prevail in theory (Combs and Ketchen, 2003 and Combs et al., 2004). Furthermore, we also find that the effect becomes stronger when the fraction of franchised units versus wholly-owned units in a franchising chain increases. Our analysis primarily contributes to the franchising literature by demonstrating important consequences of debt financing in franchising that previous research has not examined. Particularly, our work complements the earlier work of Oxenfeldt and Kelly (1968), Rubin (1978) and Norton (1995), whereas these authors specifically emphasize the costs and constraints in financing, ignoring the strategic use of debt financing.

A strong advantage of debt over equity is that interest payments are tax deductible, while dividend payments are not (Graham 2000). The debt that a firm can take on is however limited. Generally, the lower the probability of bankruptcy, the more debt the firm can take on. In this paper, we examine whether the tax benefits of debt are related to leverage in franchise chains. We introduce a new specific argument in the cost and benefit analysis in franchising that relates to both organizational economics and resource scarcity. We hypothesize that the strategic use of the franchisee's capital structure affects the franchisor's debt ratio, which provides a benefit of franchising. The primary goal of this study is to examine whether franchisors impose a limit on the franchisee's debt level in order to take tax benefits. Secondly, the paper also investigates the factors that affect the franchisee's and the franchisor's capital structures. We find evidence supporting our primary prediction that the franchisor's capital structure is interrelated with the franchisee's capital structure. We find that the franchisor's leverage is positively related to the deviation between the franchisee's predicted maximum leverage and the observed maximum leverage. This corroborates our hypothesis that as the franchisor sets a higher level of the franchisee's equity requirement, the franchisor does intend to raise more debt. We discuss in the paper that the additional debt for the franchisor is likely to yield tax benefits (Graham, 2000 and Modigliani and Miller, 1963). In order to illustrate this mechanism, we can look at Dollar Thrifty Automotive Group Inc. in 2006, a car rental company. The leverage ratio for this franchisor is 0.684 and franchisees deviate from their predicted leverage by 0.382. The regression coefficient of 0.218 in model (1) of Table 4 implies that with a zero deviation the leverage of the franchisor would have been 0.218 × 0.382 = 0.083 lower, which is 12.2% of the leverage. In the 10K filing over 2006, we find that the interest expenses over 2006 were $95.97 m. In case the company would have 12.2% lower leverage, this would reduce the interest expenses by about $11.68 m. The effective tax rate for the company equals 41.5% (tax expenses of $36.73 m over income before taxes of $88.42 m). Thus, the tax savings in 2006 equal 41.5% of $11.68 m, which is about $4.85 m. In case this saving is discounted at the cost of debt (the interest expenses are 3.5% of total debt outstanding), the discounted value equals $138.6 m, which is 21.4% of the shareholders equity in 2006 ($647.70 m).6 In this respect, our analysis resembles previous studies in risk management, i.e., hedging with derivative instruments. For example, Graham and Rogers (2002) show that firms hedge to increase their debt capacity, which enhances firm value through increased tax benefits. We should note that other benefits of debt may also be relevant. Korteweg (2010) uses market values and betas of a company's debt and equity to estimate the net benefits of leverage. These net benefits are defined as the present value of all future benefits minus the costs of debt, and are found to be about 5.5% of firm value. Increasing debt thus seems to increase firm value for the typical firm, either because of tax benefits or other benefits. One additional reason for increased debt financing is to reduce managerial discretion problems (Jensen 1986), since interest payments reduce free cash flows. A second additional reason arises in case a firm has a major blockholder, such as the founder or founding family of the company. In successful firms, these blockholders have significant resources invested in a single company, which yields a poorly diversified portfolio of assets. New financing with equity is undesirable, because this increases the poor diversification in case the insiders participate and otherwise dilutes control. Thus, financing with debt will be attractive (Denis, Denis, and Sarin 1997). The results of this study provide empirical support for the model in De Fraja and Piga (2004): in a vertical relationship the upstream party strategically uses the downstream party's debt level. Furthermore, we find that this effect is stronger when the franchisor has more franchised units. We find that our results hold when we control for the endogenous nature of the franchise decision. However, we have to stress that our results still have to be interpreted with the appropriate caution as endogeneity concerns cannot be completely ruled out, for example because many of the variables in our study are endogenous in nature. Our analysis presents a first step in understanding the interaction between decision variables in franchising. Where we model endogenous choices for franchisor leverage and maximum franchisee leverage, we assume many other variables to be exogenously determined. In future research, an important avenue to enhance our understanding of franchising systems will be to endogenize the organizational or ownership form, as well as the structure of the fees and royalties. The ultimate goal should be to design a set of structural equations to test more elaborate models and to reduce the endogeneity problems inherent in our approach. Our results supply a preliminary understanding of the determinants of the franchisee's capital structure. We find that the outlet-specific factors like outlet size and franchise age significantly affect the franchisee's debt ratio. Larger outlets and longer franchise experience can lead to a higher debt level. Furthermore, we find that the industry plays a very important role in the franchisee's capital structure. Industries like Specialty Food, Non-Food Retailing and Regular Restaurant require less equity financing, whereas the Business Service industry requires more. Executive summary This paper presents an analysis of capital structure decisions in franchising. The capital structure decision is the choice for debt versus equity financing. This choice is important, because it defines the ownership and cash flow rights in the company. More specifically, more debt financing comes at a cost, because the compulsory interest obligations increase the probability of distress. However, debts are also advantageous, because its costs are tax-deductible. Firms thus have to trade off the bankruptcy costs and tax benefits of debt financing vis-à-vis equity financing. In the business model of franchising, capital structures are set both by the franchisor and by each of the franchisees. The main idea of this paper is that the capital structures of franchisors and franchisees are interdependent. A common practice in franchising is that franchisors impose a lower boundary on the franchisees’ personal capital required in the initial total investment, i.e., a maximum debt level. For example, McDonald's requires a minimum of 100,000 dollars of equity investment by each franchisee, which is about 20 percent of the initial total investment. The vertical relation between the franchisor and the franchisee provides opportunities for the franchisor to strategically use capital structure to enhance firm value. In particular, we argue that the franchisor imposes a limit on the franchisees’ debts in order to avoid bankruptcy risk and to secure profits. Because of the resulting lower risk in the franchisees, franchisors can bear more debt and this higher debt ratio of the franchisor increases value because of the tax deductibility of interest payments. Thus, in this paper we propose that the strategic use of the franchisee's maximum debt level may affect the franchisor's capital structure. We empirically test our propositions with a large sample of U.S. data. We use the deviation of a model-based maximum debt ratio from the actual ratio an explanatory variable for franchises in model to explain the debts of franchisors. We find evidence supporting our primary prediction that the franchisor's capital structure is interrelated with the franchisee's capital structure. More specifically, we find that the franchisor's leverage is positively related to the deviation of the franchisee's leverage. That is, as the franchisor sets a higher requirement for the franchisee's equity component than expected (lower maximum leverage), the franchisor is able to raise more debt. This evidence is in line with our proposition that the strategic use of the franchisee's capital structure affects the franchisor's decision of financing. In this paper, we introduce a new specific argument in the cost and benefit analysis in franchising that relates to both organizational economics and resource scarcity. We conclude that the strategic use of the franchisee's capital structure affects the franchisor's debt ratio, which provides a benefit of franchising. The primary goal of this study was to examine whether franchisors impose a limit on the franchisee's debt level in order to take tax benefits. Secondly, the paper also investigates the factors that affect the franchisee's and the franchisor's capital structures. The managerial implications of our study are that franchisors can strategically set the required equity inlay for prospective franchisees in such a way that the business risk of the franchising structure is reduced. Of course, this reduced risk can be, and is in practice, used to increase risk via debts, but the franchisor organizations can also use the power in the vertical relationship with franchisees simply to reduce the riskiness of their activities. At the same, franchisees can learn from our study that a higher equity requirement is valuable for their franchisors. Therefore, in negotiations about fees and other franchise contract conditions, franchisees may demand a compensation for a relatively high equity requirement.