Academic journal article Quarterly Journal of Business and Economics

Ownership, Agency, and Wages: An Examination of Franchising in the Fast Food Industry

Academic journal article Quarterly Journal of Business and Economics

Ownership, Agency, and Wages: An Examination of Franchising in the Fast Food Industry

Article excerpt

A topic of controversy among economists in recent years has been whether firms adjust the level and timing of compensation to solve incentive problems. Becker and Stigler |1974~, Lazear |1981~, and others have argued that firms initially pay wages below the workers' alternative wage and later pay wages above the alternative wage to discourage shirking when monitoring is imperfect. Such a delayed-payment/bonding contract is efficient because it does not alter the present value of compensation from the first-best, full-information level. If legal or other constraints (e.g., the minimum wage) restrict up-front bonds, however, a related literature predicts that firms will pay efficiency wages.(1) An efficiency wage payment differs from a delayed-payment/bonding contract in that firms raise the present value of compensation to increase the cost of job loss and thereby discourage shirking, although compensation may also be backloaded in the efficiency wage model.

Whether firms overcome monitoring deficiencies by having workers post implicit bonds or by paying efficiency wages--or whether imperfect monitoring and shirking are indeed concerns of many firms--are questions that can only be resolved empirically.

Unfortunately, little empirical work exists exploring how firms respond to imperfect monitoring and agency problems.(2) This paper examines the labor market in the fast food industry to estimate the effect of agency problems on the structure of compensation. The institutional features of the fast food industry provide unique conditions for studying wage determination. The fast food industry is competitive, homogeneous, and nonunion. But most importantly, the fact that some restaurant outlets are owned and operated by the parent company, while others are owned and operated by individual franchisees generates variability in organizational structure that allows for a test of theories of wage determination.

It is argued that existing contractual arrangements give managers of company-owned restaurants different incentives from franchisees who typically own and manage their own restaurants. An owner-manager of a franchise has a strong incentive to expend effort supervising and monitoring his workers because he receives the residual profit generated by the enterprise; whereas a manager of a company-owned establishment is usually not paid a share of the establishment's profit, and his actions are not perfectly observed by his principal, the parent company. As Caves and Murphy |1976, p. 575~ and others have noted, the latter contractual arrangement poses a classic principal-agent problem that is likely to reduce the level of supervision and monitoring in company-owned units vis-a-vis franchised units. Some casual evidence is presented in the next section supporting the maintained assumption that principal-agent problems create monitoring and supervision difficulties in company-owned outlets.

Under the assumption that monitoring is less rigorous at company-owned outlets than at franchisee-owned outlets, the delayed-compensation model would predict that the tenure-earnings profile of workers is steeper at company-owned outlets, but total discounted compensation is equal under either form of ownership. The efficiency wage model, on the other hand, would predict that both the slope of the tenure-earnings profile and the present value of compensation are greater at company-owned outlets. Finally, the standard neoclassical model would predict no difference in the timing or level of compensation at company-owned and franchised outlets because employee effort is assumed to be exogenously determined. Two newly available cross-sectional data sets are used to test these predictions.

The main empirical finding is that low-level managers earn 9 percent higher wages at company-owned outlets than at franchised outlets, whereas crew workers earn 1 to 2 percent more at company-owned outlets. Moreover, the earnings differences result almost entirely from comparatively steeper tenure-earnings profiles at company-owned outlets. …

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