ELSEVIER

WHY FRANCHISE COMPANIES

EXPAND OVERSEAS
SCOTT A. SHANE
Georgia Institute o f Technology

EXECUTIVE Businessformat franchising is becoming an increasingly international activ-

S ~ Y ity. From 1971 to 1985, U.S. franchisors added foreign outlets at a rate of
17% per year, almost twice as fast as they added domestic outlets (Aydin
and Kacker 1990). As a result, by 1990 more than 350 U.S. companies
had more than 32,000franchised outlets overseas. By 2000, 60% of all
franchisors in the United States are expected to have outlets overseas (Hoff-
man and Preble 1993).
This study examines the 815 largest U.S. franchisors to understand what capabilities encourage
them to expand overseas. It finds that the key capability that predicts the intent to expand overseas is
superior capability to reduce franchisee opportunism. Franchisors who seek foreign franchisees have
developed a greater capability to bond against and monitor potential franchisee opportunism. The data
show that these differences are consistent across all industries in which franchising takes place.
The results of this study indicate that foreign entrepreneurs can identify the American franchisors
most likely to expand overseas by looking at their pricing structure and their monitoring capabilities.
The easy identification of characteristics from which to find American franchisors will help to reduce
the search costs ofpotential foreign franchisees. This reduction in search costs will make the establishment
of international franchise relationships less expensive.
This study also provides guidance to franchisors interested in expanding overseas. The results
show how franchisors can structure theirfranchise relationships to reduce potential franchisee opportun-
ism. This ability to reduce franchisee opportunism will make it easierfor franchisors to enter high-growth
foreign markets using the franchising business mode.
This study also has implications for researchers. It suggests that international business research
examine further the mechanisms by which firms make contractual modes of international business work.
Whereas many firms may internalize international market transactions under conditions likely to lead
to market failure, the large number of franchisors who use franchising as an international expansion
mode despite conditions of market failure suggests that more attention be paid to mechanisms that com-
panies can use to reduce the probability of failure of international contractual transactions. By helping
to explain how franchisors monitor foreign franchisees or bond them against opportunistic behavior,
this study suggests that the international business literature develop a more complex understanding of
the workings o f international business transactions than the simple choice of internalization or contractual
entry modes.

Address correspondence to Scott A. Shane, Strategic Management Group, Georgia Institute of Technology,
Atlanta, GA 30332-0520.

Journal of Business Venturing 11, 73-88

© 1996 Elsevier Science Inc. 0883 -9026/96/$15.00
655 Avenue of the Americas, New York, NY 10010 SSDI 0883-9026(95)00110-7
74 S.A. SHANE

INTRODUCTION
Business format franchising is becoming an increasingly international activity. From 1971
to 1985, U.S. franchisors added foreign outlets at a rate of 17% per year, almost twice as
fast as they added domestic outlets (Aydin and Kacker 1990). As a result, by 1990 more
than 350 U.S. companies had more than 32,000 franchised outlets overseas. Moreover, this
expansion is continuing. One-half of all franchise companies in the United States without
international sales and nine-tenths of those with international sales plan to expand internation-
ally over the next few years. By 2000, 60 % of all franchisors in the United States are expected
to have outlets overseas (Hoffman and Preble 1993).
Given the rapid growth in international franchising, researchers have sought to understand
what motivates franchisors to develop international expansion strategies. The purpose of this
study is to answer this question. This study argues that international expansion is motivated
by the possession of a superior capability to reduce franchisee opportunism. It proposes that
two characteristics are associated with this superior capability: the ability to provide franchi-
sees with an incentive not to act opportunistically and the ability to monitor more closely the
actions of franchisees.
The study proceeds in the following manner. In the next section, a theoretical model is
developed of the capabilities that lead franchisors to develop an international expansion
strategy. In the third section, this model is tested empirically on data for the 815 largest
franchise systems in the United States in 1993. The fourth section describes the results, and
the final section draws conclusions.

THEORY DEVELOPMENT
Franchisor Expansion
Franchising is an organizational form based on a legal agreement between a parent organization
(the franchisor) and a local outlet (the franchisee) to sell a product or service using a process
and brand name developed and owned by the franchisor. The franchisor typically provides
the franchisee with the right to use this intellectual properly in return for a lump sum payment
and an annual royalty fee based on sales for a specified period of time (Rubin, 1978).
Franchisors grow by expanding the size of their franchise systems. This expansion can
take place one of two ways: through the establishment of additional company-owned outlets
or through the establishment of franchised outlets. The literature on franchising has shown
that franchisors prefer to expand by franchising in geographically distant locations (Brickley
and Dark 1987; Norton 1988; Martin 1988; Brickley et al. 1991). This preference has been
explained as a function of relative agency and governance costs. The more remote the location
of an outlet, the higher the costs of monitoring employees and the greater the preference for
franchising (Brickley and Dark 1987; Martin 1988).
Research has also shown that franchisors prefer to grow by establishing geographically
focused franchise systems, saturating a geographic area, and then expanding to a new location
(Martin 1988). As Martin (1988, p. 955) explains,

Geographic dispersion creates monitoring problems for the firm. Managers of company-
owned outlets may shirk since their supervisors are not in permanent residence. Greater
dispersion in locations implies more supervisors and higher monitoring costs since time
is lost moving between locations. Shirking incentives are reduced by the franchise agreement
since the franchisee has a claim on the residual. Hence, we may expect that more remote
 WHY FRANCHISE COMPANIES EXPAND OVERSEAS 75

locations are likely to be franchised and that geographically concentrated locations will
be retained as company-owned outlets.

Because franchisors prefer to expand to geographically distant locations by establishing

franchised outlets and because franchisors prefer to focus their expansion efforts geographi-
cally, most of the international expansion of American franchise systems occurs through the
sale of franchises to foreign nationals. In fact, the empirical evidence indicates that between
73 % (Hackett 1976) and 94 % (Commerce Department 1987) of all foreign outlets of U.S.
franchise systems are established through the sale of outlets to foreign franchisees. This
phenomenon raises an interesting question: what franchisor capabilities are associated with
the adoption of an international expansion strategy?

Previous Research on International Expansion of Franchisors

Whereas some research has begun to examine the choice of entry mode of franchisors (e.g.,
Fladmoe-Lindquist and Jacques forthcoming; Hennart 1982), little research has looked at
why some franchisors have developed an explicit strategy to expand overseas and others have
not. Such an explanation is important, because many service firms use franchising as their
primary mode of overseas expansion and do not always select between different entry modes
(Fladmoe-Lindquist and Jacques forthcoming).
Previous research on the overseas expansion of franchisors has not provided a compelling
explanation for the adoption of an international expansion strategy. Much of this research has
sought to explain the overseas expansion of franchisors almost exclusively through reference
to external forces. For example, Walker (1989) and Walker and Etzel (1973) have explained
that international expansion occurs in response to inquiries of potential franchisees, whereas
Hackett (1976) and Aydin and Kacker (1990) have explained that overseas expansion is often
a response to domestic market saturation or a desire to take advantage of a foreign market
with great potential.
However, external explanations of the overseas expansion of franchisors are incomplete.
External forces cannot differentiate firms within the same industry that develop an international
expansion strategy from those that do not. Therefore, a complete explanation of the adoption
of an international expansion strategy must consider firm-level factors.
Although some prior research has sought to explain why firms that possess certain
capabilities are more likely to expand overseas, this research has failed to yield a compelling
model. Walker and Etzel (1973) showed that older and larger franchise systems are more
likely to expand overseas without positing why this should be the case. Aydin and Kacker
(1990) indicated that franchisors who own a smaller percentage of their outlets are more likely
to expand overseas, because the risks of overseas expansion would be less with franchising
than with company ownership. However, their empirical results undercut their theoretical
arguments. They found that smaller franchisors, which had fewer resources to absorb the
risk of international expansion, were more likely to expand overseas.
Huszagh et al. (1992) identified some of the internal capabilities that drive the international
expansion of franchisors upon which this study builds. These authors found that, over time,
franchisors develop better know-how and procedures for such things as site selection, operat-
ing procedures, and store design, which make overseas expansion easier. They also argued
that size provides monitoring advantages that enhance the ability to expand internationally.
However, despite their identification of some key internal capabilities, Huszagh et al. (1992)
did not develop and test a model of the external expansion of franchisors based on the possession
76 S.A. SHANE

of capabilities for dealing with franchisee opportunism. This study develops and tests the
argument that the key attribute necessary for international expansion of franchisors is a superior
capability for reducing franchisee opportunism. Such an argument is consistent with the data
gathered to date on the international expansion of franchisors.

The International Expansion Problem

An important part of the franchising agreement is permission to use the franchisor's business
system in return for a share of the franchisee's profits (Mathewson and Winter 1985; Klein
1980; Klein and Leffler 1981; Norton 1988). The franchisor's business system is the product
that it sells to franchisees and includes such things as store layout, product mix, operating
procedures, and the location selection heuristic. Hymer (1976) argued that firms expand
overseas because they possess a proprietary advantage that makes them able to outcompete local
entrepreneurs. A franchisor's business system can be considered an example of a proprietary
advantage, because the business system is unique to the franchisor (Calvet 1981). Caves
(1971) demonstrated that companies with a proprietary advantage have an incentive to expand
overseas, because they can use that advantage in foreign markets at little or no marginal cost
over the cost of developing the advantage in the domestic market. Because foreign competitors
would have to incur the total cost of developing that proprietary advantage, the firm has a
cost advantage over competitors (Caves 1982).
One of the key dimensions of a franchisor's business system is the set of mechanisms
developed to control franchisee opportunism. When business relationships are established
between two independent entities in a market setting, each party has an incentive to act oppor-
tunistically (Williamson 1985). Under such circumstances, the parties to the transaction need
to invest in mechanisms to detect and prevent cheating. These mechanisms become part of
the franchisor's set of capabilities.
The opportunity for franchisee opportunism is greater in international transactions than
purely domestic ones. The international business environment has greater uncertainty than
the domestic business environment. Miller (1992) found that the political, governmental,
currency, cultural, and macroeconomic differences across nations make international business
more uncertain than business within countries. For example, the existence of two different
government policies toward taxation or regulation lowers the stability of these regulations.
Currency misalignment, high rates of inflation, and transfer pricing make it difficult to measure
performance across borders (Miller 1992).
Distance also makes it more difficult to obtain necessary information on franchisee
behavior (Fladmoe-Lindquist and Jacques forthcoming). Communication and monitoring
costs are raised by geographic, cultural, and linguistic differences (Teece 1977). Geographical
distance raises the financial cost of monitoring, because monitors spend travel time going
from one location to another (Rubin 1978). Cultural distance makes it more difficult to identify
the appropriate managerial activities to effectively monitor franchisees (Huszagh et al. 1992),
because monitoring techniques that work in one culture may not be effective in another (Hofstede
1980). Additionally, linguistic differences impose translation and communication costs.
Because monitoring of franchisees is more difficult internationally than domestically,
one would expect that there would be a higher risk of franchisee opportunism in international
business than in domestic business. Consequently, firms which possess capabilities that make
them better able than other franchisors to control franchisee opportunism should be more
likely to develop international expansion strategies. The next section details what these capabili-
ties might be.
 WHY FRANCHISE COMPANIES EXPAND OVERSEAS 77

HYPOTHESES
Franchisors develop two key capabilities to reduce franchisee opportunism. The first is the
ability to provide franchisees with an incentive not to act opportunistically. The second is
the ability to monitor more closely the actions of franchisees.

Bonding
Given the greater potential for opportunism in the international arena, franchisors who intend
to expand overseas need to create incentives for franchisees not to act opportunistically. One
way to control opportunism is through the use ofex-ante bonding (Norton 1988). Ifa franchisee
has to pay a bond that is forfeited if he or she acts opportunistically, the franchisee has a
fnancial incentive to avoid opportunistic behavior. Typically, franchisees pay franchisors
for the use of their franchise sy stem in two w a y s - t h r o u g h an up-front fee and through ongoing
royalties and advertising fees as a percentage of sales revenues. The franchisor controls the
relative balance between the two payment mechanisms and can establish any given ratio,
holding constant the total size of the payment made for the system. Franchisors can develop
a bonding mechanism through the creation of a pricing structure that requires high up-front
payments relative to the size of payments over time.
A high franchise fee relative to the size of ongoing royalty and advertising payments
appears to be an effective bond. Franchise fees are usually a significant sum relative to the
size of the franchisee's investment in the ownership of the outlet. Estimates of the size of the
franchisor-specific investment in the new outlet approximate one-fourth of the total initial
investment (LaFontaine 1992). The data from this study indicate that the franchise fee averages
one-half of the total franchisor-specific investment. Therefore, a franchisee incurs a substantial
risk of forfeit if this ratio is high.
Moreover, according to standard franchise agreements, the franchisor has the right to
revoke the franchise agreement without return of the franchise fee if the franchisee does not
adhere to his or her contractual obligations. The higher the franchise fee relative to the size
of the royalty and advertising payments, the greater the cost to the franchisee of agreement
termination, and the more the franchisee needs to adhere to the franchise agreement to earn
an acceptable return on his or her investment in the franchise system (Alchain and Demsetz
1972; Carney and Gedajlovic 1991; Norton 1988; Combs and Castrogiovanni 1994). This
bond is a particularly effective tool, as the franchisee usually invests a large percentage of
his or her personal net worth in the purchase of the outlet (Combs and Castrogiovanni 1994,
p. 39). Under these circumstances, termination of the franchise agreement often results in
great financial hardship for the franchisee.
Given the bonding effect of a high franchise fee to royalty and advertising rate ratio,
one would expect that franchisors would alter the ratio of these two variables to control
franchisee opportunism. As the threat of opportunism is greater in international franchising
than in domestic franchising, one would expect to find higher franchise fees relative to royalty
and advertising rates among companies that intend to expand overseas. This argument leads
to the first hypothesis:
HI: The greater the ex-ante bond inherent in the franchisor's pricing structure, the more
likely a franchisor is to seek foreign franchisees.

Learned Monitoring Capabilities

Another mechanism for controlling franchisee opportunism is to monitor franchisees closely.
By carefully observing franchisee behavior, franchisors can control opportunistic behavior.
78 S.A. SHANE

If people are carefully observed, they perceive a greater likelihood of being caught and
so reduce their opportunism. Franchisors can monitor against opportunism by inspecting
franchisee facilities, examining their records, and by specifying and verifying equipment
usage or minimum standards. Therefore, monitoring is a capability that franchisors develop.
The development of this capability can be enhanced by increasing the size of the franchis-
ing system, the allocation of resources toward its development, and through learning over
time. The first source of monitoring capability comes from firm size. In franchising, monitoring
frequently requires the direct observation of the activities of franchisees (Carney and Gedajlovic
1991). This imposes an administrative cost on franchisors who need to have sufficient supervi-
sory capacity to undertake this observation (Combs and Castrogiovanni 1994).
This cost can be reduced through the use of economies of scale in monitoring. These
economies exist for two reasons. First, a hierarchy of monitors can be created such that top
level monitors observe the efforts of lower level monitors who observe the activities of
franchisees. This hierarchical structure reduces travel time between outlets and allows the
monitors to spend a greater percentage of their time observing the behavior of the franchisees.
Second,
Franchise systems with numerous units typically develop efficient routines for monitoring
and measuring performance to assure profitability and uniform delivery of the franchise
product or service. Such routines are naturally enhanced by volume comparisons across
units. The sheer volume of these comparisons can produce more educated routines for
identifying and then managing the shirker (Huszagh et al. 1992, p. 8).

Because economies of scale in monitoring exist, larger systems have lower per unit
monitoring costs and can conduct more rigorous monitoring efforts per dollar of monitoring
expenditure than smaller systems (Martin 1988). All other things being equal, these lower
marginal monitoring costs allow franchisors to devote more effort to monitoring geographically
dispersed franchisees. Therefore, franchisee monitoring capability is enhanced by the size
of the franchisor.
The second source of monitoring capability comes from the allocation of resources
toward its development. Effective monitoring mechanisms for franchisees are different from
those for employees. Franchisee opportunism is most likely to take one of two forms: inefficient
investment and free riding off the efforts of others (Carney and Gedajlovic 1991). Franchisees
underinvest in assets that have spillover effects to other outlets, because these spillovers cannot
be fully appropriated (Carney and Gedajlovic 1991). Franchisees shirk on product quality,
because the gains from shirking accrue solely to the shirker and the costs are borne by all
members of the franchise system (Norton 1988; Klein 1980). Therefore, franchisors need to
monitor franchisees to prevent inefficient investment and free riding.
In contrast, employee opportunism tends to take other forms. Franchisors must monitor
employees to reduce problems of moral hazard and adverse selection (Jensen and Meckling
1976). Employees tend to act opportunistically by shirking and providing less than the appro-
priate level of effort, because their compensation is independent of their output (Hennart
1982). Employees are not residual claimants on the output of the firm and have an incentive
to do no more than the amount required by management. As a result, managers need to
monitor employees to ensure that they perform at a minimum acceptable level (Hennart 1986).
The difference between effective mechanisms for monitoring employees and franchisees
means that franchisors must develop particular monitoring capabilities for observing franchisee
behavior. However, the entrepreneurs who found franchise systems are endowed by nature
with limited time. As firms grow, they face increasing demands on their time. They must
 WHY FRANCHISECOMPANIESEXPANDOVERSEAS 79

open markets, launch new products, and pursue new business opportunities. Consequently,
franchisors face the challenge of engaging in more and more activities in the same amount
of time, a problem known as the entrepreneurial capacity problem (Norton 1988).
Franchisors can hire professional monitors (managers) to relieve some of this burden.
However, as hired managers are not residual claimants on the proceeds of the firm, they,
too, have an incentive to shirk. As a result, professional monitors need to be monitored by
entrepreneurs. Therefore, even if they hire professional managers, franchisors face finite
limits to their monitoring capability.
Because franchisors have limited time, a trade-off exists between the development of
franchisee and employee monitoring capability. Given this trade-off, the greater the allocation
of resources to the development of franchisee monitoring capability, the more likely the
franchisor is to develop this capability. Therefore, franchisee monitoring capability is enhanced
by the relative emphasis that the franchisor places on growing through franchising.
The third source of monitoring capability comes from learning that takes place over
time. Over time, franchisors learn how to best supervise the activities of franchisees (Julian
and Castrogiovanni 1995) through organizational learning processes (Nelson and Winter
1982). The more an organization uses franchisee monitoring capability, the better it becomes
at this capability. Moreover, the more it practices, the better the organization becomes at
replicating this monitoring capability in other settings (Usher 1989). Therefore, franchisee
monitoring capability is also enhanced by the amount of time a franchisor has been offering
franchises. This argument leads to the second hypothesis:
H2: The better the monitoring capability that a franchisor develops, the more likely it is
to seek foreign franchisees.

METHODOLOGY
The sample for this study is taken from the January 1994 issue of Entrepreneur magazine,
which identifies the 815 largest U.S. franchise systems. This sample has been used in previous
studies of franchising (Martin and Justis 1993; La Fontaine 1992; Combs and Castrogiovanni
1994), and it has been shown to be representative of a random sample of all franchise systems
in the United States (Combs and Castrogiovanni 1994).
Entrepreneur magazine provides information on the franchisor's industry, year of found-
ing, the number of franchised and company-owned outlets in its system, the initial investment
required of franchisees, the franchise fee, the general and advertising royalty rate, the number
of geographic regions into which expansion has occurred, whether or not the system offers
financing, whether or not the system is seeking domestic franchisees, and whether or not the
franchisor is seeking overseas franchisees (Martin and Justis 1993). The data are validated
through comparison with Uniform Franchise Offering Circulars (UFOCs) obtained from the
franchisors (Combs and Castrogiovanni 1994).

Dependent Variable
This study seeks to predict franchisors' intent to expand overseas. The dependent variable is
the indication in Entrepreneur magazine that the franchise system is seeking foreign franchi-
sees. This variable incorporates the intention to obtain master franchisees as well as direct
franchisees because it captures the general intent of the franchisor to expand by contractual
80 S.A. SHANE

means. This study does not attempt the finer grained analysis of differentiating the intent to
expand through master franchising and direct franchising.
Although intent to expand cannot be equated with actual expansion, it is an important
concept to measure (Kraus 1995). Intent to expand captures two important decisions by the
franchisor: do we want to expand at this point in time? And do we want to do it through
franchising? Whereas external forces might lead realized strategy to diverge from intended
strategy, capturing the intended strategy of the franchisor provides valuable information about
the plans of the franchisor. Understanding how franchisor capabilities influence these intentions
can provide information about the strategies followed by franchisors.
The data to measure this variable are taken from Entrepreneurmagazine, which identifies
the intended strategy based on statements in the UFOC that the franchisor is required to
provide to potential franchisees. Given that this information is published in the UFOC, the
intent to seek franchisees either domestically or internationally can be considered a credible
commitment.

Predictor Variables
Two predictor variables are included in the study: the amount of bonding and learned monitoring
capabilities.
Bonding is measured as the ratio of the initial franchise fee paid to the franchisor divided
by the percentage royalty and advertising rates. This ratio captures the size of initial payment
for entry into the franchise system relative to the size of ongoing payments made to the
franchisor. Therefore, this ratio is a measure of the ex-ante bond that franchisees must pay
to become part of the franchise system. This measure is based on variables that have been
used in studies on franchising conducted by Martin and Justis (1993), Carney and Gedajlovic
(1991), Caves and Murphy, (1976) and Combs and Castrogiovanni (1994).
Learned monitoring capability is measured as the product of three variables: the number
of franchised outlets, franchised outlets as a percentage of the total number of outlets, and
years since franchising began. This composite measure captures the opportunities franchisors
have to learn to monitor franchisees. The number of franchised outlets captures the economies
of scale in the monitoring system. The percentage of franchised outlets captures the relative
emphasis placed on learning franchisee monitoring capability as opposed to learning company-
owned outlet monitoring capability. The number of years since franchising began taps the
time spent learning to monitor franchisees. The individual variables making up this measure
have been used in studies of franchising by Combs and Castrogiovanni (1994), LaFontaine
(1992), Norton (1988), Martin (1988), Caves and Murphy (1976), and Carney and Gedajlovic
(1991).

Control Variables
Six control variables are included in this study: finn age, initial investment, provision of
financing, geographic expansion, growth, and industry.
Firm age is measured as years since founding. The age of the company is included as
a control variable in this study, following the model of Martin and Justis (1993), Caves and
Murphy (1976), Carney and Gedajlovic ( 1991), LaFontaine and Kauffman (1994), and Combs
and Castrogiovanni (1994). As franchise systems age, they become more likely to have satu-
rated the domestic market and to have become interested in expanding overseas. Research to
 WHY FRANCHISE COMPANIESEXPAND OVERSEAS 81

date supports this argument (Hackett 1976; Walker and Etzel 1973). For this reason, in this
study, the age of the company is controlled.
Initial investment is measured as the dollar value of the initial investment and added
equipment. The initial nonfranchise fee investment includes the cost of inventory, buildings,
signs, real estate, and other investments necessary to open the franchised outlet. This variable
has been used in studies by Martin and Justis (1993), Carney and Gedajlovic (1991), Caves
and Murphy (1976), and Combs and Castrogiovanni (1994). This variable was controlled
because the ability of franchisors to attract foreign franchisees should be greater the smaller
the investment needed to open an outlet. Given the less efficient capital markets relative to
the United States that tend to prevail in most foreign countries, one would expect it to be
harder to find franchisees who can finance expensive franchised outlets than it would be to
find franchisees who can finance inexpensive outlets. This condition, combined with the lower
quality of available financial data in most foreign countries, which increases the risk of
identifying financially strong potential franchisees, means that it is more difficult to establish
cross-border agreements for expensive franchise systems than for inexpensive ones (Huszagh
et al. 1992). As a result, franchisors with expensive franchise systems should be less interested
than other franchisors in seeking foreign franchisees.
Financing is measured as a dummy variable for financing provided. Whether or not the
franchisor provides financing to franchisees was included as a control variable in the regression
analyses. The provision of financing was controlled because financing makes the international
expansion of franchise systems significantly more complicated. If financing is provided, the
franchisor needs to hedge against currency movements as well as to insure that loan agreements
are enforceable in local courts. These difficulties should reduce the incentive of companies
to franchise overseas.
Geographic expansion is measured as the number of regions out of 13 into which the
franchisor operates. This variable was included as a control variable because previous research
has shown that international expansion occurs after domestic market saturation has occurred
(Aydin and Kacker 1990; Hackett 1976). Therefore, the more regions in the United States
in which a franchisor currently operates, the closer the franchisor is to domestic market
saturation and the more likely it is to expand overseas.
The growth in the total number of outlets, expressed as the total number of outlets added
over the last two years, was included as a control variable. This variable was controlled
because more successful, fast growing systems should be more likely than less successful,
slow growing systems to adopt international expansion strategies. Researchers have shown
that overseas expansion is more costly and risky than domestic expansion (Aydin and Kacker
1990). One could argue that more successful firms should be more interested in overseas
expansion because their greater resource slack and greater ability to obtain resources from
capital markets should make them better able than less successful firms to absorb the risks
and costs of such expansion.
Industry was also included as a control variable. Control for industry was accomplished
by introducing 27 dummies for each of the industry classifications indicated in the January
1994 issue of Entrepreneur magazine. Numerous studies have shown that industry has a
significant effect on the ability of firms to transfer knowledge overseas through contractual
mechanisms (Buckley and Casson 1976; Hennart 1990; Shane 1994). Many explanations
have been offered for this variation ranging from the difficulty of codifying information
(Buckley and Casson 1976; Hennart 1990) to differences in advertising and research and
development spending (Gatignon and Anderson 1988; Caves 1982). If industry influences
82 S.A. SHANE

TABLE 1 Descriptive Statistics for the 815 Franchisors

Variable Mean SD Minimum Maximum
Learned monitoring capability 410.00 1402.00 0.00 1577.00
Bonding 359.15 374.67 0.00 4333.33
Initial investment $158,280.00 $361,010.00 $0.00 $5,500,000.00
Age 19.00 14.82 89.00 1.00
Growth 40.20 259.74 - 874.00 3906.00
Geographic dispersion 7.20 3.17 0.00 13.00
Provides financing 0.48 0.50 0.00 1.00
Personnel services 0.03 0.16 0.00 1.00
Children's products 0.02 0.13 0.00 1.00
Computers 0.00 0.07 0.00 1.00
Apparel 0.01 0.10 0.00 1.00
Auto service 0.05 0.23 0.00 1.00
Health care equipment 0.01 0.09 0.00 1.00
Optical products 0.01 0.10 0.00 1.00
Fitness centers 0.01 0.12 0.00 1.00
Building products 0.01 0.12 0.00 1.00
Business services 0.06 0.24 0.00 1.00
Bakeries 0.04 0.20 0.00 1.00
Frozen desserts 0.02 0.15 0.00 1.00
Fast food 0.17 0.38 0.00 1.00
Retail food 0.04 0.20 0.00 1.00
Home improvement 0.04 0.19 0.00 1.00
Hotel, motel 0.01 0.12 0.00 1.00
Maintenance services 0.09 0.29 0.00 1.00
Pet products 0.01 0.12 0.00 1.00
Photographic 0.03 0.17 0.00 1.00
Publishing 0.01 0.11 0.00 1.00
Real estate 0.02 0.14 0.00 1.00
Recreation 0.03 0.16 0.00 1.00
Restaurants 0.07 0.25 0.00 1.00
Miscellaneous retail 0.06 0.24 0.00 1.00
Miscellaneous service 0.07 0.25 0.00 1.00
Training 0.02 0.15 0.00 1.00
Travel 0.01 0.11 0.00 1.00

the degree to which firms use contractual mechanisms like franchising, industry effects need
to be controlled in a study of franchisor intentions to expand overseas.

RESULTS
The means and standard deviations for the variables are shown in Table 1. The correlations
between the independent variables are shown in Table 2. The correlation matrix indicates
that there may be problems of collinearity between the industry dummy variables and the
other control variables. For this reason, the hypotheses were tested using regression models
that both include and exclude the industry dummy variables.
The data were analyzed using logistic regression. Table 3 shows the results of the
regressions to predict intention to expand overseas. Model 1 shows the regression model
absent the control variables for industry. Model 2 shows the full model. The significance
levels are marked with asterisks. A negative relationship indicates that an increase in the
predictor variable reduces the probability that the franchisor seeks foreign franchisees.
 WHY FRANCHISE COMPANIES EXPAND OVERSEAS 83

TABLE 2 Correlation Matrix of the Independent Variables

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15) (16) (17)
(1) 1.00
(2) .02 1.00
(3) .05 .22 1.00
(4) .15 .04 .15 1.00
(5) .01 -.02 .02 .08 1.00
(6) .08 .05 -.15 .13 .10 1.00
(7) .26 -.03 .10 -.08 .07 .06 1.00
(8) -.03 -.06 -.03 .02 -.03 .02 -.04 1.00
(9) .00 .01 -.02 .05 -.02 .02 -.01 -.02 1.00
(10) -.03 .03 -.04 -.00 -.02 .03 -.02 -.01 -.02 1.00
(11) .11 .03 -.05 .04 .03 .05 -.00 -.02 -.03 -.02 1.00
(12) -.02 .01 -.01 .09 -.02 -.04 -.05 -.02 -.03 -.02 -.02 1.00
(13) -.07 -.07 .25 -.07 -.07 -.12 .04 -.03 -.05 -.03 -.04 -.04 1.00
(14) -.02 -.03 -.01 -.04 -.02 -.09 -.04 -.03 -.05 -.03 -.04 -.04 -.07 1.00
(15) -.03 .00 -.08 .10 .01 .11 -.06 -.03 -.05 -.03 -.04 -.05 -.07 -.07 1.00
(16) -.03 .00 -.03 .05 .02 .02 -.01 -.02 -.03 -.02 -.02 -.03 -.04 -.04 -.04 1.00
(17) -.00 -.02 -.03 .04 -.05 -.02 -.03 -.01 -.02 -.01 -.02 -.02 -.03 -.03 -.03 -.02 1.00
(18) -.03 .01 -.04 .04 .22 .10 .12 -.02 -.03 -.02 -.02 -.03 -.04 -.04 -.05 -.03 -.02
(19) -.03 .03 -.03 .07 .01 -.06 -.07 -.02 -.02 -.02 -.02 -.02 -.04 -.04 -.04 -.02 -.02
(20) -.02 .02 -.02 -.04 -.03 .04 -.05 -.01 -.01 -.01 -.01 -.01 -.02 -.02 -.02 -.01 -.01
(21) -.02 -.03 -.00 -.00 -.01 -.02 .03 -.01 -.02 -.01 -.01 -.02 -.03 -.03 -.03 -.02 -.01
(22) -.01 -.04 -.03 -.04 .01 .06 .02 -.03 -.04 -.03 -.03 -.04 -.06 -.06 -.06 -.04 -.03
(23) -.01 .02 -.03 .01 -.02 .02 -.02 -.01 -.02 -.01 -.01 -.02 -.03 -.02 -.03 -.01 -.01
(24) -.02 .02 .00 -.12 .04 .05 .07 -.01 -.02 -.01 -.01 -.02 -.03 -.03 -.03 -.06 -.01
(25) .06 .03 -.04 .04 .08 -.05 -.05 -.01 -.02 -.01 -.02 -.02 -.03 -.03 -.03 -.02 -.01
(26) -.01 .03 -.04 -.00 .01 .01 -.02 .01 -.02 -.01 -.02 -.02 -.03 -.03 -.03 -.02 -.01
(27) -.05 .04 -.08 .08 -.01 .03 -.06 -.03 -.05 -.03 -.04 -.04 -.07 -.07 -.07 -.04 -.03
(28) -.01 -.14 -.01 -.09 -.01 -.09 -.07 -.03 -.04 -.02 -.03 -.03 -.06 -.05 -.06 -.03 -.02
(29) .09 .04 -.01 .00 -.02 .01 .06 -.02 -.03 -.02 -.02 -.03 -.04 -.04 -.04 -.03 -.02
(30) .05 .05 .05 -.15 -.08 -.13 .10 -.06 -.08 -.05 -.07 -.08 -.12 -.12 -.12 -.07 -.05
(31) .02 -.03 -.01 -.06 -.02 .03 .02 -.03 -.04 -.02 -.03 -.04 -.06 -.05 -.06 -.03 -.02
(32) -.03 .05 -.05 .01 -.00 -.02 -.05 -.02 -.03 -.02 -.03 -.03 -.05 -.05 -.05 -.03 -.02
(33) .03 .02 .70 .06 -.04 -.06 .08 -.01 -.02 -.01 -.02 -.02 -.03 -.03 -.03 -.02 -.01
(34) .06 .02 -.11 .08 .11 .13 .04 -.04 -.06 -.04 -.05 -.05 -.09 -.08 -.09 -.05 -.04

T h e m o d e l c h i - s q u a r e for b o t h m o d e l s is significant, r u l i n g o u t the null h y p o t h e s i s that

all coefficients are e q u a l to z e r o . T h i s test is the e q u i v a l e n t o f a n F - t e s t in m u l t i p l e r e g r e s s i o n
a n a l y s i s (SPSS 1990). It s h o w s that the m o d e l s t h e m s e l v e s are r o b u s t .
A n e x a m i n a t i o n o f the d a t a p r o v i d e s s u p p o r t for b o t h h y p o t h e s e s . T h e r e s u l t s s h o w that
a h i g h level o f b o n d i n g p r e d i c t s i n t e n t i o n to e x p a n d o v e r s e a s (B = 0 . 0 1 ; p < .001). S i m i l a r l y ,
a high level o f m o n i t o r i n g capability predicts intention to e x p a n d o v e r s e a s (B = 0 . 0 1 ; p < .001).
T o d e m o n s t r a t e that t h e s e findings w e r e not s p u r i o u s , the a n a l y s i s w a s r u n o n a s e c o n d
m o d e l , w h i c h i n c l u d e s t h e i n d u s t r y c o n t r o l v a r i a b l e s . T h e s e r e s u l t s are e s s e n t i a l l y the s a m e
as t h o s e for the r e g r e s s i o n a n a l y s i s w i t h o u t i n d u s t r y c o n t r o l s . C o n t r o l l i n g for t h e effect o f
i n d u s t r y d o e s not c h a n g e t h e d y n a m i c s o f the r e l a t i o n s h i p b e t w e e n the p r e d i c t o r v a r i a b l e s
a n d the d e c i s i o n to seek f o r e i g n f r a n c h i s e e s .
O n e a l t e r n a t i v e e x p l a n a t i o n for the results m i g h t b e that s u c c e s s in f r a n c h i s i n g leads to
b o t h d o m e s t i c a n d i n t e r n a t i o n a l e x p a n s i o n . T o r u l e o u t this a l t e r n a t i v e h y p o t h e s i s , the pre-
d i c t i v e v a l i d i t y o f the m o d e l w a s tested to e x p l a i n the i n t e n t to e x p a n d o v e r s e a s o n t h e i n t e n t
to e x p a n d w i t h i n the U n i t e d States. I f the m o d e l that e x p l a i n e d i n t e n t to e x p a n d i n t e r n a t i o n a l l y
84 S.A. SHANE

TABLE 2 continued
(18) (19) (20) (21) (22) (23) (24) (25) (26) (27) (28) (29) (30) (31) (32) (33) (34)
(18) 1.00
( 1 9 ) - . 0 2 1.00
(20)-.01-.01 1.00
(21)-.02-.01-.01 1.00
(22)-.04-.03-.02-.02 1.00
(23) - . 0 2 - . 0 1 - . 0 1 - . 0 1 - . 0 2 1.00
(24) - . 0 2 - . 0 1 - . 0 1 - . 0 1 - . 0 2 - . 0 1 1.00
(25) - . 0 2 - . 0 2 - . 0 1 - . 0 1 - . 0 3 - . 0 1 - . 0 1 1.00
(26) - . 0 2 - . 0 2 - . 0 1 - . 0 1 - . 0 3 - . 0 1 - . 0 1 - . 0 1 1.00
(27) . 0 2 - . 0 4 - . 0 2 - . 0 3 - . 0 6 - . 0 2 - . 0 3 - . 0 3 - . 0 3 1.00
(28) - . 0 3 - . 0 3 - . 0 1 - . 0 2 - . 0 5 - . 0 2 - . 0 2 - . 0 2 - . 0 2 - . 0 5 1.00
(29) - . 0 3 - . 0 2 - . 0 1 - . 0 2 - . 0 4 - . 0 1 - . 0 2 - . 0 2 - . 0 2 - . 0 4 - . 0 3 1.00
(30) - . 0 8 - . 0 6 - . 0 3 - . 0 5 - . 1 1 - . 0 4 - . 0 5 - . 0 5 - . 0 5 - . 1 2 - . 0 9 - . 0 7 1.00
(31)-.04-.03-.01-.02-.05-.02-.02-.02-.02-.05-.04-.03-.10 1.00
(32) - . 0 3 - . 0 3 - . 0 1 - . 0 2 - . 0 5 - . 0 2 - . 0 2 - . 0 2 - . 0 2 - . 0 5 - . 0 4 - . 0 3 - . 0 9 - . 0 4 1.00
(33)-.02-.02-.01-.01-.03-.01-.01-.01-.01-.03-.03-.02-.05-.03-.02 1.00
(34) - . 0 5 - . 0 4 - . 0 2 - . 0 3 - . 0 8 - . 0 3 - . 0 3 - . 0 4 - . 0 4 - . 0 8 - . 0 7 - . 0 5 - . 1 5 - . 0 7 - . 0 6 - . 0 4 1.00
Key: (1) Learned monitoring capability; (2) Bonding; (3) Initial investment; (4) Geographic expansion; (5) Growth; (6) Dummy
variable for financing; (7) Age; (8) Dummy variable for pet products; (9) Dummy variable for photographic products; (10) Dummy
variable for publishing; (11) Dummy variable for real estate; (12) Dummy variable for recreation products; (13) Dummy variable
for restaurants; (14) Dummy variable for retail; (15) Dummy variable for service; (16) Dummy variable for training; (17) Dummy
variable for travel; (18) Dummy variable for personnel; (19) Dummy variable for children's products; (20) Dummy variable for
computers; (21) Dummy variable for apparel; (22) Dummy variable for auto products; (23) Dummy variable for health care; (24)
Dummy variable for optical products; (25) Dummy variable for fitness products; (26) Dummy variable for building products; (27)
Dummy variable for business services; (28) Dummy variable for bakeries; (29) Dummy variable for frozen desserts; (30) Dummy
variable for fast food; (31) Dummy variable for retail food; (32) Dummy variable for home improvement; (33) Dummy variable
for hotels and motels; (34) Dummy variable for maintenance services.

did not explain intent to expand domestically, this alternative explanation could be ruled out.
Table 4 shows the results of this test. The data revealed that the opposite set of capabilities
that lead to domestic expansion lead to international expansion. These results suggest that
the argument that a "success leads to expansion" model does not fit the international and
domestic expansion patterns of U.S. franchisors. They suggest that the capabilities necessary
for international expansion are different from those required for domestic expansion.

DISCUSSION
The results of this study indicate that franchisors who develop international expansion strategies
differ in a number of important ways from franchisors who do not. Franchisors who seek
foreign franchisees have developed a greater capability to bond against and monitor potential
franchisee opportunism than their domestic counterparts. Moreover, these differences are
consistent across multiple industries.
These findings support the theoretical model presented earlier. The establishment of a
foreign franchise is a contractual form of international expansion. As contractual forms of
international business are thought to be more likely to fail than contractual forms of domestic
business, franchisors need to develop superior mechanisms that protect them against franchisee
opportunism if they are to expand overseas successfully.
This study has implications for both researchers and practitioners. On the research side,
this study suggests that international business research examine further the mechanisms by
which firms make contractual modes of international business work. Whereas many firms
may internalize international market transactions under conditions likely to lead to market
 WHY FRANCHISE COMPANIES EXPAND OVERSEAS 85

TABLE 3 Results of Logistic Regression Analyses to Predict Intent to Expand Overseas

Variables B SE B SE

Learned monitoring capability 0.01 c 0.01 0.0V 0.01

Bonding 0.0V 0.01 0.01 a 0.01
Geographic expansion 0.25 ~ 0.03 0.27 c 0.03
Initial investment 0.01 0.01 -0.01 0.01
Provides financing -0.09 0.16 -0.13 0.18
Age 0.01 0.01 -0.01 0.01
Growth -0.01 0.01 -0.01 0.01
Pet products 1.37 0.98
Photographic 0.30 0.72
Publishing -0.76 0.93
Real estate -0.87 0.76
Recreation 0.40 0.69
Restaurants 0.57 0.61
Miscellaneous retail -0.93 0.58
Miscellaneous service -0.05 0.58
Training 0.39 0.74
Personnel services -0.88 0.63
Children's products 1.53 0.89
Computer 0.27 1.27
Apparel - 2.45a 1.18
Auto service 0.01 0.61
Health care equipment 0.12 1.03
Optical products - 1.60 1.28
Fitness centers 0.25 0.88
Building products - 1.52 0.88
Business services -0.11 0.56
Bakeries 1.10 0.65
Frozen Desserts - 1.11 0.71
Fast food -0.50 0.52
Retail food -0.07 0.61
Home improvement - 1.23 0.64
Hotel, motel 2.47 2.28
Maintenance services 0.35 0.55

Constant 1.14 11.79 10.17 12.69

- 2 log likelihood 889.15 ~ 831.89 b
Model chi-square 169.1V 226.37 ~

N = 815.
"p < .05.
bp < .01.
" p < .001.

failure, the large number of franchisors who use franchising as an international expansion
mode despite conditions of market failure suggests that more attention be paid to mechanisms
that companies can use to reduce the probability of failure of international contractual transac-
tions. By helping to explain how franchisors monitor foreign franchisees or bond them against
opportunistic behavior, this study suggests that the international business literature develop
a more complex understanding of the workings of international business transactions than
the simple choice of internalization or contractual entry modes.
The study also suggests that more attention be paid to researching the international
expansion of franchisors. The growth in the use of franchising as a mode of international
business suggests that researchers need to develop a greater understanding of how and why
franchisors expand overseas. The field of international business needs to develop theories of
86 S.A. SnANE

TABLE 4 Results of Logistic Regression Analyses to Predict Intent to Expand Domestically

Variables B SE B SE

Learned monitoring capability -0.01 a 0.01 -0.01 b 0.01

Bonding -0.01 b 0.0l -0.01 a 0.01
Geographic expansion 1.55 c 0.31 1.8 V 0.37
Initial investment 0.01 0.01 0.01 0.01
Provides financing -0.18 0.42 -0.19 0.55
Age 0.01 0.01 -0.01 0.01
Growth 0.01 0.01 0.01 a 0.01
Pet products -6.96 11.38
Photographic - 0.16 2.01
Publishing 3.87 87.40
Real estate 8.88 50.57
Recreation - 4.52 l 5.55
Restaurants - 1.45 1.59
Miscellaneous retail -0.80 1.59
Miscellaneous service - 1.11 1.64
Training - 3.41 2.69
Personnel services - 1.41 2.17
Children's products 4.51 58.03
Computer 9.37 113.20
Apparel -5.24 11.81
Auto service - 1.14 1.62
Health care equipment 3.39 90.83
Optical products 8.74 86.92
Fitness centers 8.97 54.32
Building products 8.05 65.76
Business services 1.67 4.27
Bakeries -2.58 1.59
Frozen desserts 7.91 46.73
Fast food 1.07 1.50
Retail food -0.80 1.59
Home improvement 7.63 38.52
Hotel, motel -7.51 66.10
Maintenance services - 1.13 1.64

Constant - 3.03 26.46 - 7.75 34.22

- 2 log likelihood 158.15 111.59
Model chi-square 167.84 c 214.4V

N = 815.
° p < .05.
~p < .01.
' p < .001.

international business that explain the internationalization of these types of businesses as well
as traditional manufacturing companies.
The finding that the international expansion of franchisors is explained by a different set
of characteristics than those that explain the domestic expansion of franchisors is important,
because much of the previous research on the international expansion of franchisors (Walker
and Etzel 1973; Hacker 1976; Aydin and Kacker 1990) has not provided an explanation for
internationalization, which is based on different factors from those that explain the domestic
expansion of franchisors. This lack of distinction has been puzzling to researchers who have
observed that not all large, successful domestic franchisors seek to expand overseas, even
though they may expand domestically. This study provides an explanation for the differences
between the international and domestic expansion strategies of franchisors. It indicates that
 WHY FRANCHISECOMPANIESEXPAND OVERSEAS 87

international expansion requires a set of capabilities different from those required of domestic
expansion.
The study also has implications for practitioners. The results of this study indicate that
foreign entrepreneurs can identify the American franchisors that are most likely to expand
overseas by looking at their pricing structure and their monitoring capabilities. The easy
identification of characteristics from which to find American franchisors will help to reduce
the search costs of potential foreign franchisees. This reduction in search costs will make the
establishment of international franchise relationships less expensive.
The results of this study will also help franchisors. As franchise growth rates in the
United States slow down, many franchisors may be looking overseas for growth opportunities.
This study provides franchisors with an explanation of a way to structure their franchise
relationships to reduce potential franchisee opportunism. This ability to reduce franchisee
opportunism will make it easier for franchisors to enter high-growth foreign markets using
the franchising business mode.
In short, this study examined a relatively unexplored t o p i c - t h e international expansion
strategies of franchise companies. The study indicates that characteristics that improve monitor-
ing capability and reduce the likelihood of franchisee opportunism increase the probability
that franchisors will seek foreign franchisees. Hopefully, this study will spur other scholars
to examine international franchising, so that we may build a theoretical base from which we
can teach franchisors and franchisees to be more successful at cross-border relationships.

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