It is commonly argued that state laws restricting franchise terminations increase the costs of controlling free-rider problems within franchise systems. For industries where individual units are prone to serving transient customers, we estimate that termination laws are associated with a decrease of two to five percent in the fraction of units that are franchised. This result suggests that the termination laws increase the costs of franchising relative to company ownership. Additional analysis indicates that the introduction of the California law was associated with an average share price decline of 6.4 percent for franchise companies operating in the state. This finding is consistent with decreased efficiency, as well as with transfers from franchisors to some existing franchisees which are suggested by the politics around the passage of the laws.
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