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BUSINESS CLIMATE AND INTERNATIONAL FRANCHISE EXPANSION

Richard C. Hoffman, Jonathan Munemo, and Sharon Watson

January 2014

ABSTRACT
In this paper, we examine how a countrys business climate affects the international expansion
decisions of U.S. franchise companies. In doing so, we establish and test various hypotheses
regarding how franchise companies international expansion plans are influenced by elements of
a countrys business climate. To test these hypotheses, we estimate a panel regression model
using different specifications. Our estimates lend support to our hypotheses and demonstrate that
a countrys business climate is an important predictor of foreign firms expansion into that
country. Implications for practice and future research are also discussed.

Professor, Perdue School of Business, Salisbury University,1101 Camden Ave, Salisbury, MD 21801, 1-410-5485398, Fax: 410- 677- 5375, E-mail: rchoffman@salisbury.edu.

Assistant Professor, Perdue School of Business, Salisbury University, 1101 Camden Ave, Salisbury, MD 21801,1410-677-0057, E-mail: jxmunemo@salisbury.edu.

Associate Professor, Dept. of Business Administration, Lerner College of Business & Economics, University of
Delaware, Newark, DE 19716, 1-302-831- 4560, E-mail: watsons@udel.edu.

1.

Introduction

Consider the following examples:


 Increased political stability and more favorable regulations prompted the expansion of
Anytime Fitness into Qatar.
 Papa Johns expansion into Russia was driven, in part, by the countrys modernization of
its business infrastructure.
In the past several decades, franchising has become an important strategy for business
growth, job creation, and economic development, and has been an effective method for firms to
enter foreign markets or expand internationally. Indeed, some of the first companies to establish
a significant presence in foreign markets have been franchise companies. As the two
introductory examples demonstrate, a favorable business climate plays a crucial role in franchise
companies decisions regarding the location of their international expansion efforts. Countries
differ widely with respect to how attractive their business environments are for new business
development. As noted by the World Banks Doing Business project, having the right set of
business regulations has an enormous impact on business growth and development within a
country, and has a profound effect on a countrys overall economic development (World Bank,
2013). In this study, we examine how a countrys business climate affects the international
expansion decisions of U.S. franchise companies. We begin by discussing the importance of
franchising in the development of a countrys economy. In the next section business climate is
defined and the use of transaction cost theory as the broad framework for this study is described.
Using transaction cost theory, we then develop hypotheses regarding how franchise companies
international expansion plans may be influenced by elements of a countrys business climate.
We test these hypotheses using data collected over a seven year period on the expansion plans of

U.S. franchise companies. Our results demonstrate that a countrys business climate is an
important predictor of foreign firms expansion into that country.
1.1.

International Franchise Expansion


As a foreign market entry mode, franchising is prevalent, in large part, because it has

lower transaction costs. Franchising allows for rapid expansion with a lower capital layout, and
therefore, it has a corresponding lower cost and risk to the company. A large portion of the cost
and risk of market entry is borne by the franchisee, who has a partial ownership stake in the local
franchise. Franchising also can lower the transaction costs of market entry associated with
cultural and market differences, through the use of local franchisees, who have in-depth
knowledge of local cultural customs and business practices (e.g., Hoffman, Kincaid and Preble,
2008). Thus, the international expansion of franchise companies to dissimilar countries often is
quite rapid. Many of the U.S. companies that were early entrants into dissimilar countries such
as China and India were franchise companies. For example, in 1987 KFC was the first American
fast food company to open in China. Only twenty years later, the company had more than 1,800
outlets in 400 cities across China (Franchise Direct, 2008).
For these reasons, franchising has become an especially important driver of growth in
developing economies. For example, Brazil has an active franchising sector with 2010 sales of
approximately $48 billion, or just over two percent of Brazils GDP. According to the Brazilian
Franchising Association (ABF, 2011), Brazil had approximately 1,855 franchise systems
operating over 86,000 units. Moreover, the Russian Franchising Association reported that there
were more than 450 franchise systems and 8,500 franchisees operating in Russia in 2010 (World
Franchise Associates, 2011), with fast food (22% share) and retail (46% share) the leading
sectors in that country (Global Trade.net, 2010). In the past decade, franchising has become

increasingly prevalent in China as well, due in part to new regulations in 2004 that more clearly
defined how foreign franchise businesses can operate in that country, making franchising a more
attractive investment (International Franchise Association, 2013). Chinas franchise sector has
82,000 units and is growing at 49% annually, but still makes up only 3% of the countrys retail
sales, thus there still is much potential for growth (International Franchise Association, 2013). In
India, franchising is experiencing similar levels of growth, at over 30% annually, stimulated by
economic liberalization and reform (Shah, 2008). Yet, franchises account for only 2% of Indias
retail sales (Franchise Direct, 2013), indicating a market ready for growth. Franchising also
continues to be the preferred model for international businesses to expand quickly into the
rapidly developing economies of the Middle East (Young, 2010). The Middle East has a total
population of over 300 million, with 60 percent under 25 years old and over 400,000 high networth individuals ready to invest in new businesses (Franchise UAE.com, 2011).
From these examples, it becomes clear that franchising has spread globally to become an
established method of doing business in numerous countries, including many developing
countries. Research (e.g., Teegen, 2000) has shown that a countrys business climate is an
important driver of new business creation, for both local companies as well as inward investment
by foreign franchise companies. Because of the important role of franchise companies in the
establishment and growth of new businesses in emerging economies, we need to understand how
the international expansion plans of franchise companies are affected by different elements of a
countrys business climate. In this study we examine the impact of local business climate factors
such as good governance, business regulations, taxes, and media availability on the international
expansion plans of U.S. franchise companies.

2.

Business Climate, Transaction Cost Theory and Franchising


Business climate is defined as the broad economic, political/regulatory, technological,

and socio-cultural sectors/institutions that characterize a national market (e.g., Ghemawat, 2001;
Alon, 2006; Hoffman, Kincaid and Preble, 2008). Our particular focus will be on the
political/regulatory climate as these sectors affect not only entry, but also on-going operations
and business transactions. We also examine select economic and technological characteristics
that are especially important to the franchising sector and to the time during which the study was
conducted.
The broad theoretical framework useful for guiding an examination of the effect a
countrys business climate has on business growth is transaction cost theory. According to
transaction cost theory, firms seek to expand in a cost effective manner to insure profitability
(e.g., Williamson, 1975). A key challenge to transaction efficiencies is uncertainty about the
future in the firms environment. Uncertainty increases the firms transaction costs, especially
with regard to search, information processing, and adaptation. According to Teece (1981), the
transfer of firm knowledge across borders may be carried out more efficiently within the firm by
using direct investment. Others (e.g., Contractor and Kundu, 1998; Fladmoe-Lindquist, 1996)
have identified franchising as a hybrid business form that lies between markets and hierarchies,
thereby, also providing efficiencies in market transactions.
In global markets, franchising allows for incremental decisions as expansion unfolds in
various markets, and the use of franchisees with local knowledge improves the decision
processes associated with the uncertainties of expanding into specific markets (Sashi and
Karupuur , 2002). The franchisors use of a largely standard business format helps reduce the
costs resulting from economies in purchasing, standard products/services, uniform brand and

logo (Kauffmann and Eroglu, 1998), and provides administrative economies by using standard
operating procedures for each unit (Caves, 1996; Shane, 1996). In the next section we apply a
transaction cost perspective to help explain the influence a countrys business climate is likely to
have on the international expansion of franchising companies.
3.

Business Climate and Franchise Expansion: Some Hypotheses


Up until the present, the majority of the studies examining market factors affecting

international franchise expansion have focused on macro country market characteristics, such as
economic growth, political risk/stability, cultural similarity, and geographic distance (e.g., Alon
& McKee, 1999; Hoffman, Kincaid & Preble, 2008; Michael, 2003). Other than some descriptive
surveys (e.g., Hoffman & Preble, 2004), there are no systematic studies that focus on how more
specific aspects of an international markets business climate impact franchise expansion. Yet,
over the years, surveys consistently have revealed that the local business climate is a concern for
franchisors when expanding internationally (e.g., Hackett ; 1976; Preble and Hoffman, 1995).
Using transaction cost theory, we examine the following sources of uncertainty
associated with the business climate of international markets: political, technological, and
economic. Along with socio-cultural uncertainty, these are the primary areas of uncertainty
defined in the literature as affecting firms foreign entry mode (e.g., Anderson and Gatignon,
1986). Our hypotheses are organized to address some of the costs of entry associated with
confronting such uncertainties in international markets.
3.1.

Political Uncertainty of the Business Climate


According to transaction cost theory, a particular source of uncertainty in international

markets is that associated with political uncertainty (Sashi and Karuppur, 2002). Changes in
industrial policy or business regulations pose risks that may increase the costs of doing business,

such as restrictions on investment, repatriation of profits, and tax structure. All of these can
affect the cost structure of firms. The need to monitor the political risk of nations when
conducting foreign investment is well established in the literature (e.g., Alon and Martin, 1998;
Hamilton and Kashlak, 1999). Government policies pertaining to disclosure, tariffs, taxes,
profitability, etc. sometimes create uncertinty regarding entry costs and, thereby, affect
franchsiors perceived risk of foreign market entry (e.g., Eroglu, 1992; Hoffman & Preble,
2004). Furthermore, assessing the political risk of nations increases search and information
processing costs for firms anticipating international expansion.
Stability of government policies also impacts the conduct of franchise businesses because
franchise contracts vary significantly across countries (Fladmoe-Linquist, 1996). Moreover,
political instability has a negative impact on the franchisors ability to monitor franchisees in
foreign markets and, thereby, increases administrative costs for the firm (Fladmoe-Linquist &
Jacque, 1995). There is some evidence that the diffusion (e.g., Hoffman and Preble, 2001) and
penetration (Hoffman, et al., 2008) of franchise firms into foreign markets is facilitated by good
governance. Thus,
Hypothesis 1: Good governance (political stability and government effectiveness) has a positive
impact on franchise expansion.
From the above discussion, it appears that reduced political uncertainty in a country at
the aggregate level tends to reduce transaction costs. However, at the firm level, it is the specific
business regulations associated with starting and managing the daily operations that have a more
direct impact on firm transaction costs. The analysis of business entry regulation is important for
U.S. franchisors future expansion plans for at least two additional reasons. First, as noted by the
World Bank (2004) and Klapper, Laeven & Rajan (2006), bureaucratic entry regulations are
costly and impede new firm creation, even in industries that naturally should have high entry,
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such as franchising. Second, Klapper et al. (2006) also found that higher bureaucratic barriers to
entry in naturally high entry industries reduce productivity growth in these industries because the
disciplinary effects of competition are inhibited. Therefore, the effectiveness of franchising as a
strategy for business growth critically depends on the nature of the prevailing regulatory business
climate in foreign markets.
Sound business regulation (e.g., licenses, contracts, credit, labor, etc.) ensure that firms
tend to play by the same rules so that the market will determine success or failure, thus reducing
uncertainty for decision makers. At the same time, too much regulation may stifle competition
and, worse yet, add costs that impede profitable performance. For example, Latin American
countries with high levels of political stability, together with a deregulated environment, tend to
attract high levels of inward FDI (Bengoa & Sanchez-Robles, 2003). In another study, higher
market and labor regulations were negatively correlated with the entry of small and mediumsized firms in OECD countries (Scarpetta, Hemmings, Tressel & Woo, 2002). Moreover,
Klapper et al. (2006) found that business regulations that are costly to the firm tend to reduce
firm entry into industries that normally have low entry barriers. Hackett (1976) revealed that
franchisors were concerned about regulations affecting taxes and profit repatriation as they
expanded internationally. In the following decades, other surveys revealed similar concerns
associated with international expansion. More recently, additional regulations specific to
franchising have been areas of concern for franchisors including disclosure requirements,
contract law (e.g., Preble and Hoffman, 1995), royalty taxes, value added taxes, and tariffs
(Hoffman & Preble, 2004). Consequently, specific business regulations and taxes remain an
important concern for international franchisors.Thus, on the one hand, business regulations
provide consistent rules for all, whereas, on the other hand, regulations such as excessive

disclosure laws, licensing fees, or poor contract enforcement may also raise the costs of doing
business in a country market. Taking these contradictatory impacts into account, we expect that
there is some point of diminishing return to business regulation, beyond which it ceases to
promote a good business climate for firms. Hence,
Hypothesis 2a: Business entry regulations will have positive impact on franchise
expansion as long as they reduce the costs of entry.
2b: Once regulations become excessive so as to increase the costs of entry, they will have
a negative impact on entry.
Certain business entry regulations are costly and impede new firm creation (World Bank,
2004; Klapper et al., 2006). For example, both the prevailing tax level and the uncertainty of a
nations tax policy have the tendency to increase transaction costs (e.g., Sashi and Karuppur,
2002). Taxes represent additional costs that reduce the rents (profits) that firms are able to
appropriate for themselves (e.g., Williamson, 1975). While todays firms are aware of the need
for taxation, they prefer markets with a lower tax burden. Franchising firms are also concerned
with a variety of taxes (Hoffman & Preble, 2004) that may reduce the earnings of their
businesses, which often have low margins. Recently, a negative relationship was found between
corporate taxation rates and firm entry into foreign markets (Da Rin, Giacomo & Sembenelli,
2011). Since taxes increase transaction costs for firms, the impact of the tax climate on franchise
expansion is expected to be as follows:
Hypothesis 3: A countrys corporate tax rate is negatively related to franchise expansion.
3.2.

Technological Uncertainty of the Business Climate


In the context of this study, technological uncertainty refers to the condition of the

nations infrastructure, such as communication, transportation, and banking (e.g., Teegen, 2000;
Hoffman et al., 2008). Of particular importance to franchisors is the communications
infrastructure, and specifically, the availability of media. Media availability is crucial because
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todays franchises offer branded products or services along with proven methods for operating
the business. The use of the brand name enables franchises to achieve economies across the
system (Caves and Murphy, 1976), as well as to attract franchisees (e.g., Zachary et al., 2011)
and customers. Consumers in most countries rely on the media for most of their product
information (e.g., Talkudar, Sudhir and Ainslie, 2002). Expansion of the franchise system is
motivated, in part, by the desire to develop and maintain brand equity, and it also permits the
development of scale economies in promotion and marketing costs over a larger number of units
(Carney and Gedaljovik, 1991), thereby, creating more efficiencies for the franchise system.
Furthermore, economies can be further achieved by using similar media (e.g., Hoffman et
al., 2008) in various country markets. Given the importance of branding, franchise systems are
confronted with technological uncertainty in international markets regarding whether they will
have the necessary media to continue to build brand equity and system promotional efficiencies.
For example, one study noted that franchisors were concerned with the regulation of signage in
China (Hoffman & Preble, 2004). Thus, media availability has been associated with both the
franchisors ability to build brand equity, and with higher levels of market penetration (Talukdar
et al., 2002). Thus, due to the importance of media for maintaining brand equity and promoting
system efficiencies in doing business across borders, the following is suggested:
Hypothesis 4: The level of media infrastructure (internet access, teledensity)in a country
is positively related to franchise expansion.
3.3.

Economic Uncertainty of the Business Climate


Economic growth is viewed as a positive feature that makes a foreign market attractive

for firms in general and franchisors in particular (e.g., Evans and Mavondo, 2002; Hoffman &
Preble, 2004). Economic uncertainty is the result of adverse economic events such as higher
interest rates, inflation, and changes in aggregate demand (e.g., Sashi and Karuppur, 2002).
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Unforeseen events such as recessions and financial crises also create uncertainty for decision
makers. Economic uncertainty creates higher perceived risk of market entry on the part of
franchisors (Eroglu, 1992) such that they are less likely to expand in markets without favorable
economic growth (e.g., Hoffman et al., 2008). Uncertain economic events may depress profits
either through higher costs of doing business associated with higher interest rates or reduced
revenues due to higher prices or lowered demand. Sudden economic events such as the onset of a
recession are likely to magnify the higher perceived risk of doing business in a market when
demand is likely to be depressed. The 2008-09 financial crisis occurred as a natural experiment
during the data collection period. It seemed opportune, therefore, to explore whether the financial
crisis had an impact on the international expansion plans of US franchisors.
The initial impact of the crisis appeared to slow down the international expansion of U. S.
franchises. However, this was short lived for two reasons as noted in a recent analysis of over
300 expansion plan announcements by U.S franchisors from 2005-2011 (Preble, Hoffman &
Watson, 2013). First, the crisiss effect abroad lagged behind the US and as a result many
international markets were still attractive to U.S. firms. Secondly, even when the crisis affected
the emerging markets (which represented 70% of the target markets for U.S. firms), their
economies still grew at attractive rates in comparison to the USA. For example, in the two largest
markets for U.S. franchisors during this time period, China grew at no less than 8 %, and India
grew at no less than 4 % during the crisis. Thus, international markets proved to be more
attractive alternatives to the weak domestic market for U.S. franchisors. Thus, we suggest the
following:
Hypothesis 5: The 2008-09 financial crisis will be positively related to franchise
expansion.

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4.

Data and Empirical Strategy

4.1.

Overview of the Data


We developed our sample using press announcements made by U.S. franchise companies

regarding expansion plans or moves they made into specific international markets. Press
announcements document specific expansion locations and numbers of units, which leads to a
more accurate measure of international expansion than previous studies that used surveys to
collect data about expansion plans (Preble and Hoffman, 1995; Hoffman and Preble, 2004).
These press announcements provide data on concrete expansion plans that already are being
implemented, not merely estimates of future expansion.
The data collection process consisted of several steps. First, we monitored SmartBrief
(ifa@smartbrief.com), the e-newsletter of the International Franchise Association (IFA), and
collected all announcements of international expansions. As the worlds largest franchise
association, the IFA serves as an important source of news for the franchise sector. SmartBrief is
an organization that provides e-newsletters in a number of industry sectors by searching
numerous sources of print and online news and information, summarizing and assembling the
results, and reporting them in a number of e-newsletters. The IFA SmartBrief is one of these enewsletters, and is published approximately every other day. Information in the IFA SmartBrief
includes announcements by IFA members, as well as news items from trade magazines and
websites, international and regional business media, and other sources of franchise related news,
providing a comprehensive set of franchise news. For this study, we collected all of the press
announcements made by U.S. franchisors regarding concrete plans they have for expanding their
international operations. The data were collected over a seven year period (2005-2011) from

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articles that appeared in the IFA SmartBrief that announced specific franchisor expansion plans
into foreign locales.
Thirty-eight firms made 101 announcements during this period that provided the data for
this study. Each press announcement was coded with respect to the country location of the
expansion, the number of units being opened, date of expansion, mode of entry, and the reasons
cited for the expansion into that location. The sample is dominated by firms in the lodging (26%,
e.g., Choice Hotels, Hilton, Marriott, etc.), restaurant ( 39%, e.g., Burger King, Dairy Queen,
McDonalds, Pizza Hut, Taco Bell, etc.) and retail (18%, Baskin-Robbins, Gap, Krispy Kreme,
Seven Eleven, etc.) industries.
Country business regulation data were obtained from the World Banks Doing Business
project (World Bank, 2013), which has made available objective measures of business
regulations and their enforcement across economies. Using standardized case studies, the Doing
Business project provides comprehensive quantitative data on business regulations that are
comparable across 189 countries and over time. These data can thus be used to analyze specific
business strategies that U.S. franchisors can implement to enhance business productivity and
growth in international markets. We also used data on corporate tax, infrastructure, urban
population and economic development from the World Banks World Development Indicators
(WDI) databank, as well as data on governance from the World Banks World Wide Governance
Indicators databank.
4.2.

Model Specification and Summary Statistics


The effect of business climate on U.S. franchisors future international expansion plans is

determined by estimating equation (1) below.


             
     ! "  # $%    &  ' (1)
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Subscript i denotes firm-i and subscript t denotes time. The dependent variable (franchise
expansion) is the number of units planned for a country market in the future (time t+s) divided
by the urban population of the country. This is consistent with prior measures of franchise
expansion (e.g., Hoffman and Preble, 2001). Turning to the right hand side of the equation (1),
three indicators are used to assess business regulations. The first is the distance to the frontier,
where the frontier is an aggregate score which reflects the most efficient regulatory practice. An
economys distance to the frontier is measured on a scale of 0 to 100, with zero representing the
worst performance and 100 the best or frontier. It enables us to capture the absolute quality of
the regulatory environment as well as its improvement over time. The second indicator is entry
regulation, measured by the cost of business start-up procedures as a percent of GNI per capita.
Our third indicator of business regulations is the national corporate tax rate, measured as a
percentage of profits.
In addition to business regulations, we also include several other variables that past
studies have identified as potentially important explanatory variables of franchise expansion (see
for example Hoffman et al., 2008). These include economic development measured by real GDP
per capita, and measures of media infrastructure and governance. The media infrastructure of
each country consisted of two variables- teledensity or number of phone lines per 100 people and
internet access or the number of internet users per 100 people. Governance was represented by
three indicators, namely, political stability, voice and accountability, and government
effectiveness. A dummy variable is also included to estimate the impact of the 2008-09 financial
crisis on franchise expansion. The parameter & captures firm fixed effects (firm heterogeneity
biases), and ' is an independent and identically distributed mean-zero shock. Because of the
difference in timing between franchise expansion and the explanatory variables, endogeneity is
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less of a problem. Variable descriptions are provided in Table 1. A few firms did not have data in
all periods (2005-2011), making the sample an unbalanced panel. Summary statistics for
franchise expansion and the business climate variables are shown in Table 2.
5.

Findings

5.1.

Distance to Frontier, Entry Regulation, and Future International Franchise


Expansion Plans
Results from equation (1) obtained by estimating different specifications are presented in

Table 3. A panel estimation is performed for all estimations in order to exploit both the crosssection and time series dimensions of the data, and to capture any firm fixed effects which affect
franchise expansion. For all estimations, robust standard errors are provided in parentheses. In
the top panel, we focus on distance to the frontier and find that the estimated coefficient on
distance to the frontier is positive and statistically significant at the 1% level in column (1). This
implies that countries that are closing the gap from the frontier by adopting more efficient
business regulations are attractive destinations for US franchise expansion. However, business
regulations may in part reflect the level of development in the sense that countries with good
business regulations also generally tend to be more developed. We therefore control for a
countrys GDP per capita in column (2), and the estimated coefficient on distance to the frontier
remains positive and statistically significant at the 1% level. We are therefore confident that our
measure of distance to the frontier is not simply capturing the level of a countrys development.
Column (3) shows the results when the rest of the control variables are included. Again, we find
that the estimated coefficient on distance to the frontier is positive and statistically significant at
the 1% level.
In the bottom panel, the results in column (1) reveal that business entry regulation has a
positive effect on franchise expansion which is statistically significant at the 10% level,
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marginally supporting hypothesis 2a. Some regulation is necessary to insure that the rules are
similar for all organizations which reduces the cost of information search regarding this element
of the business climate. Moreover, the effect of the quadratic entry regulation term on franchise
expansion is negative and also statistically significant at the 10% level reflecting marginal
support for hypothesis 2b. The insignificance of entry regulation in column (2) could be the
result of omitted variable bias, and so we include additional controls in column (3), and the
results improve significantly. The positive impact of entry regulation on franchise expansion is
now statistically significant at the 5% level, and the negative quadratic term for entry regulation
is now statistically significant at the 1% level. The full model thus provides strong support for
both hypothesis 2a and hypothesis 2b. Taken together these results imply that up to a certain
point, an increase in entry regulation significantly improves franchise expansion. Thereafter,
higher entry regulation becomes excessive because it raises the costs of entry and, therefore,
significantly impedes franchise expansion.
5.2.

Other Elements of the Business Climate


Political uncertainty stemming from lack of good governance at the country level was the

subject of the first hypothesis. The results reveal support for hypothesis 1 that good governance
matters for franchise expansion. The estimated coefficient on voice and accountability is positive
and statistically significant at the 1% level, and the estimated coefficient on government
effectiveness is also positive and statistically significant at the 10% level in the top panel and at
the 5% level in the bottom panel. Political stability also has a positive effect on franchise
expansion. It is, however, not reported because it had the least statistically significant coefficient.
Transaction costs associated with political uncertainty of specific regulations associated
with the start and operations of a business were the subject of the second hypothesis. Because

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taxes have the effect of raising the cost of doing business in a country, the third hypothesis
suggested that the nations corporate tax rate would have a negative impact on franchise
expansion. The results reveal a negative coefficient for taxes, which is statistically significant
and consistent with the finding that higher taxes lead to less franchise expansion, supporting
hypothesis 3. Conversely, foreign markets with lower corporate tax rates are significantly more
attractive destinations for U.S. franchise operations.
Franchisors also face technological uncertainty when trying to assess a nations
infrastructure as this also has a distinct impact on their costs of doing business. The fourth
hypothesis focused on communications infrastructure, because franchises are businesses which
offer branded products and services. The ability to develop and maintain brand equity is
important for franchise success to attract customers, thereby raising revenue, and to reduce
promotion costs by attracting more franchisors to the system. Key to success in this regard is
media availability in country markets. The results from Table 3 show that the availability of
communication infrastructure (internet access) has a positive effect on franchise expansion
which is significant at the 1% level. The estimated coefficient on teledensity was not statistically
significant and is therefore not reported.
Nothing causes economic uncertainty more than sudden economic shocks, such as a
financial crisis. Support was found for hypothesis 5 concerning the positive impact of the 200809 financial crisis on the expansion of U.S. franchisors. The estimated coefficient for the crisis
variable is positive, and is statistically significant at the 1% level. As noted before, the crisiss
effect abroad lagged behind the US and as a result many international markets were still
attractive to U.S. firms. Even when the crisis affected the emerging markets, their economies

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still grew at attractive rates in comparison to the USA. Thus, international markets proved to be
more attractive alternatives to the weak domestic market for U.S. franchisors.
6.

Summary and Implications


This is the first study to examine the actual expansion plans of franchising firms. All

previous studies (e.g., Arthur Andersen, 1996; Schletrich and Aliouche, 2006) have merely
surveyed their expansion intentions. As a result, the findings here are likely to more directly
relate to the firms actions vis a vis the business climate of host countries. Furthermore, previous
studies (e.g., Hoffman et al., 2008; Michael, 2003) have focused primarily on the macro
environmental climate of host countries and its effects on franchise expansion. By focusing on
more specific aspects of the business climate, we are able to identify those factors that most
directly impact the costs of entry and daily operations of franchise businesses in host countries.
International expansion poses uncertainty for firms concerning the business setting they
are likely to encounter in various markets. The potential costs of doing business in uncertain
conditions increase due to search and information processing costs as well as unknown demand
characteristics. This study sought to examine selected aspects of a countrys business climate
using a transaction cost perspective. In doing so, we established and tested several hypotheses
regarding expansion into country markets when faced with uncertainties posed by the broad
political climate as well as specific business regulations (entry and taxes), technological
infrastructure (e.g. media availability), and the economic uncertainty posed by the financial
crisis.
This studys results found support for the hypothesis relating to the positive relationship
between good governance and franchise expansion. This supports similar findings for
multinationals in general (e.g., Hamilton and Kashlak, 1999) and franchisors in particular (e.g.,

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Hoffman, et al., 2008). This study, however, provides stronger evidence that good government is
good for business because, unlike the previous studies, this research used direct measures of
governance such as the stability of the system, citizen participation, and the quality of public
service. Many previous studies have used measures of political risk which incorporate
investment and economic risk as well as political stability. Our results show the positive impacts
that a good governance system can have on business entry.
Of particular importance was the finding regarding business entry regulations. Having
some regulations helps define the playing field for all firms and reduces the costs of information
search for firms entering new markets. However, too much regulation increases the costs of
doing business, thereby, dissuading firms from entering markets at all. This also hurts the
economic development of nations that impose excessive regulations. Our data also suggest a
diminishing return from regulation after a certain point, a fact policy makers should be made
aware of. While taxes may be a fact of life in all nations, our data reveal that excessive taxation
also dissuades the entry of franchisors into nations. This indicates that tax policy does indeed
affect economic development from foreign investment.
The results also revealed that franchising firms need a good media infrastructure to build
and maintain brand equity and to spread their promotion costs over more franchised units to
create system-wide efficiencies. While prior studies (e.g., Hoffman et al., 2008; Michael, 2003)
have shown the importance of radio, TV, and newspapers for international franchise expansion,
this study extends the importance of the twenty first century media, the internet, as a source of
franchise expansion. Unlike other media, the internet permits franchising firms to have a
constant presence for customers and potential franchisees.

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This is the first study to establish directly that the financial crisis had a positive effect on
international franchise expansion. In collecting longitudinal data, sudden unexpected changes
can be viewed as a problem, but in this case it proved to be an opportunity to study the impact of
an economic shock on business expansion. Furthermore, the use of longitudinal data permitted us
to capture the plans of franchising firms as they unfolded. This points to the added power of such
longitudinal data over cross-sectional data.
In addition, this study also supports the use of transaction cost theory as a theoretical
framework that is broad enough to examine the impact of national business climate on firm
growth. The theory encompasses decision uncertainty as well as examines the costs and revenue
impacts of actions taken by managers and their firms. It appears to be a parsimonious theory with
robust explanatory power.
Our data on franchise firms international expansion is limited to those expansions that
were reported in press announcements. Some firms may choose not to make public
announcements of their specific expansion plans. Thus, expansions that were not reported to the
press may not be included in our sample. However, the IFA SmartBrief, the source of our
expansion data, proactively searches for and reports on news and information from a number of
sources, not just official press releases, and the IFA includes most major franchise companies as
members, so the set of announcements from which we draw our data is most likely fairly
representative of the franchise sector. Additionally, the franchise companies included in our
sample are active across a number of industries, including hotels and lodging, restaurants, auto
care, and fitness, so the results are fairly generalizable. We do not, however, have data on
manufacturing firms, so the results may not be as applicable to firms in that sector.
Despite these limitations, we offer some implications for practice and future research.

20

Managers would do well to become familiar with the specific business climate of an international
market prior to entry. Basic licensing, contract law, credit reports, taxes, and the like are
important but may also be costly. Having knowledge of the regulatory climate enables managers
to weigh the costs associated with business entry. Franchisors must also assess the availability of
appropriate media as this affects their ability to build brand equity efficiently as they expand into
new country markets.
While the results of this study indicate that a countrys business climate is related to the
international expansion location decisions of U.S. franchise companies, it also is important to
understand how the local business climate impacts the subsequent performance and growth of
the foreign business units established in the country. Future research should examine the longer
term effects of the elements of business climate studied here on franchise companies success
and future growth in host countries. Moreover, research determining the right amount of
regulation for business entry is both warranted and needed. Finally, while the use of franchise
data from franchise associations using surveys has already been established (e.g., Preble and
Hoffman, 1995; Hoffman and Preble, 2004), this study reveals that franchise association
websites provide a wealth of data which may be systematically collected over time to answer a
variety of research questions pertaining to the franchise sector.

21

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25

Table 1: Variables
Variables

Description

Franchise expansion

Number of franchise units a firm plans to establish abroad divided by


total urban population (in millions).
Distance to frontier
An aggregate measure of the distance of each economy to the
frontier, which represents the highest performance observed on
each of the indicators of business regulations. It ranges from 0 to
100, where 0 represents the lowest performance and 100 the frontier.
Entry regulation
Cost of business start-up procedures (% of GNI per capita).
Teledensity
Telephone lines per 100 people.
Internet access
Internet users per 100 people.
Corporate tax
Total tax rate (% of commercial profits).
Political stability*
The likelihood that the government will be destabilized by
unconstitutional or violent means, including terrorism.
Voice and accountability*
The extent to which a countrys citizens are able to participate in
selecting their government, as well as freedom of expression, freedom
of association, and a free media.
Government effectiveness*
The quality of public services, the capacity of the civil service and its
independence from political pressures; and the quality of policy
formulation.
Financial crisis
Dummy variable for the financial crisis in 2009.
Real GDP per capita
GDP per capita (constant 2000 US$).
*It is measured on a scale ranging from -2.5 to 2.5, with higher values corresponding to better outcomes.

26

Table 2: Summary Statistics


Franchise expansion
Distance to frontier
Entry regulation
Internet access
Teledensity
Corporate tax
Political stability
Voice and accountability
Government effectiveness
Real GDP per capita

Mean
1.38
61.50
20.95
32.46
21.35
52.95
-0.43
-0.43
0.33
7755.16

Std. Dev.
4.77
12.94
25.94
23.79
14.39
18.57
0.75
1.04
0.68
11038.60

27

Maximum
45.18
91.70
78.40
84.73
61.21
81.20
1.21
1.53
2.27
40837.27

Minimum
0.00
41.40
0.30
2.39
2.87
14.10
-1.56
-1.77
-0.57
577.66

Obs.
101
101
101
101
101
101
101
101
101
101

Table 3: Regression Results


(Dependent variable: franchise expansion)
Explanatory variables

(1)

(2)

(3)

0.067***
(0.016)

0.159***
(0.030)

-2.751
(1.409)
0.51

-0.137***
(0.027)
-7.311
(1.965)
0.53

0.068***
(0.022)
0.101***
(0.018)
1.373***
(0.367)
1.469*
(0.883)
1.162***
(0.328)
-0.783***
(0.215)
-0.367***
(0.086)
-0.656
(1.950)
0.60

Top Panel
Distance to frontier
Internet access
Voice and accountability
Government effectiveness
Financial crisis

Trend
Real GDP per capita

Constant
Goodness of fit (R2)
Bottom Panel
Entry regulation
Entry regulation squared
Corporate tax

0.145*
(0.079)
-0.002*
(0.001)
-0.065***
(0.016)

0.143
(0.091)
-0.002
(0.001)
-0.066***
(0.014)

3.770
(0.461)
0.53
101

-0.002
(0.021)
3.830
(0.519)
0.53
101

Internet access
Voice and accountability
Government effectiveness
Financial crisis
Trend
Real GDP per capita

Constant
Goodness of fit (R2)
Observations

0.372**
(0.152)
-0.004***
(0.001)
-0.020**
(0.008)
0.226***
(0.068)
0.757***
(0.157)
2.315**
(0.917)
1.233***
(0.265)
-1.158***
(0.350)
-0.448***
(0.114)
-1.596
(1.954)
0.67
101

Notes: (a) White (robust) standard errors are in parentheses. (b) *implies the coefficient is significant at the 10
percent level. **implies the coefficient is significant at the 5 percent level. ***implies the coefficient is significant
at the 1 percent level.

28