Essays on Business Economics

This dissertation consists of three essays, of which two are related. In the first essay I model the interaction between a franchisor and its franchisees. I examine how a franchisor uses the investment requirements she asks franchisees as a tool to reduce franchisees' underprovision of sales effort. Theoretically, I show that if the franchisor's reputation is highly important the franchisor asks for higher investment requirements when penalizing a misbehaving franchise is more difficult (weaker law enforcement) and when directly monitoring franchisees is more costly.In the second essay, I empirically test the theoretical predictions of the first essay using two datasets at the franchisor level. I measure weak law enforcement using the passing of state level good-cause termination/nonrenewal laws for franchise contracts and I measure monitoring costs using the number of states in which a franchisor operates. Using a database that contains information for 278 franchisors, before and after the laws were passed in some states, I find that the passing of the laws implied an incremental 4.7% increase in investment requirements for franchisors located in states where the laws were passed. Using a large database (10,047 franchisor-year observations), posterior to the passing of the laws, I find that franchisors located in states where good-cause termination/nonrenewal laws were passed ask for investment requirements 4.5% higher than franchisors located in states without such laws. Using both datasets I find evidence that franchisors that expand their operations to an additional state increase the average investment requirements they ask a prospective franchisee between 0.6-1%.The third essay, which is in conjunction with Gordon Phillips, empirically studies how financial distress and bankruptcy affects firms' choices of product quality and prices using data from the airline industry. We find that an airline's quality and pricing decisions are differentially affected by financial distress and bankruptcy. Product quality decreases when airlines are in financial distress, consistent with financial distress reducing a firm's incentive to invest in quality. In addition, firms price more aggressively when in financial distress consistent with them trying to increase short-term market share and revenues. In contrast, in bankruptcy product quality increases relative to financial distress periods.