Quality Signaling through Ex-Ante Voluntary Information Disclosure in Entrepreneurial Networks: Evidence from Franchising

Author(s): Farhad Sadeh and Manish Kacker
Web Index: 2017-03
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Abstract

This paper examines antecedents of ex-ante voluntary information disclosures for standardized contracts in entrepreneurial networks. Entrepreneurs (e.g., franchisors) may make such disclosures to prospective business partners in order to signal profitability of partnering, attract financial and managerial resources and develop their entrepreneurial networks. In practice, only a fraction of franchisors make financial performance representations (FPR), an ex-ante voluntary information disclosure to prospective franchisees. We address gaps in the signaling, voluntary information disclosure, franchising, entrepreneurship and small and medium enterprises (SME) literatures. We draw on signaling theory to develop a theoretical framework and investigate factors that influence a franchisor’s disclosure decision. We evaluate hypotheses from our theoretical framework through econometric analyses of multi-sector panel data for the U.S. franchising industry. We estimate a logit model and use lagged independent variables to address our dichotomous independent variable and potential endogeneity respectively. Our results support the view that firms signal their quality through FPRs to attract potential business partners and expand their entrepreneurial networks. Beyond the extant literature, we find that a rigorous partner qualification mechanism is another driver of voluntary information disclosure in franchising. Our findings also provide empirical support for the complementary role played by multiple quality signaling mechanisms used by franchisors and yield public policy implications for franchising.

Valuation Insight

Firms provide financial performance representations as a voluntary disclosure of information to potential business partners. The voluntary information disclosure adds value to the firm by providing a signal of the firm's quality and accordingly attracting suitable business partners and expanding the firm's entrepreneurial networks. Empirical analysis supports this signaling mechanism as complementary to other signals employed by franchisors, yielding implications for the value of franchising.

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