Performance implications of using signaling and screening for expanding interfirm business networks: evidence from franchising

Abstract

Entrepreneurial business firms such as franchisors can enhance their network performance by attracting high-quality partners and preventing low-quality partners from joining the network.We draw on agency and transaction cost theories and the substantive literature on voluntary information disclosure to develop a theoretical framework that examines the consequences of using signaling and screening mechanisms for interfirm network performance.Our model posits a complementary effect for signaling and screening because of their ability to offset the disadvantages of each other. We empirically evaluate our hypotheses through econometric analyses of a unique multi-sector panel dataset from the U.S. franchising industry. We find that ex-ante signaling and screening at the contractual relationship formation stage are complementary mechanisms that enhance network performance when they are used together. Additionally, we find that specific investments by the focal firm and by the partners positively moderate the performance impact of screening and signaling,respectively. Our findings suggest that the joint use of screening and signaling and the synchronization of specific investment commitments by both sides can assist an entrepreneurial business network in mitigating the double-sided adverse selection problem at the formation stage of dyadic network partnerships and enhancing network performance. Valuation Insight: The paper shows how franchisors can use a combination of screening and signaling mechanisms to add value to their firm by improving the quality of partners they attract to their network.