Journal of law, economics and organization, 2015, Vol. 31, No. 1, pp. 3-39Williamson's 1976 study of natural-monopoly franchise bidding launched extensive debate concerning the degree to which transaction-cost problems afflict government franchising. We propose that municipalities vary in ability to discipline franchisees, and that this heterogeneous ability affects franchise renewal patterns and the quasi-rents that franchisees extract. We study provision of municipal water services in France, a setting characterized by both direct public provision and franchised private providers. We find that small municipalities pay a significant price premium for franchisee-provided water when compared with publicly provided water; in contrast, large municipalities do not pay a premium on average. Further, large municipalities are less likely to renew an incumbent franchisee that charges an “excessive” price, while small municipalities’ renewal patterns are not influenced by franchisees’ excessive pricing. We interpret the results as evidence that although large municipalities can discipline franchisees and thus prevent extraction of quasi-rents, small municipalities are less able to do so due to weaker outside options.
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