Why do so many transactions take place within firms rather than between independent agents via markets? This column sheds new light on this question by analysing hotel chains’ decisions about whether to outsource management to independent franchisees. Properties with the lowest and the highest occupancy rates tend to be managed by franchisees, at arm's length from the hotel chain. This variation in organisational form is consistent with the authors’ model in which the incentives embodied in management contracts vary with property-level productivity.