On the Theory and Practice of Transfer Pricing

The management of any large organisation necessitates the delegation of some measure of authority to lower echelons, and the larger and the more diversified the organisation becomes, the more insistent will be the call for increased divisional autonomy by the extension of the price system to internal transactions. One of the reasons why the analysis of this issue should be of special interest to economists is the unprecedented growth of multinational enterprises, another is that, as noted long ago, the relevant problems of the decentralised corporation are analogous to those of the theory of the ideal socialist state (cf. e.g. Arrow, 1959, p. 9; Baumol and Fabian, 1964, p. 1, and Hirshleifer, 1964, p. 27). More recent contributions to the development of this aspect include those of Ruefli (197lb), Ronen (1974), Groves and Loeb (1976), Bailey and Boe (1976), etc. Since the central purpose of this chapter is to concentrate on the problems of transfer pricing in divisionalised corporations, such contributions fall largely outside its scope. The interested reader will find numerous further references in those cited, but when following them up he should not forget that, impressive as several of the proposed theories are when viewed as intellectual efforts, they have not so far been found to be of practical use in the management of any of the countries of the socialist camp, the literature of which also abounds in spirited contributions to the discussion. He should note also that the country within that camp that can justly claim to have attained the highest level of general welfare happens to be the one that has given the greatest scope to the operation of the free price system.