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Strategic incentives for kepping one set of books under the Arm's Length Principle

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  • Ana B. Lemus

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    Abstract

    The OECD recommendation that transfer prices between parent firms and their subsidiaries be consistent with the Arm's Length Principle (ALP) for tax purposes does not restrict internal pricing policies. I show that under imperfect competition parents' accounting policies determine the properties of market outcomes: if parents keep one set of books (i.e., their internal transfer prices are consistent with the ALP), then competition in the external (home) market softens (intensifies) relative to the equilibrium where parents and subsidiaries are integrated. In contrast, if firms keep two sets of books (i.e., their internal transfer prices differ from those used for tax purposes) or maintain asymmetric accounting policies, then competition intensifies in both markets. Keeping one set of books is equilibrium in most of the parameter space.

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    Bibliographic Info

    Paper provided by Universidad Carlos III, Departamento de Economía in its series Economics Working Papers with number we1135.

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    Date of creation: Nov 2011
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    Handle: RePEc:cte:werepe:we1135

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    Related research

    Keywords: Transfer pricing regulation; Arm´s Length Principle; imperfect competition; vertical separation.;

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    1. Chongwoo Choe & Noriaki Matsushima, 2012. "The Arm’s Length Principle and Tacit Collusion," Development Research Unit Working Paper Series 02-12, Monash University, Department of Economics.
    2. Diego Moreno & Luis Úbeda, 2001. "Capacity precommitment and price competition yield Cournot outcomes," Economics Working Papers we014408, Universidad Carlos III, Departamento de Economía.
    3. A. Lemus & Diego Moreno, 2011. "The non-neutrality of the arm's length principle with imperfect competition," Economics Working Papers we1134, Universidad Carlos III, Departamento de Economía.
    4. Ware, Roger, 1985. "Inventory Holding as a Strategic Weapon to Deter Entry," Economica, London School of Economics and Political Science, vol. 52(205), pages 93-101, February.
    5. Nielsen, Søren Bo & Raimondos-Møller, Pascalis & Schjelderup, Guttorm, 2006. "Taxes and Decision Rights in Multinationals," Working Papers 07-2006, Copenhagen Business School, Department of Economics.
    6. Alan Auerbach & Michael P. Devereux & Helen Simpson, 2007. "Taxing Corporate Income," CESifo Working Paper Series 2139, CESifo Group Munich.
    7. Charles E. Hyde & Chongwoo Choe, 2005. "Keeping Two Sets of Books: The Relationship Between Tax and Incentive Transfer Prices," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 14(1), pages 165-186, 03.
    8. Korn, Evelyn & Lengsfeld, Stephan, 2007. "Duopolistic Competition, Taxes, and the Arm's-Length Principle," Hannover Economic Papers (HEP) dp-378, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
    9. Anil Arya & Brian Mittendorf, 2008. "Pricing Internal Trade to Get a Leg up on External Rivals," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 17(3), pages 709-731, 09.
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