IDEAS home Printed from https://ideas.repec.org/a/jfr/afr111/v7y2018i3p221.html
   My bibliography  Save this article

Tradeoffs Between Specific Investment and Optimal Resource Allocation: A Comparison of Different Transfer Pricing Policies

Author

Listed:
  • Savita A Sahay

Abstract

This paper uses a principal-agent framework to analyze the tension between incentives for specific investment by the agent, and resource allocation that is optimal from the principal’s perspective.  The analysis considers a decentralized firm in which central management can institute different transfer pricing policies to motivate divisional managers to undertake investment and production decisions.  Some well-known properties of the methods are identified- a transfer price that uses a markup over and above actual costs can provide investment incentives but leads to sub-optimal resource allocation; negotiated transfer pricing suffers from the problem of under-investment even though its ex post performance is optimal; and standard cost-based transfer pricing entails over-reporting of standards, which results in inefficient levels of trade as well as low investment. The paper establishes a clear ranking amongst the three methods studied. It is shown that the overall performance of actual cost-based transfer pricing is superior if the buying division’s investments are important, while negotiated transfer pricing dominates if those of the selling division are important. The overall performance of standard cost-based method is inferior to that of the actual cost-based method, even though the latter has weaker investment incentives.

Suggested Citation

  • Savita A Sahay, 2018. "Tradeoffs Between Specific Investment and Optimal Resource Allocation: A Comparison of Different Transfer Pricing Policies," Accounting and Finance Research, Sciedu Press, vol. 7(3), pages 221-221, August.
    • Handle: RePEc:jfr:afr111:v:7:y:2018:i:3:p:221
    as

    Download full text from publisher

    File URL: https://www.sciedupress.com/journal/index.php/afr/article/download/13752/8625
    Download Restriction: no
    File URL: https://www.sciedupress.com/journal/index.php/afr/article/view/13752
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Jack Hirshleifer, 1956. "On the Economics of Transfer Pricing," The Journal of Business, University of Chicago Press, vol. 29, pages 172-172.
    2. Holmstrom, Bengt & Tirole, Jean, 1991. "Transfer Pricing and Organizational Form," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 7(2), pages 201-228, Fall.
    3. Vaysman, Igor, 1998. "A model of negotiated transfer pricing," Journal of Accounting and Economics, Elsevier, vol. 25(3), pages 349-384, June.
    4. Dikolli, Shane S. & Vaysman, Igor, 2006. "Information technology, organizational design, and transfer pricing," Journal of Accounting and Economics, Elsevier, vol. 41(1-2), pages 201-234, April.
    5. Francois Hennart, Jean, 1988. "Upstream vertical integration in the aluminum and tin industries : A comparative study of the choice between market and intrafirm coordination," Journal of Economic Behavior & Organization, Elsevier, vol. 9(3), pages 281-299, April.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Clemens Löffler & Thomas Pfeiffer & Ulf Schiller & Joachim Wagner, 2011. "Zentralisierung, Transferpreise und spezifische Investitionen: Ein selektiver Verfahrensvergleich," Schmalenbach Journal of Business Research, Springer, vol. 63(63), pages 1-33, January.
    2. Markus Arnold & Florian Elsinger & Frederick W. Rankin, 2021. "The Unintended Consequences of Headquarters’ Involvement in Decentralized Transfer Price Negotiations: Experimental Evidence," Management Science, INFORMS, vol. 67(12), pages 7912-7931, December.
    3. Edward Johnson & Nicole Bastian Johnson & Thomas Pfeiffer, 2016. "Dual transfer pricing with internal and external trade," Review of Accounting Studies, Springer, vol. 21(1), pages 140-164, March.
    4. Claus-Jochen Haake & Jan Thomas Martini, 2013. "Negotiating Transfer Prices," Group Decision and Negotiation, Springer, vol. 22(4), pages 657-680, July.
    5. Asmund Rygh & Gabriel R. G. Benito, 2018. "Capital Structure of Foreign Direct Investments: A Transaction Cost Analysis," Management International Review, Springer, vol. 58(3), pages 389-411, June.
    6. Eitan Goldman & Gary Gorton, 2000. "The Visible Hand, the Invisible Hand and Efficiency," NBER Working Papers 7587, National Bureau of Economic Research, Inc.
    7. Dan Li & Manuel Portugal Ferreira, 2008. "Internal and External Factors on Firms’ Transfer Pricing Decisions: Insights from Organization Studies," Notas Económicas, Faculty of Economics, University of Coimbra, issue 27, pages 23-38, June.
    8. Ciabuschi, Francesco & Dellestrand, Henrik & Kappen, Philip, 2012. "The good, the bad, and the ugly: Technology transfer competence, rent-seeking, and bargaining power," Journal of World Business, Elsevier, vol. 47(4), pages 664-674.
    9. Savita A. Sahay, 2014. "Transfer Pricing in a Multi-Product Environment," Accounting and Finance Research, Sciedu Press, vol. 3(4), pages 132-132, August.
    10. Peter C. Dawson & Stephen M. Miller, 2009. "International Transfer Pricing for Goods and Intangible Asset Licenses in a Decentralized Multinational Corporation: Review and Extensions," Working Papers 0901, University of Nevada, Las Vegas , Department of Economics.
    11. V. G. Narayanan & Michael Smith, 2000. "Impact of Competition and Taxes on Responsibility Center Organization and Transfer Prices," Contemporary Accounting Research, John Wiley & Sons, vol. 17(3), pages 497-529, September.
    12. Diaw, K., 2003. "Cost Allocation as a Coordination Mechanism," Discussion Paper 2003-128, Tilburg University, Center for Economic Research.
    13. Madhav V. Rajan & Stefan Reichelstein, 2004. "ANNIVERSARY ARTICLE: A Perspective on ÜAsymmetric Information, Incentives and Intrafirm Resource AllocationÝ," Management Science, INFORMS, vol. 50(12), pages 1615-1623, December.
    14. Bornemann, Tobias, 2018. "Do transfer pricing rules distort R&D investment decisions?," arqus Discussion Papers in Quantitative Tax Research 233, arqus - Arbeitskreis Quantitative Steuerlehre.
    15. Bodo Knoll & Nadine Riedel, 2015. "Transfer Pricing Laws," ifo DICE Report, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 12(04), pages 22-26, January.
    16. Alexis H. Kunz & Thomas Pfeiffer, 2001. "Kapitalmarktorientierte Unternehmenspublizität und der Informationsverbund zwischen in- und externem Rechnungswesen," Schmalenbach Journal of Business Research, Springer, vol. 53(5), pages 500-530, August.
    17. Bodo Knoll & Nadine Riedel, 2015. "Transfer Pricing Laws," ifo DICE Report, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 12(4), pages 22-26, 01.
    18. Barick Chung & Eric Rasmusen, 2008. "Price Discrimination between Retailers with and without Market Power," Working Papers 2008-14, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
    19. Renato Matta, 2019. "Product costing in the strategic formation of a supply chain," Annals of Operations Research, Springer, vol. 272(1), pages 389-427, January.
    20. Cecchini, Mark & Leitch, Robert & Strobel, Caroline, 2013. "Multinational transfer pricing: A transaction cost and resource based view," Journal of Accounting Literature, Elsevier, vol. 31(1), pages 31-48.

    More about this item

    JEL classification:

    • R00 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General - - - General
    • Z0 - Other Special Topics - - General

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:jfr:afr111:v:7:y:2018:i:3:p:221. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Sciedu Press (email available below). General contact details of provider: https://edirc.repec.org/data/cepflch.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.