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

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  • Lemus Torres, Ana Belén

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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  • Lemus Torres, Ana Belén, 2011. "Strategic incentives for kepping one set of books under the Arm's Length Principle," UC3M Working papers. Economics we1135, Universidad Carlos III de Madrid. Departamento de Economía.
  • Handle: RePEc:cte:werepe:we1135
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    1. 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, September.
    2. Søren Bo Nielsen & Pascalis Raimondos-Møller & Guttorm Schjelderup, 2008. "Taxes and Decision Rights in Multinationals," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 10(2), pages 245-258, April.
    3. 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, March.
    4. 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.
    5. Moreno, Diego & Ubeda, Luis, 2001. "Capacity precommitment and price competition yield cournot outcomes," UC3M Working papers. Economics we014408, Universidad Carlos III de Madrid. Departamento de Economía.
    6. 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.
    7. Alan Auerbach & Michael P. Devereux & Helen Simpson, 2007. "Taxing Corporate Income," CESifo Working Paper Series 2139, CESifo Group Munich.
    8. Choe, Chongwoo & Matsushima, Noriaki, 2013. "The arm's length principle and tacit collusion," International Journal of Industrial Organization, Elsevier, vol. 31(1), pages 119-130.
    9. Moreno Ruiz, Diego & Lemus Torres, Ana Belén, 2011. "The non-neutrality of the arm's length principle with imperfect competition," UC3M Working papers. Economics we1134, Universidad Carlos III de Madrid. Departamento de Economía.
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    Keywords

    Vertical separation;

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