Negotiated transfer pricing and uncertain regulation: a simulated trust game approach

This study presents a novel approach to transfer pricing within multinational enterprises (MNEs), focusing on the strategic dynamics between two key divisions, the parent and subsidiary, operating in distinct countries that vary in corporate tax rates. Departing from traditional literature, we introduce a trust game framework to model the negotiation of transfer pricing among divisional managers. Our agent-based algorithm simulates an economy comprising multiple MNEs and a regulating State. The simulation outcomes shed light on the complex interplay of factors in this context. Without State intervention and managerial influence, MNEs tend to maximize their transfer pricing, strategically shifting profits to lower-tax jurisdictions. However, when we incorporate managerial negotiation, increasing transfer pricing leads to a decline in parent division profits but a surge in subsidiary division profits, ultimately increasing the overall MNE's profitability. The State's role emerges as pivotal, with the potential for random controls and penalties to nudge the game dynamics toward a cooperative equilibrium. This research offers valuable insights into the multifaceted world of international tax planning and coordination, underscoring the intricate balance between profit optimization and regulatory compliance in a globalized economy.