A model of negotiated transfer pricing

International Transfer Pricing for Goods and Intangible Asset Licenses in a Decentralized Multinational Corporation: Review and Extensions

“…Negotiated transfer pricing, where division managements choose the transfer price as well as the quantity of intra-firm trade, reflects common practice (Vaysman 1998;Chalos and Haka 1990;Eccles 1985b;Price Waterhouse 1984;Tang, Walter, and Raymond 1979;Wu and Sharp 1979;Vancil 1978). Therefore, we relax the centralized transfer pricing assumption.…”

“…In sum, Halperin and Srinidhi (1991) and Vaysman (1998) assume taxable income and performance evaluation depend on the transfer price. In the domestic case in Hansen and Kimbrell (1991), the decentralized firm achieves the firm-wide optimal quantity of intra-firm trade because minimizing division tax payments is independent of the transfer price.…”

“…In the domestic case in Hansen and Kimbrell (1991), the decentralized firm achieves the firm-wide optimal quantity of intra-firm trade because minimizing division tax payments is independent of the transfer price. In the international context in Halperin and Srinidhi (1991) and Vaysman (1998), the negotiated transfer price minimizes tax payments as well as divides the joint gain in combined division profit, leading to a sub-optimal negotiated transfer price. That is, no guarantee exists that the negotiated transfer price will be selected on the upper or lower arm's length boundary.…”

“…That is, no guarantee exists that the negotiated transfer price will be selected on the upper or lower arm's length boundary. In Hansen and Kimbrell (1991), Halperin and Srinidhi (1991) and Vaysman (1998), agency costs can occur because performance evaluation reflects the transfer price, which, in turn, depends on the relative bargaining power rather than relative contribution to MNC after-tax profit. Solutions to this problem include, for example, Choi and Day's (1998) conclusion that top management can address the tradeoff between tax avoidance and management incentives by using incentive compensation based on multiple performance measures.…”

“…Our negotiated transfer pricing model builds on Hansen and Kimbrell (1991), Srinidhi (1991), andVaysman (1998). We borrow the following assumptions: (1) The MNC divisions face different tax rates, (2) division management compensation depends on division profit, (3) division managements possess private information about their respective division's operations and market, (4) divisions play a positive-sum game, and (5), if negotiation impasse occurs at the end of the bargaining period, top management sets the transfer price (i.e., centralized transfer pricing).…”