Transfer Pricing in the Decentralized Multinational Corporation

This paper considers how the multinational corporation's transfer price responds to changes in international corporate effective tax rates. It extends the decentralized decision-making analysis of transfer pricing in the context of different tax rates. It adopts and extends Bond's (1980) model of the decentralized multinational corporation that assumes centralized transfer pricing. The direction of transfer price change is as expected, while the magnitude of change is likely to be less than predicted by the Horst (1971), centralized decision-making model. The paper extends the model further by assuming negotiated transfer pricing, where the analysis is partitioned into perfect and imperfect information cases. The negotiated transfer pricing result reverts to the Horst (1971), or centralized decision-making, result, under perfect information. Under imperfect information, the centralized decision-making result obtains when top management successfully informs division general managers or it successfully implements a non-monetary reward scheme to encourage division general managers to cooperate. Under simplifying assumptions, centralized decision-making dominates decentralized decision-making, while negotiated transfer pricing weakly dominates centralized transfer pricing.

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

We review and extend the core literature on international transfer price manipulation to avoid or evade taxes. Under negotiated transfer pricing with a viable bargaining structure, including performance evaluation disconnected from the transfer price, divisions voluntarily exchange accurate information to obtain firm-wide optimality, a result not dependent on restraint from exercising internal market power. For intangible licenses, a larger optimal profit shift for a given tax rate change strengthens incentives for transfer pricing abuse. In practice, an intangible's arm's length range is viewed as a guideline, a context where incentives for abuse materialize. Transfer pricing for intangibles obliges greater tax authority scrutiny.