Gray Markets and Multinational Transfer Pricing

Romana L. Autrey () and Francesco Bova ()
Additional contact information
Romana L. Autrey: Harvard Business School, Accounting and Management Unit
Francesco Bova: Rotman School of Management, University of Toronto

No 09-098, Harvard Business School Working Papers from Harvard Business School

Abstract: Gray markets arise when a manufacturer's products are sold outside of its authorized channels, for instance when goods designated for a foreign market are resold domestically. One method multinationals use to combat gray markets is to increase internal transfer prices to foreign subsidiaries in order to increase the gray market's cost base. We illustrate that, when a gray market competitor is present, the optimal price for internal transfers not only exceeds marginal cost, but is also a function of the competitiveness of the upstream economy. Moreover, the presence of a gray market competitor may cause unintended social welfare consequences when domestic governments mandate the use of arm's length transfer prices between international subsidiaries. When markets are sealed, arm's length transfer pricing strictly increases domestic social welfare. In contrast, we demonstrate that when a gray market competitor is present, mandating the use of arm's length transfer pricing decreases domestic social welfare when the domestic market is sufficiently large relative to the foreign market. Specifically, a shift to arm's length transfer pricing erodes domestic consumer surplus by making the gray market less competitive domestically, which in turn may offset any domestic welfare gains that accompany a shift to arm's length transfer pricing. Finally, the analysis illustrates that in a gray market setting, the transfer price that maximizes a multinational's profits may also be the same one that maximizes the social welfare of the domestic economy that houses it.

Keywords: transfer pricing; gray markets; regulation (search for similar items in EconPapers)
JEL-codes: D43 F23 M41 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2009-02, Revised 2009-10
New Economics Papers: this item is included in nep-mic, nep-mkt and nep-reg
References: Add references at CitEc
Citations:

Downloads: (external link)
http://www.hbs.edu/research/pdf/09-098.pdf Revised version, 2009 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:hbs:wpaper:09-098

Access Statistics for this paper

More papers in Harvard Business School Working Papers from Harvard Business School Contact information at EDIRC.
Bibliographic data for series maintained by HBS ().