Negotiated versus Cost-Based Transfer Pricing

Tim Baldenius, Stefan Reichelstein and Savita A. Sahay
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Tim Baldenius: Columbia University
Stefan Reichelstein: University of California
Savita A. Sahay: Baruch College, CUNY

Review of Accounting Studies, 1999, vol. 4, issue 2, No 1, 67-91

Abstract: Abstract This paper studies an incomplete contracting model to compare the effectiveness of alternative transfer pricing mechanisms. Transfer pricing serves the dual purpose of guiding intracompany transfers and providing incentives for upfront investments at the divisional level. When transfer prices are determined through negotiation, divisional managers will have insufficient investment incentives due to “hold-up” problems. While cost-based transfer pricing can avoid such “hold-ups”, it does suffer from distortions in intracompany transfers. Our analysis shows that negotiation frequently performs better than a cost-based pricing system, though we identify circumstances under which cost-based transfer pricing emerges as the superior alternative.

Keywords: Public Finance; Price System; Transfer Price; Price Mechanism; Dual Purpose (search for similar items in EconPapers)
Date: 1999
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DOI: 10.1023/A:1009638001487

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