Negotiated Transfer Pricing, Specific Investment, and Optimal Capacity Choice

Stefan Wielenberg
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Stefan Wielenberg: Otto-von-Guericke-University

Review of Accounting Studies, 2000, vol. 5, issue 3, No 1, 197-216

Abstract: Abstract This paper investigatesinvestment decisions in a divisionalized firm, in which an upstreamdivision supplies an intermediate product to a downstream division.The upstream division's investment includes two simultaneousdecisions. First, the division determines its capacity level,and second, it invests in a firm specific production technologythat lowers the marginal cost of production. Both the capacityand the specificity decision must be made before the actual demandfor the intermediate product is observable. Since the terms ofinternal trade are negotiated between the divisions, the upstreamdivision faces the well-known holdup problem and thus has incentivesto underinvest. It turns out that a simple contract stipulatinga minimum quantity and a transfer price for excessive quantitiesis sufficient to induce the efficient capacity and specificitydecisions.

Keywords: Marginal Cost; Specific Production; Minimum Quantity; Intermediate Product; Transfer Price (search for similar items in EconPapers)
Date: 2000
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DOI: 10.1023/A:1009604809480

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