Negotiated Transfer Pricing, Specific Investment, and Optimal Capacity Choice

Negotiated Transfer Pricing, Specific Investment, and Optimal Capacity Choice 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. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Accounting Studies Springer Journals

Negotiated Transfer Pricing, Specific Investment, and Optimal Capacity Choice

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Publisher
Kluwer Academic Publishers
Copyright
Copyright © 2000 by Kluwer Academic Publishers
Subject
Business and Management; Accounting/Auditing; Corporate Finance; Public Finance
ISSN
1380-6653
eISSN
1573-7136
D.O.I.
10.1023/A:1009604809480
Publisher site
See Article on Publisher Site

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.

Journal

Review of Accounting StudiesSpringer Journals

Published: Oct 16, 2004

References

  • Negotiated versus Cost-Based Transfer Pricing
    Baldenius, T.; Reichelstein, S.; Sahay, S.
  • Cadillac Contracts and Up-Front Payments: Efficient Investment under Expectation Damages
    Edlin, A.

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