The optimal focus of transfer prices: pre-tax profitability versus tax minimization

The optimal focus of transfer prices: pre-tax profitability versus tax minimization This paper studies transfer prices influencing managerial decisions and determining corporate taxes in a multinational firm. Common sense suggests that the transfer price decision should be made to maximize the firm’s after-tax profit and thus achieve the optimal trade-off between pre-tax profitability and tax minimization. Based on a model of a decentralized firm facing asymmetric information with respect to operations, I examine why this conclusion does not hold in general. In particular, I demonstrate that a policy of negotiated transfer pricing, under which the divisions exploit their superior information but select the transfer price to maximize the firm’s pre-tax profit, is the firm’s optimal organizational choice if the high-tax division’s productivity is high. With respect to the firm’s discretion over the transfer price, I identify situations where the firm’s optimal policy choice does not depend on the arm’s length range and where less discretion increases the firm’s profitability. Review of Accounting Studies Springer Journals

The optimal focus of transfer prices: pre-tax profitability versus tax minimization

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Springer US
Copyright © 2015 by Springer Science+Business Media New York
Economics / Management Science; Accounting/Auditing; Finance/Investment/Banking; Public Finance & Economics
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