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. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Accounting Studies Springer Journals

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

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Publisher
Springer US
Copyright
Copyright © 2015 by Springer Science+Business Media New York
Subject
Economics / Management Science; Accounting/Auditing; Finance/Investment/Banking; Public Finance & Economics
ISSN
1380-6653
eISSN
1573-7136
D.O.I.
10.1007/s11142-015-9321-3
Publisher site
See Article on Publisher Site

Abstract

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.

Journal

Review of Accounting StudiesSpringer Journals

Published: Apr 14, 2015

References

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