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Abstract:
This chapter reviews the recent economic literature on transfer pricing. As a starting point, we take Hirshleifer's transfer pricing model and discuss the basic structure of the most widely used model extensions. We review transfer pricing models with asymmetric information, transfer pricing models in incomplete contracting settings, strategic transfer pricing models, and international transfer pricing models with firms operating in different tax jurisdictions.

The results offer a rich set of different explanations for the wide variety of transfer pricing methods in practice but they also show that it is impossible to give a general recommendation about 'the' best transfer pricing method. By contrast, only limited progress has been made in arriving at a sufficient theory of decentralization. The models are either silent about organizational issues, or the advantages of decentralization are based on more or less restrictive informational assumptions.

We conclude that the economic transfer pricing research has certainly improved the understanding of the relative usefulness of alternative transfer pricing methods for a carefully selected set of assumptions. Further theoretical and empirical research seems necessary for a better understanding of the economic reasons for decentralization and for explaining some unresolved empirical puzzles.

Transfer Pricing, Decentralization, Responsibilty Centers, Theory of the firm

Abstract:
Cost-based transfer pricing is used by many firms. However, there exist many cost-based methods that may be centralized or decentralized. If centralized, the firm's central office has discretion how accurately to measure the divisions' costs. In order to measure cost reliably, the firm must incur considerable setup costs for an information system. This paper analyzes the tradeoff between the fixed costs of such information gathering and the incentives that arise under several cost-based methods. Our central result is that transfer prices should be based on centralized standard costs if the returns on investments are high and/or if cost uncertainty is low. Decentralization should occur if there is intermediate uncertainty. Finally, transfer pricing should be centralized and based on actual costs if uncertainty is high.

Transfer Pricing, Centralization, Decentralization, ERP Systems

Abstract:
This paper examines the choice between actual and standard cost based transfer pricing rules. In synthesizing the literature, we introduce a general framework to discuss the properties of such transfer pricing rules. Using the level of information asymmetry and the degree of cost uncertainty as two key drivers, we study the relative performance of transfer pricing schemes. We show that transfer prices based on centrally estimated standard costs are optimal if costs are rather deterministic. If cost uncertainty rises and the buyer is sufficiently well informed about cost data at the trading stage, actual cost based schemes that include a markup become superior. Within this class, simple cost-plus markups are dominated by markups that are also contingent on revenue information. However, if there is asymmetric information, actual costing loses its ability to control trade. In this case, a decentralized scheme based on reported standard costs is optimal.

Transfer Pricing, Specific Investments, Costs

Abstract:
The so-called disclosure principle is a 'puzzle' in the accounting literature: Game theoretic models of financial markets show that in equilibrium firms should disclose all their private information. Yet, the result is not convincing. Researchers have therefore built sophisticated models in order to demonstrate for which reasons the disclosure principle might fail. This note shows that even in the original model there are multiple equilibria. In those equilibria good types disclose and bad types do not. The commonly known full disclosure equilibrium is a limit point of the equilibrium set.

disclosure, nonproprietary information, perfect Bayesian equilibria

Abstract:
The so-called disclosure principle is a 'puzzle' in the accounting literature: Game theoretic models of financial markets show that in equilibrium firms should disclose all their private information. Yet, the result is not convincing. Researchers have therefore built sophisticated models in order to demonstrate for which reasons the disclosure principle might fail. This note shows that even in the original model there are multiple equilibria. In those equilibria good types disclose and bad types do not. The commonly known full disclosure equilibrium is a limit point of the equilibrium set.

disclosure, nonproprietary information, perfect Bayesian equilibria

Abstract:
This paper studies the influence of a manager's pre-decision use of an information system on the central office's provision of such a system. At the outset, the manager is ignorant about the cost of an investment project. Higher effort of using the information system raises the probability that the manager is informed at the project proposal stage. The central office does not know whether it faces an informed or an ignorant manager.

We derive three new results. First, to limit managerial slack for potentially ignorant managers, the central office sharply cuts investment-budgets if the expected net present value of the project is high. Second, if the expected net present value is high (low), the manager's effort to use the information system is higher (lower) than in the First Best solution. Third, the central office strategically provides no information system if the expected net present value of the investment project exceeds some cutoff value.

capital budgeting, managerial slack, hold-up, use of an information system

Abstract:
We consider supplier-credit contracting between a manufacturer and a liquidity-constrained dealer. We show that the timeliness according to which the dealer receives demand information has a significant impact on the optimal contract. If the manufacturer cannot be sure that a dealer without liquidity has demand information when the contract is written, the optimal contract pools an ignorant dealer with a dealer who knows that there are unfavorable demand conditions whereas dealers with favorable demand information are screened. If the dealer's liquidity rises, the manufacturer proposes a contract that resembles the solution of a classic adverse selection model in the spirit of Harris, Kriebel, and Raviv (1982). For high liquidity, the optimal supplier-credit contract pools an ignorant dealer with dealers who have favorable demand information whereas dealers with unfavorable demand information are screened.

Supplier credit, supply chain contract, limited liquidity, ignorance

Abstract:
We investigate cost-based access pricing in regulated network industries. Building on recent progress in the accounting literature, we show that a regulator must choose a particular depreciation schedule, namely, relative replacement cost depreciation in order to prevent the network provider from playing manipulative games with the cost-based access price. We then show that the network provider is put at a strategic disadvantage if the regulator sets the access price equal to long-run incremental costs and the downstream market is symmetric. This result may be understood by looking at strategic interaction in the downstream market where both firms are better off if they behave “softly”. If the regulator sets a low access price, he commits the downstream competitor to price aggressively. Then, the entire burden of softening competition must be borne by the network provider. Finally, since consumer prices are decreasing in the access price, we conclude that the regulator faces a tradeoff between low consumer prices and a level playing field on the downstream market.

access pricing, depreciation

Abstract:
This paper considers optimal contracts in supply chains that consist of firms and face a potential investment hold-up problem. We show that option contracts may solve the incentive problems. First, we provide case-study evidence for the use of option contracts in the semiconductor industry. As our second contribution, we generalize the earlier option contract approach by introducing continuous quantities. Third, we extend the setting to n parties. For long supply chains, the first-best allocation can be achieved if there is a particular order of renegotiations.

Abstract:
This paper reviews traditional German cost accounting in general and its most pervasive cost accounting system, namely, marginal costing, in particular. An outline of the structure of the system is followed by a discussion of its relationship to activity-based costing. We then consider how both systems can be applied in short-run decision making and finally summarize the manner in which marginal costing supports cost variance analysis.