Gray Markets and Multinational Transfer Pricing
Romana L. Autrey
University of Illinois at Urbana-Champaign - Department of Accountancy
University of Toronto - Rotman School of Management
July 20, 2011
Harvard Business School Accounting & Management Unit Working Paper No. 09-098
Accounting Review, Forthcoming
Gray markets arise when a manufacturer’s products are sold outside of its authorized channels, for instance when goods designated by a multinational firm for sale in a foreign market are resold domestically. One method multinationals use to combat gray markets is to increase transfer prices to foreign subsidiaries in order to increase the gray market’s cost base. We illustrate that, when a gray market competitor exists, the optimal transfer price to a foreign subsidiary exceeds marginal cost and is decreasing in the competitiveness of the domestic market. However, a multinational’s discretion in setting transfer prices may be limited by mandatory arm’s length transfer pricing rules. Provided gray markets exist, we characterize when mandating arm’s length transfer pricing lowers domestic social welfare relative to unrestricted transfer pricing. We also demonstrate that gray markets can lead to higher domestic tax revenues, even when gray market firms do not pay taxes domestically.
Number of Pages in PDF File: 51
Keywords: Transfer pricing, gray markets, regulation
JEL Classification: M41, D43, F23
Date posted: March 6, 2009 ; Last revised: July 23, 2011
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