Do Transfer Pricing Rules Distort R&D Investment Decisions?
47 Pages Posted: 2 Feb 2018
Date Written: February 1, 2018
This study analyzes the impact of transfer pricing on multinational enterprises’ R&D investment decisions. Speciﬁcally, I examine the eﬀects of two commonly used contract designs to exchange and develop intangible assets across group aﬃliates: licensing and cost sharing agreements. Whilst serving as a tool to allocate taxable income between group aﬃliates, the economic implications of licensing and cost sharing agreements diﬀer. Whereas licensing agreements provide for a sharing rule on the intangible’s proﬁts, cost sharing agreements on the other hand provide a sharing rule on R&D development costs. This diﬀerence matters when ﬁrms simultaneously use internal transfer prices to allocate taxable income and provide local management with suﬃcient investment incentives. Using a multiple-agent, moral hazard investment framework I model a multinational ﬁrm with comparable group afﬁliates in two countries that delegates the R&D investment decision to a local risk and eﬀort averse aﬃliate manager. The results suggest that the optimal contract not only depends on available tax beneﬁts, but also on R&D investment and manager speciﬁc characteristics. A licensing agreement provides management with larger incentives to invest in R&D mitigating agency concerns associated with R&D. On the other hand, using a cost sharing agreement the ﬁrm can cater diﬀerent risk preferences among managers potentially increasing investment. The arm’s length principle however may distort an eﬃcient allocation of R&D costs when using a cost sharing agreement.
Keywords: transfer pricing, R&D investment, taxes
JEL Classification: H21, H25
Suggested Citation: Suggested Citation