Hua Lee
Fu Jen Catholic University
Ho-Mou Wu
National Taiwan University
Abstract: This paper explores the strategic interactions between transfer pricing and organization form; we propose a transfer pricing mechanism that may be implemented from the viewpoint of organization design in the presence of asymmetric information under the settings of a three-tier hierarchy. We indigenes the choices of transfer pricing mechanism and organization design by connecting the decision authority over the transfer price and quantity transferred to organizational forms including delegation, partly delegation, and centralization. Main results indicate that, whatever the organization forms, the transfer price is a cost-based markup price and hence the subunits of the organization are profit centers. Moreover, each organization form can be the principal¡¦s most preferred choice. If the production costs of both divisions are small, and, the marginal net revenue is higher than a threshold the principal is inclined to choose decentralization, delegating the formal authority to the agent whose private information is more valuable. Conversely, if the production costs are relatively large, and the marginal net revenue is lower than the threshold, the principal is probable to choose partly delegation, the principal chooses the transfer price and delegates the formal authority over the quantity transferred to the agent whose division marginal cost is greater. The threshold is comprised by the marginal production costs of both divisions, the agents¡¦ costs of effort, and the informational costs preventing the agents dishonestly report the private information. Under the scenario of a three-tier hierarchy, centralization is accidentally the best organization form, since only one quantity transferred satisfies the constraints induced by both agents¡¦ incentives and one transfer price, which is not maximizing the principal¡¦s expected income. Surprisingly, we find that possessing formal authority is not absolutely favorable to the agent, and that acquiring real authority may be better for the principal¡¦s interest if he appropriately allocates the formal authority.
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