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A performance comparison of strategic transfer pricing and tidy cost allocation in presence of product market competition and congestion costs


Göx, Robert (1999). A performance comparison of strategic transfer pricing and tidy cost allocation in presence of product market competition and congestion costs. Social Science Research Network 150598, University of Zurich.

Abstract

This paper compares the performance of transfer pricing and tidy cost allocations in a multiproduct firm in presence of output market competition and production externalities. In absence of competition, tidy cost allocations are creating inefficient allocations within the firm while transfer prices can always be adjusted to replicate the first best solution of the centralized firm. While the second result is well known, the first result draws a parallel to the impossibility of solving the free rider problem in team production by a profit sharing scheme. Under duopolistic competition, transfer prices are still the best accounting rule but the solution depends on the nature of competition on the final product market. When firms compete in prices, the strategic rationale requires to allocate more than the total cost of the congested service to the duopolistic departments. While transfer prices can still be adjusted accordingly, the tidiness requirement prevents the cost allocation scheme from providing the desired strategic incentives to the firms' managers. Under quantity competition, the strategic motive requires to allocate less than the cost of the service to the duopolistic departments. Although a tidy cost allocation scheme does not contradict the required direction of the strategic effect, the optimal allocation is at best found incidentally while the transfer prices can again always be adjusted in an optimal way.

This paper compares the performance of transfer pricing and tidy cost allocations in a multiproduct firm in presence of output market competition and production externalities. In absence of competition, tidy cost allocations are creating inefficient allocations within the firm while transfer prices can always be adjusted to replicate the first best solution of the centralized firm. While the second result is well known, the first result draws a parallel to the impossibility of solving the free rider problem in team production by a profit sharing scheme. Under duopolistic competition, transfer prices are still the best accounting rule but the solution depends on the nature of competition on the final product market. When firms compete in prices, the strategic rationale requires to allocate more than the total cost of the congested service to the duopolistic departments. While transfer prices can still be adjusted accordingly, the tidiness requirement prevents the cost allocation scheme from providing the desired strategic incentives to the firms' managers. Under quantity competition, the strategic motive requires to allocate less than the cost of the service to the duopolistic departments. Although a tidy cost allocation scheme does not contradict the required direction of the strategic effect, the optimal allocation is at best found incidentally while the transfer prices can again always be adjusted in an optimal way.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Business Administration
Dewey Decimal Classification:330 Economics
JEL Classification:D43, L13, L22, M40, M46
Language:English
Date:1999
Deposited On:05 Jul 2013 08:36
Last Modified:05 Apr 2016 16:51
Series Name:Social Science Research Network
Publisher DOI:https://doi.org/10.2139/ssrn.150598
Official URL:http://papers.ssrn.com/sol3/papers.cfm?abstract_id=150598
Other Identification Number:merlin-id:8265
Permanent URL: https://doi.org/10.5167/uzh-79188

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