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Strategic transfer pricing, absorption costing and vertical integration


Göx, Robert F (1998). Strategic transfer pricing, absorption costing and vertical integration. Social Science Research Network 98661, SSRN.

Abstract

This paper analyzes the use of transfer pricing as a strategic device in divisionalized firms facing duopolistic price competition. When transfer prices are observable, both firms' headquarters will exclude their marketing division from the external input market and charge a transfer price above the market price of the intermediate product to induce their marketing managers to behave as softer competitors on the final product market. When transfer prices are not observable, strategic transfer pricing is not an equilibrium, and the optimal transfer price equals the market price of the intermediate product. As an alternative, the firms can signal their competitor a transfer price above the market price of the intermediate input through a proper choice of their accounting system. The paper identifies conditions under which the choice of absorption costing is a dominant strategy for both firms. Moreover, when the firms' products are close substitutes, the strategic benefits of full cost based transfer pricing can provide incentives to maintain a production department that would not be able to survive as a separate firm in the long run.

Abstract

This paper analyzes the use of transfer pricing as a strategic device in divisionalized firms facing duopolistic price competition. When transfer prices are observable, both firms' headquarters will exclude their marketing division from the external input market and charge a transfer price above the market price of the intermediate product to induce their marketing managers to behave as softer competitors on the final product market. When transfer prices are not observable, strategic transfer pricing is not an equilibrium, and the optimal transfer price equals the market price of the intermediate product. As an alternative, the firms can signal their competitor a transfer price above the market price of the intermediate input through a proper choice of their accounting system. The paper identifies conditions under which the choice of absorption costing is a dominant strategy for both firms. Moreover, when the firms' products are close substitutes, the strategic benefits of full cost based transfer pricing can provide incentives to maintain a production department that would not be able to survive as a separate firm in the long run.

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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
Language:English
Date:1998
Deposited On:05 Jul 2013 09:12
Last Modified:14 Aug 2017 13:08
Series Name:Social Science Research Network
ISSN:1556-5068
Publisher DOI:https://doi.org/10.2139/ssrn.98661
Other Identification Number:merlin-id:8264

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