Abstract
Both older and recent literature on transfer pricing is not unified about the opinion whether optimal transfer price should be equal to marginal cost of supplying company and set by centralized decision (of vertically integrated multibusiness enterprise headquarters) or whether it should be set by negotiation or even set on level of market (arms-length) price. Those, who argue for setting transfer price by negotiation or at the market price base their arguments on market imperfections like information asymmetry, motivation of managers, et cetera. This paper deals inter alia with problem of methodology transfer pricing mathematical modelling. We prove that optimal transfer price should be equal to average cost of the supplying division plus part (or whole) economic profit of the multibusiness enterprise, independent on the market conditions at the market of either intermediate or final product. Setting transfer price on the level of marginal cost is inefficient and would earlier or later lead to loss of multibusiness enterprise's ability to compete its rivals. Applicability of results of our research on multinational enterprises gives us possibility to use it for further research on optimal design of transfer pricing rules setting and of multinationals' taxation.
Highlights
Due to the increasing role of multibusiness enterprises and their impact on national welfare, on effectiveness of economic policies and on quality of our lives, we should have interest to clearly and well understand how to deal with transfer pricing issues
Both older and recent literature on transfer pricing are not unified about the opinion whether the optimal transfer price should be equal to marginal cost of supplying company and set by centralized decision or whether it should be set by negotiation or even set on the level of market price
Those, who argue for setting transfer price by negotiation or at the market price levels, base their arguments on market imperfections like information asymmetry, motivation of managers, et cetera
Summary
Due to the increasing role of multibusiness enterprises (hereinafter “MBE”) and their impact on national welfare, on effectiveness of economic policies and on quality of our lives, we should have interest to clearly and well understand how to deal with transfer pricing issues. Baldenius and Melumad and Reichelstein (2004) extend the Hirshleifer’s (1956) solution of optimal transfer price in a tax-free world that is the marginal cost of the supplying division, by tax issue. After that these authors argue that: “optimal internal transfer price should be a weighted average of the pre-tax marginal cost and the most favourable arm’s length price.” Hirschey (2003) clearly states that optimal transfer price should be set on the level of marginal cost of the supplying division and the same conclusion could be found in many other textbooks on managerial economics. Otherwise the contemporary literature aims rather on the information asymmetry, integration of manager’s and tax objectives or setting of the optimal transfer price with respect to the particular problems of financial management
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