Optimal transfer pricing schemes for work averse division managers with private information

Abstract

This paper models a decentralized firm under information asymmetry and effort disutility on the part of managers. We assume that managers choose efforts before observing some private information. However, after the effort choice managers receive private information on their cost parameters which they report to the headquarters. There exist many situations in which managers need to take efforts before obtaining private information; for example, the regular maintenance effort on the machine, the effort on R&D for reducing costs and the effort taken to build relationships with the supplier. Two models are considered in this paper based on the timing of acquisition of private information by the managers. We derive optimal coordination mechanisms to facilitate internal transactions for the models. The equilibrium outcome of this paper suggests that: 1) regardless of the timing of managers' information acquisition, the optimal output level under asymmetric information can have overproduction or underproduction when compared with the full information optimal output; 2) under certain demand conditions managers cannot receive any information rent benefit for their private information even if they have the option to renege on the contract after obtaining their private information.