The Unintended Consequences of Headquarterss Involvement in Decentralized Transfer Price Negotiations: Experimental Evidence

Abstract

This study investigates how headquarters involvement affects the efficiency of decentralized transfer price negotiations. Prior research assumes that decentralized managers negotiate transfer prices autonomously. However, evidence suggests that headquarters can become involved in transfer price negotiations, particularly after negotiation failure. While the intention of headquarters involvement is to overcome inefficiencies arising from decentralized managers’ inability to agree on a transfer price, we suggest that such involvement is likely to have the unintended consequences of further reducing both agreement frequency and the efficiency of negotiated transfer pricing. Reduced agreement is likely to occur because decentralized managers are likely to feel less responsible for the negotiation outcome and may be overly optimistic about headquarters’ decision. Reduced efficiency is likely to result because overconfidence is likely to make headquarters underestimate its informational disadvantage compared to decentralized managers and, consequently, induces inefficient transfer decisions. For the same reasons, inefficiency is likely to be the larger, the more decision authority headquarters takes over after negotiation failure. In an experiment, we manipulate whether headquarters involvement is absent vs. present. Nested within headquarters involvement present are two conditions: one where, after negotiation failure, headquarters suggests a transfer price that either decentralized manager can reject (weak involvement) and one where it can impose a price at which they must trade (strong involvement). Consistent with our predictions, we find that headquarters involvement reduces the frequency of negotiation agreement and the efficiency of transfer pricing. Additionally, we find that efficiency is reduced more when headquarters involvement is strong rather than weak. We contribute to the literature on negotiated transfer pricing by providing evidence about headquarters’ biased perceptions of negotiation impasse and the unintended consequences of its involvement. Additionally, our study informs organizations about the benefits of committing to non-involvement in decentralized transfer price negotiations.