The optimal focus of transfer prices: pre-tax profitability versus tax minimization

Martini JT (2015)
Review of Accounting Studies 20(2): 866-898.

Journal Article | Published | English

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Abstract
This paper studies transfer prices influencing managerial decisions and determining corporate taxes in a multinational firm. Common sense suggests that the transfer price decision should be made to maximize the firm's after-tax profit and thus achieve the optimal trade-off between pre-tax profitability and tax minimization. Based on a model of a decentralized firm facing asymmetric information with respect to operations, I examine why this conclusion does not hold in general. In particular, I demonstrate that a policy of negotiated transfer pricing, under which the divisions exploit their superior information but select the transfer price to maximize the firm's pre-tax profit, is the firm's optimal organizational choice if the high-tax division's productivity is high. With respect to the firm's discretion over the transfer price, I identify situations where the firm's optimal policy choice does not depend on the arm's length range and where less discretion increases the firm's profitability.
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Martini JT. The optimal focus of transfer prices: pre-tax profitability versus tax minimization. Review of Accounting Studies. 2015;20(2):866-898.
Martini, J. T. (2015). The optimal focus of transfer prices: pre-tax profitability versus tax minimization. Review of Accounting Studies, 20(2), 866-898.
Martini, J. T. (2015). The optimal focus of transfer prices: pre-tax profitability versus tax minimization. Review of Accounting Studies 20, 866-898.
Martini, J.T., 2015. The optimal focus of transfer prices: pre-tax profitability versus tax minimization. Review of Accounting Studies, 20(2), p 866-898.
J.T. Martini, “The optimal focus of transfer prices: pre-tax profitability versus tax minimization”, Review of Accounting Studies, vol. 20, 2015, pp. 866-898.
Martini, J.T.: The optimal focus of transfer prices: pre-tax profitability versus tax minimization. Review of Accounting Studies. 20, 866-898 (2015).
Martini, Jan Thomas. “The optimal focus of transfer prices: pre-tax profitability versus tax minimization”. Review of Accounting Studies 20.2 (2015): 866-898.
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