Optimal Transfer Pricing in a Vertically-Related and Imperfectly Competitive Market

32 Pages Posted: 11 Jul 2014

See all articles by Winston W. Chang

Winston W. Chang

University at Buffalo - Department of Economics

Han Eol Ryu

Korea Institute for Industrial Economics and Trade

Date Written: August 24, 2012

Abstract

The objective of this paper is to find the significant factors that crucially affect a firm’s optimal transfer pricing policy. To achieve such a goal, it suffices to examine three minimalist vertical models: the first one contains a vertically integrated monopoly in both input and output markets, the second one consists of a vertically integrated firm that monopolizes an intermediate input for its own and rival’s downstream divisions, and the third one comprises two vertically integrated firms competing in a final goods market. Four modes of competition are considered: Cournot, Bertrand, Stackelberg quantity and Stackelberg price. The paper shows that the optimal transfer pricing policy depends on four specifications: the vertical structure, the production technology, the demand characteristics and the competition mode. It finds numerous patterns on optimal transfer pricing: for example, under the same demand structure and competition mode, the two vertical models can yield diametrically opposite transfer pricing strategies; within a given vertical model, different competition modes may yield the same or different optimal strategies; and within a given competition mode, the four possible pairings of ordinary substitutes/complements on the demand side and strategic substitutes/complements on the firm side can also produce quite different results. In addition, the paper illustrates how the optimal transfer pricing policy is affected when the additional factors of income tax and tariff distortions are considered. With all the significant factors affecting the optimal transfer pricing delineated, the paper has laid a foundation for further studies in transfer pricing under more general structures. An important implication of our results is that the optimal transfer pricing policy may not be simply determined by the common practice of shifting profits from high- to low-tax jurisdictions.

Suggested Citation

Chang, Winston W. and Ryu, Han Eol, Optimal Transfer Pricing in a Vertically-Related and Imperfectly Competitive Market (August 24, 2012). Available at SSRN: https://ssrn.com/abstract=2464278 or http://dx.doi.org/10.2139/ssrn.2464278

Winston W. Chang (Contact Author)

University at Buffalo - Department of Economics ( email )

453 Fronczak Hall
Department of Economics, SUNY at Buffalo
Buffalo, NY 14260
United States
716-645-8671 (Phone)
716-645-2127 (Fax)

HOME PAGE: http://arts-sciences.buffalo.edu/economics/faculty/faculty-directory/chang.html

Han Eol Ryu

Korea Institute for Industrial Economics and Trade ( email )

370, Sicheong-daero,
Sejong-Si, 339-007
Korea, Republic of (South Korea)
82-44-287-3248 (Phone)

HOME PAGE: http://www.kiet.re.kr

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