Cost-Reduction Investment and Market-Based Transfer Pricing

Abstract

This research shows that the market-based transfer price exceeds the marginal cost when a divisionalized firm's upstream division can choose the cost reduction investment without information asymmetry or competition. This outcome cannot be obtained, when the firm uses the administrative transfer price. If the firm uses the market-based transfer price, the upstream division can control the level of transfer price through the market price decision and sets the transfer price higher than the administrative transfer price situation. This outcome supports the results of prior empirical research and explains why the firm chooses a transfer price that exceeds the marginal cost from a different perspective than past studies.