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Compensation and Transfer Pricing in a Principal-Agent Model

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  • Besanko, David
  • Sibley, David S

Abstract

This paper studies transfer prices and compensation mechanisms in a principal-agent model with moral hazard and private information by the agent. Production requires unobservable effort by the agent and a purchased input. In general, it is optimal for the principal to create an internal market for the input and charge the agent a tax or subsidy that differs from the market price. Conditions are found under which the optimal compensation function is given by the difference between a nonlinear "revenue" function depending only on output and a nonlinear transfer pricing function that depends only on the amount of the purchased input. Copyright 1991 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Suggested Citation

  • Besanko, David & Sibley, David S, 1991. "Compensation and Transfer Pricing in a Principal-Agent Model," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 32(1), pages 55-68, February.
    • Handle: RePEc:ier:iecrev:v:32:y:1991:i:1:p:55-68
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    Cited by:

    1. Talajić Mirko & Vrankić Ilko & Kopal Robert, 2021. "Analytical approach to the influence of motivation on the dynamics of heterogeneous employees and expected average costs of efficient work," Zagreb International Review of Economics and Business, Sciendo, vol. 24(2), pages 77-104.
    2. Yeom, Sungsoo & Balachandran, Kashi R & Ronen, Joshua, 2000. "The Role of Transfer Price for Coordination and Control within a Firm," Review of Quantitative Finance and Accounting, Springer, vol. 14(2), pages 161-192, March.
    3. Lamar Pierce, 2012. "Organizational Structure and the Limits of Knowledge Sharing: Incentive Conflict and Agency in Car Leasing," Management Science, INFORMS, vol. 58(6), pages 1106-1121, June.
    4. Lewis, Tracy R. & Sappington, David E. M., 1995. "Using markets to allocate pollution permits and other scarce resource rights under limited information," Journal of Public Economics, Elsevier, vol. 57(3), pages 431-455, July.
    5. Tae-Young Paik & Pradyot K. Sen, 1995. "Project Evaluation and Control in Decentralized Firms: Is Capital Rationing Always Optimal?," Management Science, INFORMS, vol. 41(8), pages 1404-1414, August.
    6. Clemens Löffler & Thomas Pfeiffer & Ulf Schiller & Joachim Wagner, 2011. "Zentralisierung, Transferpreise und spezifische Investitionen: Ein selektiver Verfahrensvergleich," Schmalenbach Journal of Business Research, Springer, vol. 63(63), pages 1-33, January.
    7. García, Diego, 2014. "Optimal contracts with privately informed agents and active principals," Journal of Corporate Finance, Elsevier, vol. 29(C), pages 695-709.
    8. Eric John Slof, 1999. "Transfer prices and incentive contracts in vertically-integrated divisionalized companies," European Accounting Review, Taylor & Francis Journals, vol. 8(2), pages 265-286.
    9. Martini, Jan Thomas & Niemann, Rainer & Simons, Dirk, 2007. "Transfer pricing or formula apportionment? Tax-induced distortions of multinationals' investment and production decisions," arqus Discussion Papers in Quantitative Tax Research 27, arqus - Arbeitskreis Quantitative Steuerlehre.
    10. Jan Thomas Martini & Rainer Niemann & Dirk Simons, 2007. "Transfer Pricing or Formula Apportionment? Tax-Induced Distortions of Multinationals’ Investment and Production Decisions," CESifo Working Paper Series 2020, CESifo.

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