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Transfer price and equilibrium in multidivisional firms: an examination of divisional autonomy and central control

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  • Alireza Dorestani

Abstract

The problem faced by a firm that oversees two divisions, one of which produces and one of which uses an intermediate good, is considered. Since divisions have information that is not available to the centre, it is useful to allow the divisions some autonomy in their sales and procurement decisions. The analysis allows the centre to specify the transfer price that must be used in trades between divisions as well as placing restraints on their ability to trade with outside firms. In most of the models presented in this paper, the centre cannot observe the market price of the intermediate product, and in some models it cannot observe divisional costs. It is shown how the centre can obtain the full information solution in the simplest case by using a penalty factor that encourages internal trade. However, when divisional costs are not observable, the full information outcome is not obtainable. In this case, the optimal value of the penalty factor implies a tradeoff between the benefits of allowing divisions to act to take advantage of price opportunities in outside markets and savings in transactions costs of trades between divisions.

Suggested Citation

  • Alireza Dorestani, 2004. "Transfer price and equilibrium in multidivisional firms: an examination of divisional autonomy and central control," Applied Economics, Taylor & Francis Journals, vol. 36(17), pages 1899-1906.
    • Handle: RePEc:taf:applec:v:36:y:2004:i:17:p:1899-1906
    DOI: 10.1080/0003684042000291911
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    References listed on IDEAS

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    Cited by:

    1. Xinxin Hu & Izak Duenyas & Roman Kapuscinski, 2007. "Existence of Coordinating Transshipment Prices in a Two-Location Inventory Model," Management Science, INFORMS, vol. 53(8), pages 1289-1302, August.

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