||External and Internal Pricing in Multidivisional Firms
Tim Baldenius; Stefan J. Reichelstein
||Multidivisional firms frequently rely on external market prices in order to value internal transactions across profit centers. This paper examines market-based transfer
pricing when an upstream division has monopoly power in selling a proprietary component both to a downstream division within the same firm and to external customers.
When internal transfers are valued at the prevailing market price, the resulting transactions are distorted by double marginalization. The imposition of intracompany discounts will always improve overall firm profits provided the supplying division is capacity constrained. Under certain conditions it is then possible to design discount
rules so that the resulting prices and sales quantities are effcient from the corporate
perspective. In contrast, the impact of intracompany discounts remains ambiguous
when the capacity of the selling division is essentially unlimited. It is then generally
impossible to achieve fully effcient outcomes by means of market-based transfer pricing unless the external market for the component is suffciently large relative to the
||Journal of Accounting Research, March 2006, Vol. 44 Issue 1, pp. 1-28
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