Decentralization and Transfer Pricing

This paper presents a simple model of a partially decentralized multinational firm (MNF) in competition with a rival firm. It is shown that transfer pricing can be used as a rent-shifting device by the MNF to compete with the rival. This arises because the MNF headquarters uses the transfer price to manage different subsidiaries. The specific value of the transfer price chosen by the MNF depends on whether the rival firm produces the intermediate good or the final good or both of them, and whether the rival is integrated or not. In particular, both decentralization and competition with a fully integrated rival result in lower transfer prices