Corporate profit tax, managerial delegation and multinational firm's transfer pricing

This paper analyzes the transfer pricing decision of the multinational firm. There are differences in profit tax rates between home-country and host-country. The multinational firm determines the transfer price to its overseas affiliate and delegates the responsibility of deciding on the final sales to its affiliate manager. We find that: (1) The multinational firm will set a higher transfer price if its affiliate hires a manager. If the host-country firm also hires a manager, the managerial delegation may lead to an asymmetry “prisoner's dilemma”. (2) When home-country's tax rate is higher than that in the host-country, multinational firm tends to set a lower transfer price relative to the marginal production cost. (3) When host-country's tax rate is higher than that in the home-country, an increase in the host-country corporate tax rate decreases multinational firm's profit and the consumer surplus, while its impact on the host-country firm's profit is non-monotone; an increase in the home-country tax rate decreases host-country firm's profit, increases consumer surplus, but has a non-monotone impact on multinational firm's profit.