Intrafirm resource allocation: the economics of transfer pricing and cost allocations in accounting
A theory of intrafirm allocation under information asymmetry based on Myerson's general theory of mechanisms is developed. From the general model, it is shown that every Myerson equilibrium resource allocation mechanism is a “cost plus” type of transfer pricing. Specializing the general model to allow risk-neutral agents, we derive the exact form of the compensation schemes in dominant strategy equilibrium transfer pricing mechanism. The general Myerson agency problem is transformed into a central planner's problem enabling us to bypass the first-order approach to the problem. The closed form solution shows that each of the agents' compensation schemes is composed of a profit-sharing component, a cost refund, taxes, and subsidies, making it a Groves-like scheme. Additional results show that if the principal is asymmetrically informed about one of the agents only, the agent may derive rent from private information under monotonic compensation schemes, and we provide additional conditions under which Hirshleifer's classical marginal cost pricing is in equilibrium.
Contemporary Accounting Research
Amershi, A. H.,& Cheng, P. (1990). Intrafirm resource allocation: the economics of transfer pricing and cost allocations in accounting. Contemporary Accounting Research, 7 (1), 61-99. http://dx.doi.org/10.1111/j.1911-3846.1990.tb00801.x