Seminar: A Multinational Firm’s Strategic Decision of Selling to a Rival: The Impacts of Tax and Transfer Pricing

The University of Iowa INFORMS Student Chapter and the Department of Management Sciences of the University of Iowa have jointly organized a seminar on April 14, 2016 at 2 PM in Room C131 Pomerantz Center. Vernon Ning Hsu of CUHK Business School, Chinese University of Hong Kong will give a talk with the following title and abstract:

  • A Multinational Firm’s Strategic Decision of Selling to a Rival: The Impacts of Tax and Transfer Pricing


We consider an integrated multinational firm (MNF) who produces a product in a low-tax country and sells it in a high-tax country. The global firm faces the decision of whether to sell the product (and at what price) to an external rival who has its own in-house production capability. Using a Cournot competition model, we show that in additional to the traditional tradeoffs between wholesale and retail profits, two salient elements of the transfer pricing between the MNF’s affiliated divisions—namely the incoming shifting effect (the tax benefit of generating more profits in the low tax division) and the arm’s length principle (ALP) effect (the requirement of selling to internal and external buyers at a single market-based price)—have significant impacts on the outcomes of sale or no sale between the two rivals.

We find that when the income shifting effect is weak, a sale will (will not) occur when the rival’s (in-house) cost is low (high). This is because under ALP, the pricing parity removes the MNF’s ability to aggressively prop up its retail division’s competitiveness through a low transfer price. Thus the rival is motivated to buy from the MNF, even at a price higher than its own cost, in exchange for a softened competition in the retail market. On the other hand, the MNF would rather forego its wholesale profits by not selling to a weak rival (with a high cost) in order to maintain its retail market dominance. When the income shifting effect is strong, the outcome of sale or no sale is reversed—the sale will (will not) occur when the rival’s cost is high (low). This is because the higher benefit from income shifting magnifies the attractiveness of wholesale profits, making the MNF more willing to sell to the rival. However, when the rival is competitively strong with a low cost, it will refuse to buy from the MNF even when being offered a price lower than its own cost, knowing well that the latter’s tax cost is too high for it to become a credible threat in the retail market via a low transfer price.