Strategic Incentives for Keeping One Set of Books in International Transfer Pricing

This paper analyses the optimal accounting and transfer pricing policies of two multinational duopolists facing price competition in the final product market. Our main finding is that firms in industries with a small number of competitors may benefit from using the same transfer price for tax and managerial purposes, even if the tax and managerial objectives are conflicting. This result contrasts earlier theoretical research having established the superiority of separate prices for tax and managerial purposes in a non-strategic setting. We analyze two different tax environments and identify conditions for which a joint commitment to a policy of one set of books is a dominant strategy equilibrium for both scenarios. We find that the existence of this equilibrium is more likely if the products are close substitutes, so that there is a high intensity of competition in the product market. Our analysis broadens the theoretical understanding of the factors governing the optimal accounting policy and provides testable empirical predictions. According to our results, the practice of one set of books should be the prevalent accounting method in markets with a small number of competitors and similar products.