Economic literature has proposed several incentive mechanisms in order to induce agents in divisionalized organizations to reveal their private information. Among these mechanisms the class of Groves mechanisms has the distinguishing property of implementing truthful reporting as an equilibrium in dominant strategies. However, critiques maintain that agents may collude and transmit false information to headquarters. This paper demonstrates that the agents' collusion game results in a prisoners' dilemma because agents cannot credibly commit themselves to play the collusive message strategies. The paper also outlines an organizational setting to enhance the plausibility of the fundamental assumptions underlying the Groves/Loeb approach, in which payoffs are observable ex post so that compensation contracts can be based on them. The task of informing headquarters is not assigned to the division manager himself but to a pertinent management accountant. This setting reduces the impact of subjective utility components of agents' payoffs so that the assumptions of this mechanism seem more realistic.
One of the major functions of transfer pricing is the optimal coordination of internal trade between responsibility centers in decentralized firms. According to standard theory the efficient level of internal trade is achieved by marginal cost pricing. If one of the firm's profit centers faces duopolistic competition on the final product market, the firm's headquarters can gain a strategic advantage when it systematically distorts the transfer price. Because headquarters cannot credibly commit to the equilibrium strategy that is induced by transfer pricing, the market outcome achieved by strategic transfer pricing cannot be replicated by centralized decision making. Since unobservable contracts cannot serve as credible precommitments unless they are employed for other than strategic reasons, the applicability of the basic concept is limited to observable transfer prices. When transfer prices are unobservable and the firms are facing price competition, however, the desired strategic advantages can also be achieved by a commitment to a full-cost system or by the delegation of the authority over the terms of internal trade to the producing division.
This paper analyses the use of transfer pricing as a strategic device in divisionalized firms facing duopolistic price competition. When transfer prices are observable, both firms’ headquarters will charge a transfer price above the marginal cost of the intermediate product to induce their marketing managers to behave as softer competitors in the final product market. When transfer prices are not observable, strategic transfer pricing is not an equilibrium and the optimal transfer price equals the marginal cost of the intermediate product. As a strategic alternative, however, the firms can signal the use of transfer prices above marginal cost to their competitors by a publicly observable commitment to an absorption costing system. The paper identifies conditions under which the choice of absorption costing is a dominant strategy equilibrium.
This paper analyzes the choice among alternative fixed and variable cost structures under demand uncertainty. We show that the standard decision rules for the choice among cost structures under certainty continue to hold if the decision maker is risk neutral. If the decision maker is risk averse, the optimal cost structure depends on the decision model. With cost-based decision making, the break even quantities are lower than under certainty. If the decision is based on contribution margins, the opposite holds. That is, a cost structure with higher fixed and lower variable cost becomes attractive for a lower (higher) quantity than under certainty if the decision maker is risk averse and makes his decision on the basis of cost (contribution margin). We also show that cost structures that are dominated under certainty can become attractive for a risk averse decision maker. Finally, we provide a simple agency model and show that the choice among different cost structures can not be separated from the optimal solution of the agency problem even if the principal is risk neutral. More generally, our results suggest that a simple comparison of cost functions is usually not sufficient for an optimal choice between cost structures under uncertainty.
We study the optimal accounting policy of a financially constrained firm that pledges assets to raise debt capital for financing a risky project. The accounting system provides information about the value of the collateral. Absent accounting regulation, the optimal accounting system is conditionally conservative: it recognizes an impairment loss if the asset value is below a certain threshold, but never reports unrealized gains. We describe the optimal impairment rule and the optimal precision of the accounting information, and we provide comparative static results that lead to testable predictions on the determinants of impairment rules.
