Organization of production in a multinational firm: Transfer pricing, learning by doing and coordination cost

Recent empirical evidence on income shifting points to three key observations: First, there is some evidence of income shifting. Second, firms do not take full advantage of income shifting opportunities. And finally, the role of transfer pricing is not clear. In the first essay, I develop a simple framework to explore the role of transfer pricing under differential taxation. Its main contribution is in understanding the effect of internal and external factors on transfer payments and the reported firm profits. Taxes affect the reported subsidiary profits in a way that might seem like income shifting. I conclude that the above behavior need not imply that the MNCs set transfer prices to avoid taxes, but rather reflect the firm's attempt to coordinate its internal activities.;In the second essay, we develop a model to understand the role of a lower subsidiary knowledge-base in limiting international outsourcing. The model results suggest that outsourcing can be static or dynamic depending on the wage-gap and the initial knowledge gap between the parent firm and its subsidiary. For a given initial knowledge level of the subsidiary, there is a critical relative wage below which there is no incentive for the parent firm to transfer capabilities to its subsidiary. Introducing the scale effect leads to an interesting implication for labor allocation within the parent firm and the learning process in the subsidiary, respectively.;The third essay extends the work of Becker and Murphy (Becker, G. S. and K. J. Murphy, 1992, ‘The Division of Labor, Coordination Costs, and Knowledge’, Quarterly Journal of Economics, 57 (4), pp. 1137–60) to the case of international outsourcing by introducing a role for coordination cost as a reason for incomplete outsourcing. A multinational firm faces two types of costs: firm-wide coordination costs and outsourcing-specific costs. An increase in the firm-wide coordination cost increases outsourcing and decreases the division of labor. Outsourcing-specific coordination cost effects are counter-intuitive: an increase lowers outsourcing but increases the division of labor. The main contribution comes from understanding how coordination costs alter the intra-firm division of labor and the organization of production within the multinational firm.