INFORMATION INDUCTANCE IN A TRANSFER PRICING SETTING

This study investigates the behavior of divisional managers when a decomposition model is employed for setting transfer prices. It was hypothesized that divisional managers, perceiving the transfer price as a factor affecting their performance evaluation, would have an incentive to engage in dysfunctional behavior by manipulating the information transmitted to the central unit. Such a phenomenon is an example of information inductance.;The hypotheses of the study were derived from theoretical developments in the literature. Two research methods were employed to test the implications of the theoretical framework: a simulation of a decomposition model and a laboratory experiment. The results of the simulated model were used as a benchmark for the evaluation of experimental results.;The experimental environment consisted of a two-division company where a product is transferred from one division to the other. Student subjects assumed the role of the supplying-division manager. Utilizing an interactive computer program and information describing the company, subjects suggested a price for the transferred product. The experimental treatments manipulated each of the three independent variables under study.;Overall, the proposed hypotheses were supported by the obtained results. The results indicated that, within the experimental environment, dysfunctional behavior was found to be higher when (1) no externally-determined market price exists for the transferred product, (2) the product is important to divisional profitability, and (3) divisional profits are emphasized for performance evaluation.;The general objectives of this study were (1) to study the nature of dysfunctional behavior associated with transfer pricing and (2) to investigate the empirical validity of several theoretical propositions developed in the literature. The principal focus centered on the effects of specific situational variables on the behavior of divisional managers in transfer pricing. The independent variables included (1) the existence of a market price for the transferred product, (2) the evaluation and reward basis, and (3) the importance of the transferred product.