AN OPTIMAL INTERNATIONAL TRANSFER PRICING SYSTEM: A NONLINEAR MULTI-OBJECTIVE APPROACH

This study proposes a mathematical modeling approach to determine an optimal international transfer pricing system for multinational firms.;The study shows that the accounting approach to setting those prices provides a wide conceptual range of alternatives with no authoritative standards for imposing a specific price with this range. However, tax authorities have certain requirements on international prices. Moreover, multinational firms are generally faced with many opposing objectives and independent interests in determining their worldwide intraaffiliate prices.;The study has proceeded to define major opposing forces and objectives behind the determination of international transfer prices, such as: (1) Accounting measurement rules and standards prevailing in the countries of the multinational firm's operations. (2) Third party forces: income tax and custom authorities, joint ventures and minority interests, the management of nation segments, and national interests of host countries. (3) International management price biasing preferences: defensive, offensive and administrative objectives.;After analyzing those relevant objectives and forces, appropriate functional relationships among the pertinent factors of the pricing system were developed and incorporated in an appropriate multi-objective model based on nonlinear goal programming.;The study emphasizes three major characteristics in dealing with the problem: (1) it has multiple conflicting objectives; (2) international transfer prices cannot be determined in isolation, but must be determined simultaneously with the allocation of resources among the international entity, and (3) the value of an international transfer price is not irrelevant to the entity as a whole, but has numerous impacts on the entity's overall profitability.;The model was solved under alternative priority structures to achieve its multiple conflicting goals. The model solutions were analyzed and associated with both income statements of the trading affiliates and the firm's worldwide profit.;The model final solution provides international management a means by which optimal intraaffiliate prices and their associated unit flows can be determined. It also addresses two issues: (1) how the derived prices are to be considered for accounting and authoritative purposes, and (2) whether or not measurement standards can be imposed on international transfer pricing and what is the role of the model in this respect.