Corporate Profit Tax and MNF's Transfer Pricing with Decentralized Delegation

This paper analyzes the transfer pricing decision of the multinational firm (MNF). There are differences in profit tax rates between home-country and host-country. The MNF determines the transfer price to its overseas affiliate and delegates the responsibility of deciding on the final sales (decentralization) to its affiliate manager. We find that: (1) MNF will set a higher transfer price if its affiliate hires a manager. If the host-country firm also hires a manager, the delegation may lead to an “asymmetry” prisoner's Dilemma. (2) When home-country’s tax rate is higher than that in the host-country, MNF tends to set a lower transfer price relative to the marginal production cost. (3) When host-country’s tax rate is higher than that in the home-country, an increase in the host-country corporate tax rate decreases MNF’s profit and the consumer surplus, while its impact on the host-country firm’s profit is non-monotone; an increase in the home-country tax rate decreases host-country firm’s profit, increases consumer surplus, but has a non-monotone impact on MNF’s profit