Duopolistic Competition, Taxes, and theArm's-Length Principle

Numerous (high-tax) countries presume that multinational ¯rms use their transfer-pricing policies to shift pro¯ts into countries with lower tax rates. To avoid thecorresponding loss in tax revenues, tax authorities develop constantly tighteningrules to curb transfer-price distortions. A®ected ¯rms include the decision of com-pliance to these rules into their strategic considerations. In a scenario with arm's-length regulation in two countries, we analyze the transfer-pricing policy of a ¯rmthat uses the same transfer price for tax and managerial incentive purposes.[...]