Decentralization, Transfer Pricing, and Tacit Collusion

Research in accounting traditionally regards transfer pricing as an intra-firm transaction problem. Within the context of a simple Cournot model, we demonstrate that firms can use transfer prices strategically as a collusive device. While firms are individually better off from a centralized organizational form with each internal division transferring intermediate goods at marginal cost, all firms benefit from a collusive agreement to organize along profit centers, transferring goods above marginal cost. This collusion yields roughly twice the competitive profits and is sustainable even when collusion on quantities is not. This practice may also escape legal scrutiny, even though the same cost shifting between regulated monopolists and their corporate affiliates is regarded as a major concern for regulators and researchers.