A TWO-STAGE ANALYSIS OF INTERDIVISIONAL TRANSFER PRICING NEGOTIATIONS

Managerial negotiation is the preferred transfer pricing method in many companies. This study describes the organizational and economic forces that impact exchanges of goods and services between domestic divisions. Two forces are described in detail: previous negotiation results and market demand conditions. Each is shown to lead to bargaining power imbalance (asymmetry) between division managers.;The hypotheses were tested with a business club simulation using a 2 x 3 factorial design. Each pair of subjects bargained for five successive periods, during which the outside market price was altered. The 54 pairs interacted under asymmetric or balanced conditions which were reversed or left unchanged in the final period. Compensation rules encouraged each one to enhance personal profit but also to reach agreement with the opposite party. Expectations concerning negotiation outcomes were elicited prior to the last two periods.;The experimental results prompt these conclusions. Market demand conditions were poor predictors of transfer pricing behaviors and outcomes. Subjects did not adapt their goals to the market conditions as traditional economics would predict. Previous negotiation results forecasted somewhat better, with systematic differences in satisfaction scores and variances from the market price. Prenegotiation constructs were not associated in significant ways with negotiation behaviors.;Previous profit level became a significant covariate in several models. This confirmed that subjects had created their own bargaining history, and that they compared their own profits with those of their opposite. Evidence emerged that they sought to bring their profit totals closer to each other over time, building equity into their relationship. The study also pioneers in defining and testing several prenegotiation constructs.;The negotiation process itself is analyzed into two stages: a preliminary setting of expectations (prenegotiation) and a subsequent series of offers and counteroffers leading to agreement of stalemate (negotiation). Five hypotheses link the independent variables to negotiator behavior (time spent, variance of price from optimum, satisfaction and equity ratings and frequency of stalemates). Three other hypotheses predict responses at the prenegotiation stage. Associations are also predicted between prenegotiation expectations and negotiator behavior.