~ 1Pergamon

PIh S0969-5931 (96)00042-X

btternational Business Review Vol. 6, No. 2, pp. 127-145, 1997
~ 1997 Elsevier Science Ltd. All rights reserved
Printed in Great Britain
0969-5931/97 $17.00 + 0.00

E x a m i n i n g the
Examining
, ,
the Role of Transfe,r Role of
Transfer
Pricing.as a Strategy for Pricing

Multinational Firms
Karen S. Cravens
The University of Tulsa, School of Accounting, 600 South College
Avenue, Tulsa, OK 74104-3189, USA

Abstract--In contrast to a purely tax-driven mechanism, international transfer pricing can be

considered as a means to accomplish corporate objectives and thus create strategic
consequences. This paper examines the results of a survey of executives of US-based
multinational firms who describe the international transfer pricing objectives and strategies of
their firms. Results indicate that executives are not solely focused on taxation issues as the
primary objective of international transfer pricing. Multinationals employ transfer pricing to
assist in achieving competitive advantage and other corporate objectives as well. This study
investigates the influence of transfer pricing on corporate performance and the link involving the
effectiveness of transfer pricing in accomplishing objectives. In general, executives perceive
that transfer pricing does influence measures of corporate performance. This is supported by the
finding that transfer pricing also contributes toward achieving objectives. © 1997 Elsevier
Science Ltd

Key Words--International transfer pricing, Multinational firms

Introduction
As the world seems to progress towards a truly global economy, this action
focuses attention on the multinational firm. From a competitive standpoint, it
is essential for both domestic and multinational competitors to understand how
the multinational firm operates. Multinationals have the power to exert a
tremendous amount of influence. The largest 300 multinationals account for
roughly 25% of the world's productive assets (The Economist, May 22, 1993).
Moreover, the rationale for the existence of the multinational firm is the ability
to utilize operations in a variety of countries. Normal operations for these firms
typically involve the transfer of goods, raw materials, intangibles or services
between related entities of the multinational parent. Since the entities are
related, yet separate, a transfer price must be assigned to the transfer. The
importance of the concept of transfer pricing is highlighted by the fact that
approximately 80% of Fortune 1000 companies must select transfer pricing
strategies, requiring a complex array of financial, legal, and operational
considerations (Eccles, 1985: p. 2). In 1986, almost 36% of the United States'
imports and exports were transactions between US firms and their foreign
affiliates or parents (Cho, 1990). Approximately 55% of the trade between the
European Union and Japan, 40% of the trade between the EU and the US, and
80% of the trade between Japan and the US is between parent companies and
foreign subsidiaries (Stewart, 1993).

127
128

International The transfer price is the intemal value placed on a raw material, good, or
Business service as it moves from one related organizational entity to another within a
Review consolidated corporate group. Transfer prices may apply to departments,
6,2 divisions, subsidiaries or affiliate business units. Transfer pricing is an
accounting convention which is receiving an increasing amount of public
concern. Much of the attention focuses on how multinational firms employ
transfer pricing to avoid paying income taxes. Importantly, it is increasingly
apparent that attempting to minimize the tax burden is only one of the
objectives of an international transfer pricing strategy.
Collecting unpaid taxes from foreign firms operating in the US is a political
issue and has generated a great deal of govemment monitoring. Other nations
experiencing similar transfer pricing debates are seeking potential solutions to
the problems. Corporations must contend with the public relations issue of
pricing actions in addition to developing strategies for transfer pricing
situations. Making these decisions while competing in several countries further
complicates the process and highlights the critical importance of transfer
pricing in all aspects of multinational operations.
Transfer pricing is a strategy rather than a procedure (Eccles, 1985; Spicer,
1988). This perspective points to the importance of transfer pricing in the
overall corporate strategy and performance of the multinational firm. The
transfer pricing method employed by a firm is how it executes the transfer
pricing strategy. If firms employ transfer pricing to accomplish multiple
objectives, then the effectiveness of transfer pricing becomes even more
important to overall corporate success. Given the complex environment in
which multinational enterprises (MNEs) operate, the objective of this study is
to examine the impact of transfer pricing strategy on business strategy and
performance and consider the extent to which international transfer pricing is
primarily tax-driven.
Top executives in a large sample of multinational corporations were asked
to describe and evaluate their transfer pricing objectives and strategies. An
analysis of the findings and a discussion of the implications concerning the
role of transfer pricing as a strategy for multinational firms follows. First, the
relationship between transfer pricing and business strategy within the
multinational context is examined. Next the strategic objectives of transfer
pricing are considered, followed by an analysis of the process of transfer
pricing. The research approach is described with an evaluation of how transfer
pricing influences organizational performance, including the relationship
between the influences and transfer pricing effectiveness. Finally, the strategic
implications of transfer pricing are discussed, along with how a firm may
employ transfer pricing to compete in the global economy.

Transfer Pricing Objectives, Strategy, and Consequences

Since global markets create imperfections that offer comparative advantages,
the MNE is logically in the best position to access these opportunities (Leitch
and Barrett, 1992). The MNE has a distinct profit advantage over a purely
domestic firm operating in the same marketplace (Benvignati, 1987). This
 129

advantage results from a combination of factors relating to ownership, Examining the

location, and internationalization: Role of
Transfer
Ownership advantagesinclude (1) capital assets that give an organizationa competitiveedge, Pricing
(2) economiesof scale, (3) access to markets, (4) products to distribute, and (5) diversity of
products. Location advantages include (1) material sourcing, (2) a good labor market, (3)
cooperative governmentalpolicies (including tax policies), (4) governmental services and
infrastructure, and (5) local markets. Internationalization advantages include (1) stable
supplies, (2) control of markets, (3) exploitation of technology, (4) vertical integration
economies, and (5) markets (Leitch and Barrett, 1992: p. 49).

The Role of Transfer Pricing

In taking full advantage of the these potential benefits, the MNE often must
rely on transfers of goods, raw materials, intangibles or services among the
business units. Transfers allow the MNE to exercise its "multinationality". If
the MNE acted solely without these transfers, then there would be no rationale
for it to exist and domestic firms would dominate each country's marketplace.
Consequently, since separate legal entities are involved which compete in
different countries, it is necessary to assign a value to the transfer of products.
The transfer price is critically important as it is the means by which the
multinational does a considerable amount of its business.
Transfer pricing plays a more critical role in overall firm operations than
previously considered. In a domestic environment, issues related to manage-
ment evaluation and performance are generally the major concern with respect
to transfer pricing. However, the multinational firm is faced with numerous
complicating factors within the global marketplace. While the internal issues
of management evaluation and performance are significant for these firms,
they must be considered in conjunction with issues such as taxation,
competitive advantage, foreign exchange, cash controls and inflation. The
transfer pricing strategy increases in complexity with each additional national
market that the MNE enters. Through this multinationality MNEs maximize
their objectives by exploiting the market imperfections that arise from
exchange process differentials (Leitch and Barrett, 1992). Exploitation is
generally accomplished in whole or in part by internal transfers among related
entities of the MNE. Since the transfer pricing mechanism is often critical in
the accomplishment of these global objectives, then transfer pricing does
indeed function as an instrument of strategy.
Corporate strategy may be viewed as an organizational process consisting of
formulation and implementation (Andrews, 1987). Transfer pricing falls into
the implementation phase of strategy. This role is also supported by an analysis
of the relationship between strategy and transfer pricing. "The relationship
between strategy and transfer pricing policy is so intimate that it is nearly a
tautology" (Eccles, 1985: p. 9). It is apparent that the transfer pricing policy is
an integral part of the organization's strategy and should not be considered in
isolation as merely an accounting technique. Thus, transfer pricing decisions
130

International Relationship between International Transfer

Business Pricing and Corporate Strategy
Review Corporate
6,2 Objectives I
I
Strategy
Mechanisms [
I
Internati°nalII
I I I I
Strategic [
Direct I Alliance Other I Incentive
Figure 1. Foreign or Transfer Mechanisms Plans
Relationship between Investment JointVentures PricingPolicies
International Transfer
Pricing and Corporate
I
I Strategic Consequences I
Strategy

are active components of strategy, rather than responses to accounting and tax
conventions. Clearly in some tax situations, the MNE may indeed have no
choice regarding international transfer pricing. However, the objective of this
paper is to demonstrate that international transfer pricing can function as a
component of strategy in accomplishing additional objectives beyond
compliance with tax regulations.
Figure 1 describes the relationship between international transfer pricing
and strategy for the MNE. Once management determines overall objectives,
various strategies may be used to accomplish the objectives. Transfer pricing is
a managed activity that contributes to achieving corporate objectives. Other
actions such as strategic alliances, joint ventures, incentive compensation plans
for executives, and direct foreign investment may also be employed. The MNE
encounters a complex situation because its objectives often have international
and domestic implications.

Important Issues
There are several key issues concerning the use of transfer pricing as an
instrument of corporate strategy:
(1) What is unique about the international environment for transfer pricing
within the context of multinational operations?
(2) Is transfer pricing a management control tool, or instead, a component of
corporate strategy?
(3) Does the MNE employ transfer pricing to achieve a variety of objectives,
or is the motivation solely tax driven?
(4) Is transfer pricing effective in achieving management's intended
objectives?

International environment. The MNE must make decisions about different

national markets and competitive situations, and then assimilate and
coordinate these decisions to craft a cohesive plan for transfer pricing. It is
extremely challenging to make decisions which apply uniformly in a variety of
 131

national markets. Complicating this nationalistic identity is the changing view E x a m i n i n g the
toward national boundaries. With the execution of the European Union, Role of
traditional borders and means of differentiation have been blurred (Khan and Transfer
Ravenscroft, 1992). Similarly, other less formal alliances involving several Pricing
countries exist throughout the world.
An additional complication in the international environment is the escalating
use of strategic alliances between companies. Over 50% of the companies in
this study have one or more alliances. Thirty percent have 10 or more
alliances. Multinational firms are engaging in these collaborative arrangements
in order to pursue common strategic goals that are individually not achievable.
Though strategic alliance partners are separate firms, they are related in the
sense of their common project. The partners, via the alliance, will transfer
goods or technology between each other. The alliance relationship raises
several interesting questions. Are alliance partners truly related parties, or does
a hybrid-type inter-organizational arrangement apply? How is the appropriate
transfer price determined when transfers are involved? All of these issues are
not specifically addressed, yet this research provides insights into the role that
transfer pricing plays in the MNE.

Strategic motivation. The concept of management control centers on the

implementation of corporate strategies (Anthony et al., 1992). Strategy cannot
be carried out without a control mechanism. Certainly, transfer pricing is a
mechanism, but it is also the means by which the strategy is accomplished
along with several other control mechanisms.

"The transfer price is not primarily an accounting tool. Rather, it is a behavioral tool that
motivates managers to take the fight decisions" (Anthony et al., 1992)

So transfer pricing is a tool and a component of management control. Yet,

when using transfer pricing as a control mechanism, the firm is accomplishing
strategic objectives, and transfer pricing is more than a control mechanism.
Given the decentralized nature of the typical company, the role of transfer
pricing becomes even more critical. It is the mechanism by which information
is transferred (Horngren, 1989).

"There is an increasing recognition that successful strategists are those who adopt a systemic
and integrated approach towards their value-added activities, including those which are taken
outside their national boundaries" (Dunning, 1993: p. 187)

Pricing objectives. Government officials, congressional leaders, and the media

focus on tax motivations in the use of transfer pricing. Importantly, this study
indicates that MNEs pursue multiple objectives rather than the management of
taxes as the sole objective of international transfer pricing. This broad approach
is further supported by transactions subsequent to the post-tax reform decline in
the statutory US corporate tax rate as compared to other countries. This might
suggest that MNEs should be motivated to shift income to thus pay more taxes in
132

International the US and less taxes in countries with higher tax rates. This sort of strategy
Business would lead to a lower tax burden overall for the MNE. Interestingly, this is not
Review the case (Khalaf, 1990; Martz and Thomas, 1991; Scholes and Wolfson, 1992).
6,2
Impact on results. The best measure of effectiveness for any strategy is the
extent to which management's objectives are met. This measure of success is
also appropriate for transfer pricing. If indeed transfer pricing is viewed as a
strategy, then the outcome is particularly critical. If transfer pricing is not
effective, then alternate mechanisms may be employed to generate strategic
consequences. Consideration of effectiveness is a departure from the
traditional focus for transfer pricing, since it is most often perceived as an
accounting tool where the choice of the appropriate method is of sole
importance. Instead, a strategic view that recognizes transfer pricing as a
component in strategy is proposed, which mandates assessing its effectiveness.
Executives' opinions and preferences concerning these important transfer
pricing issues are presented and their implications examined in the following
discussion.

Strategic Objectives of Transfer Pricing

The strategic objectives of international transfer pricing fall into three areas:
(1) taxation-related objectives; (2) internal management-oriented objectives;
and (3) international or operational objectives (Abdallah, 1989; A1-Eryani et
al., 1990; Arpan, 1972; Borkowski, 1990; Business International and Ernst and
Young, 1991; Hoshower and Mandel, 1986; Plasschaert, 1979; Tang, 1992)

Objectives of International Transfer Pricing

• Manage the Tax Burden

• Comply with Tax Regulations

• Manage Tariffs

• Promote Equitable Performance Evaluation

• Motivation of Managers

• Promote Goal Congruence

• Maintain Competitive Market Position

• Mitigate Cash Transfer Restrictions

• Minimize Inflation Risk

• Manage Foreign Currency Exchange

Figure 2.
Objectives of • Address Social or Political Concerns
International Transfer
• Reflect Actual Costs and Income Consistently
Pricing
 133

Illustrative pricing objectives are shown in Fig. 2. These objectives represent Examining the
areas of business activity which are essential to the continued success of the Role of
MNE, and may also be achieved by other strategies. Transfer
Pricing
Taxation-related Objectives
Transfer pricing is most often thought of as a means to manage the overall
income tax burden for the MNE and to comply with the myriad of tax
regulations associated with internal transfers. Most nations have transfer
pricing laws similar to section 482 of the US Internal Revenue Code to prohibit
the manipulation of transfer prices to "evade" income taxes. Numerous
operating and investment decisions are based upon the tax situation of the
MNE as a whole. The MNE must consider a variety of tax rates and situations
in different countries. There are tax credits and incentives which may alter the
decision environment when several countries are involved.
Tariffs levied by countries on the import and export of goods may also be
managed through transfer pricing. Transfer pricing establishes the value for the
item transferred and thus determines the tariff paid. Transfers may be
employed to generate a particular amount of source country content to thus
avoid incurring tariffs. For example, the US Customs Service investigated
Honda for allegedly importing autos from Canada into the US without the
required 50% North American content to avoid paying tariffs (Magnusson,
1991; Magnusson et al., 1991). Honda supposedly employed transfers through
affiliates to allow Japanese-made parts to appear as if they were made in the
US.
The interaction of the income tax and tariff objectives also complicates the
determination of a transfer price. This relationship illustrates how transfer
pricing decisions cannot be made in isolation. Since the objectives are
strategic, they do overlap. The MNE may desire a high price for a good
transferred from a subsidiary to lower the net income of the subsidiary and thus
the income tax. However, the tariff is also based on the transfer price value and
will be deducted from taxable income of the subsidiary. Therefore, the tariff
rate actually lowers the effective tax rate. The transfer price establishes the
minimum value for the item as it may encounter subsequent transfers. This in
turn affects the final pricing of the good and ultimately the MNE's competitive
position.

Internal or Management-oriented Objectives

For purely domestic transfers, internal or management-oriented objectives
most often influence transfer pricing decisions. Typically firms concurrently
seek to promote an equitable performance evaluation system, along with
motivating managers and promoting goal congruence between the goals of the
managers and the goals of the firm. These objectives apply equally to MNEs,
yet impose additional complications relating to culture, customs, exchange
rates and inflation.
Through a transfer pricing policy, corporate goals may be achieved by
providing incentives for managers to acquire goods or raw materials needed in
134

International production from other departments, subsidiaries, or related parties. Even

Business though purchasing the same item from external sources may be less expensive,
Review the goals of the entire corporate group are met by the internal purchase. The
6,2 transfer price can be adjusted so that the manager who is compelled to
purchase the good internally will not suffer in terms of his or her own goals
relating to compensation or evaluation.

International or Operational Objectives

Perhaps the most strategic of any of the transfer pricing objectives is
maintaining (or creating) a competitive market position. The ultimate goal of
the MNE must be to compete in a global economy. This is most often done
through either a differentiation strategy, or by becoming the low cost producer
of a product (Porter, 1985). The appropriate transfer price can allow a
subsidiary to enter a new market at a competitive price, or allow a market
leader to institute price reductions in response to slack demand or a general
decline in economic conditions in a particular geographic area.
In conjunction with internal objectives, transfer pricing may assist the MNE
in managing foreign currency exchange and fluctuations in inflation levels.
The transfer price is not a substitute for hedging and other management
techniques. Instead, it is a means by which the MNE can internally control
these variations when dealing with evaluation, motivation and external pricing
issues.
Cash transfer restrictions are particular to the international environment.
Many countries impose limitations on the transfer of cash or repatriation of
earnings from the country. A transfer price may be created to transfer the good
out of the restricting country with a high or low value according the desired
effect.
Finally, MNEs may use a transfer price to justify investment in local
economies or employment of local workers in response to social or political
concerns. A (low) transfer price may allow a subsidiary in a temporarily
economically depressed region to continue operations. This could avoid
negative publicity and foster a cooperative relationship with local leaders in
terms of the continued employment of citizens who may have limited
additional outlets for employment.

Multiple Strategic Objectives

It is apparent that transfer pricing is employed in a variety of strategic
situations. In each case, the pricing decision is intended to accomplish a
specific objective. In fact, being in a position to accomplish these objectives is
the primary rationale for the existence of the MNE, since its units are
interdependent.

"The subsidiary exists as an alternative to the market, for which the purpose is the execution
of transactions. The foreign subsidiary and headquarters must, therefore, be linked through
the existence of these transactions. This interdependence is further explicated through current
strategic explanations of the multinational corporation" (Roth and Nigh, 1992: p. 279)
 135

Research Approach Examining the

To investigate transfer pricing effectiveness, a sample of publicly-traded Role of
multinational finns was selected to maximize the likelihood of response and Transfer
collection of corresponding financial data. A core group of 179 firms were Pricing
identified from The World Directory of Multinationals. This directory lists the
500 largest multinational firms in the world. The 179 firms represent all of the
US-based finns in the directory. To increase the sample, an additional 363 finns
were selected by a word search of financial statement footnotes of over 10 000
firms traded on US stock exchanges. These 363 firms were all of the US-based
finns which reported geographic segment information under SFAS 14.
The resulting total sample consists of 542 finns with subsidiaries in a variety
of countries. Both methods of determining the sample increase the likelihood
of selecting larger multinational firms. This type of sample may consist of
firms with a greater volume of international transfers and thus a greater
relative importance for transfer pricing objectives and policies.
The questionnaire was directed by name to an individual representative
of top management, usually the controller, vice president of finance, or chief
financial officer. Questionnaire data were combined with published company
financial information. The overall response rate was 21% which is
comparable to similar studies (AI-Eryani et al., 1990; Tang, 1992; Yunker,
1983). Of the 114 responding companies, 82 provided usable responses.
Those not used included firms that do not employ transfer pricing and
incomplete responses. The sample firms represent a broad cross section
of large US-based multinationals. Nearly two-thirds are manufacturing firms
with some concentration in the computer and industrial equipment sectors.
Several consumer products finns are included in the sample. The sample
bias towards manufacturers is not surprising as these type of firms are most
likely to engage in international transfer pricing due to the nature of the
typical production process and the prevalence of off-shore manufacturing
operations.
The typical respondent firm has an average sales level of $4.4 billion with a
corresponding asset value of $4.6 billion. The MNEs on the average compete
in more than 11 countries and recognize 46 subsidiaries in the affiliated group.
As well as being involved with internal transfers averaging $440 million, the
average respondent reports exports of $949 million.
The results of a study investigating international transfer pricing objectives
confirm that MNEs do seek multiple objectives from their transfer pricing
decisions. The executives' views regarding transfer pricing objectives are
shown in Table 1 which lists only the objective rated as the most important by
the respondent firms. Although tax motivations are clearly present, other
objectives are considered as important by almost half of the executives
participating in the study. Interestingly, tariff management is low in
importance. Table 2 incorporates the three most important objectives of each
responding MNE, employing an average of the rankings by the respondents.
The tax burden remains the dominant objective, but diminishes somewhat in
relative importance. Maintaining a competitive position is a more critical
136

International Objectives %
Business
Taxation-related
Review Manage tariffs 4
6,2 Comply with tax regulations 7
Manage the tax burden 40
51
Internal Management-oriented
Equitable performance evaluation
Motivation
Promote goal congruence
21
International or Operational
Cash transfer restrictions 2
Table 1.
Competitive position 21
Primary Objectives of
International Transfer Reflect actual costs and income 5
Pricing for 28
Multinational Firms

objective when evaluating the averaged three primary transfer pricing

objectives, rather than primary objectives alone.
The increased importance of the internal management objectives also
indicates that MNEs pursue a strategic approach in transfer pricing. The
relative importance of the internal management objectives also reinforces the
similarity between international and domestic transfer pricing concerns for
MNEs.
What is most interesting about the study results is that managing the tax
burden, or complying with tax law is not the singular focus of transfer pricing
for all MNEs. These findings clearly contradict our prior understanding of the
overwhelming dominance of tax issues in international transfer pricing
motivations. Previous studies have asserted that firms have very little choice
other than to mold transfer pricing to fit tax strategies. Indeed, this is not the

Manage the tax burden and related objectives 28%

Maintain competitive position 17%
Promote equitable performance evaluation 11%
Promote goal congruence 10%
Motivate employees 10%
Manage tariffs and related objectives 9%
Comply with tax regulations 7%
Mitigate cash transfer restrictions 4%
Manage foreign exchange 2%
Table 2. Address social and political concerns 1%
Three Most Important
Manage inflation 1%
Objectives of
International Transfer
Pricing (Ranked using Total 100%
a Weighted Average)
 137

case. Transfer pricing is an active management strategy. This finding also Examining the
suggests that the transfer pricing method is not the primary consideration. Role of
Much of the academic and management emphasis in the past centers on how to Transfer
determine transfer pricing methods, rather than why the methods are used. This Pricing
distinction is very important. Also of note is the fact that 21% of respondents
listed internal or management-oriented objectives as primary transfer pricing
objectives. These internal objectives are generally emphasized for purely
domestic transfers. It appears that the MNE is also concerned with these issues
on an international scale. This concern is supported by the fact that normally
MNEs employ the same transfer pricing method for both domestic and
international transfers (Borkowski, 1992).

Implementing Transfer Pricing Strategies

Typically, transfer pricing is accomplished by using one of four general
pricing methods: (1) cost-based; (2) market-based; (3) negotiated; or (4) dual.
Several variations of these four primary methods also occur in practice. A cost-
based pricing policy relies on the cost to acquire or manufacture the item to be
transferred as the transfer price. Market-based methods use the external market
price for the same or similar item as a frame of reference. The actual price may
be above, below, or equal to the external market price. Negotiated methods
allow the two (or more) internal business units involved in the transfer of the
item to jointly decide on the transfer price. A dual transfer price exists where
the price of the item transferred is different for the internal business units
involved in the transfer.
Complications exist where there is not an established external market for an
item. This is particularly true in the case of intangible goods such as
technology, patents, and trademarks. In the US, the Internal Revenue Service
also provides guidelines for setting an appropriate "arm's-length" price.
However, other than for taxation-related issues, there are few guidelines
regarding an appropriate price.
The same transfer pricing method may be used by one MNE to minimize the
overall income tax burden and by another to mitigate inconsistencies in
performance evaluations among business units in different countries. This
highlights the importance of evaluating the underlying motivation for using the
transfer pricing method, rather than deciding which method is used. The
method itself is the mechanism, but the objective of transfer pricing allows

Method Present Borkowski Borkowski A1-Eryani Tang

Study (1990) (1990) et al. (1990) (1992)
International International Domestic International International
Cost 42% 52% 45% 49% 41%
Market 33% 33% 33% 35% 46% TaMe 3.
Negotiated 18% 15% 22% 15% 13% TransferPricing
Dual 7% 0% 0% 1% 0% Methods Employedby
Multinational Firms
138

International MNEs to execute strategy. Transfer pricing is essential because the various
Business international business units do not exist in isolation, and it is this mechanism
Review which facilitates the transfers and removes the isolation. This allows the MNE
6,2 to pursue competitive advantage situations.
However, from a descriptive standpoint, it is interesting to determine which
transfer pricing methods were employed by firms participating in this study.
Table 3 describes the international transfer pricing methods. Three out of four
firms employ either cost-based (42%) or market-based (33%) transfer pricing
methods. Although negotiated transfer pricing is more common for domestic
transfers, 18% of the multinational respondents relied on negotiated transfer
prices. This result may be due to the fact that 59% of the sample use the same
transfer pricing determination method for both international and domestic
transfers. Only a small portion of the companies (7%) use dual transfer pricing
methods. It is also difficult to ascertain the extent to which a MNE selects a
method according to simplicity of operation or ease of implementation. In
other research, executives indicate choosing a readily understood method as an
objective of transfer pricing (Borkowski, 1990). It is also likely that once a
firm has selected a transfer pricing method, there will be some reluctance to
change the method.
Much of the contemporary research attention focused on transfer pricing
looks at "predicting" the method which would be used by a MNE, or
"prescribing" the appropriate method. However, the general conclusion from
this research and others (Borkowski, 1990; Eccles, 1985; Spicer, 1988) is that
there is no one correct method. Indeed then, contingency theory applies to
international transfer pricing. Each MNE chooses a method which best fits the
needs of the firm in terms of strategy implementation. "Consequently, no one
"correct" transfer price can be prescribed for all MNCs" (Borkowski, 1992: p.
35). Therefore, it is important to understand what a MNE seeks to accomplish
through transfer pricing. Strategic objectives drive transfer pricing decisions
The study results provide information as to what large MNEs attempt to
achieve through the use of transfer pricing as an active strategy. The firms
employ transfer pricing as a component part of their overall global strategy,
which involves differing objectives and alternative transfer pricing methods.

Transfer Pricing and Corporate Performance

In deciding whether to use transfer pricing as an instrument of strategy, some
indication of its potential effectiveness is needed. While transfer pricing is
recognized as a means to accomplish various strategic objectives, there is little
evidence to suggest whether or not MNEs perceive transfer pricing as effective
in achieving these objectives. Can transfer pricing eventually influence
corporate performance by accomplishing strategic objectives? Similarly, if
transfer pricing is not effective, then it is essential to determine if another
mechanism is more appropriate. Understanding the influence of transfer
pricing also provides a consideration of how it can be used in conjunction with
other tools to influence corporate performance, and thus achieve strategic
objectives. What makes transfer pricing so potentially powerful is that it is
 139

applicable to a variety of objectives, yet can still provide the desired positive Examining the
effect on corporate performance. Role of
Transfer
Evaluating Effectiveness Pricing
The two primary means to evaluate the effectiveness of transfer pricing are: (1)
considering whether or not the firm has made pricing decisions which
positively affect corporate performance and (2) whether the managers of the
entities feel that they are fairly rewarded for their activities (Eccles, 1985). An
executive assessment of the influence of transfer pricing on corporate
performance captures both of these dimensions. Executives are less likely to
employ a technique to accomplish a desired objective which is not predisposed
to be successful or does not contribute to attaining their own personal
compensation goals. Since most MNE executives are evaluated in terms of
corporate performance, it is essential for them to be able to choose techniques
which translate to results.
To consider effectiveness, the most direct line of inquiry is to ask
representatives of MNEs if transfer pricing does influence various measures of
corporate performance. Along with this type of executive assessment, an
objective comparison can be made. Overall corporate performance is a
relevant measure of success since most firms employ transfer pricing to
accomplish a variety of strategic objectives. Strategy is a collection of goals
with a common pattern, rather than a group of separate purposes (Andrews,
1987). Thus, specific measures of performance relating to individual transfer
pricing objectives will not capture the strategic dimension of transfer pricing.
These individual measures of performance will often not be informative from a
research perspective.
As noted earlier, firms may employ the same transfer pricing policy to
accomplish an objective, yet the direction of the effect may be opposite. For
example, two firms may attempt to manage tariffs through transfer pricing.
One finn may attempt to maximize the value of the good in the country where
the tariffs are assessed, while another firm may attempt to minimize the value.
Depending upon the relative tariff situation in that locale, the firm will seek to
pay low or high tariffs. This makes it difficult to evaluate the success of the
policy in achieving the desired level of tariffs. Similarly, if a firm is attempting
to manage the income tax burden through transfer pricing, then a measure of
success might focus on the tax burden. However, it is generally not possible for
researchers to determine what the tax burden might have been without
employing transfer pricing as a strategic tool. A MNE may seek to pay lower
taxes in one country and thus desire low taxable income. Or, a foreign tax
credit situation may justify increasing taxable income to create a high level of
tax.

How Executives Assess Transfer Pricing Effectiveness

For these reasons, overall corporate performance measures were used in this
research to determine the influence of transfer pricing. Implicit in this
consideration is an assessment of the effectiveness of transfer pricing.
140

International Executives were asked to indicate their perceptions of the influence of the
Business MNE's transfer pricing on various measures of corporate performance.
Review Importantly, to assess the effectiveness of transfer pricing in terms of strategic
6,2 objectives, it is first necessary to determine if MNE executives view transfer
pricing decisions as a means to influence corporate performance. Influence
was measured by the respondent's perception of influence as depicted on a
seven-point scale ranging from no influence (1) to major influence (7).
Executives were able to focus on the degree of influence instead of the
direction of the desired effect of the transfer pricing method. Using this
approach results are comparable even if MNEs are attempting to satisfy
different objectives through transfer pricing.
Several general measures of corporate performance were used in this study:
(1) profitability relative to key competition; (2) market share; (3) firm growth;
(4) customer satisfaction; and (5) return on investment. The first two measures
provide an indication of the competitive position of the firm. Firm growth is an
internal dimension that measures the same type of performance relative to
internal standards. Customer satisfaction is obviously market determined and
captures the influence of the transfer price more indirectly in terms of
facilitating a competitive market position. Return on investment is a widely
employed measure of comparative success in corporate operations and
investment decisions. These measures of performance also relate to the
economic decisions through which transfer pricing affects corporate
performance. The economic decisions include such choices as the appropriate
selling price of the product, the output level for the product, the capital
investment decision, and whether to exit a business (Eccles, 1985).
Additionally, these are common measures upon which executive compensation
may be based.

No Major
Influence Influence
1 2 3 4 5 6 7

Profitability relative 21% 11% 13% 18% 23% 13% 1%

to key competition

Market share 21% 14% 17% 18% 18% 11% 1%

Firm growth 18% t4% 18% 27% 17% 5% 1%

Customer satisfaction 27% 23% 14% 21% 10% 5% 0%

Table 4.
The Influence of
Transfer Pricing on Return on investment 13% 12% 13% 22% 30% 7% 3%
Measures of Corporate
Performance
 141

Perceived Influence of Transfer Pricing Examining the

The executives' assessments of the impact of transfer pricing on corporate Role of
performance are shown in Table 4, The results indicate an important, although Transfer
not dominant, strategic role of transfer pricing. A substantial portion (40%) of Pricing
executives indicate that transfer pricing influences return on investment. This
provides clear support for the strategic role of transfer pricing in nearly half of
the firms in the sample. The influence of transfer pricing on the other
components of performance ranges from 15% (customer satisfaction) to 37%
(relative profitability). These results offer evidence that MNE executives
attach some importance to the influence of transfer pricing on overall firm
performance.
As transfer pricing is only one tool available to the firm to execute corporate
strategy, it would not be reasonable to expect all of the executives to indicate
that transfer pricing has a major influence on corporate performance. The
results indicate that executives perceive transfer pricing strategy as important,
but as only one of the strategies employed by MNEs to affect corporate
performance. This sample represents a group of large, publicly-held MNEs.
The fact that these firms have a variety of alternative mechanisms available
attests to the importance of transfer pricing.
Of even more interest is the importance of transfer pricing in terms of
overall corporate performance given the evaluation structure of lower
management. Many of the respondent firms state that lower-level (subsidiary
or division) managers are evaluated more on their own unit's performance
rather than on overall corporate performance. The study results also indicate
that these managers have a substantial amount of input into the transfer pricing
decision. This suggests that transfer pricing may function more as a strategic
tool to achieve corporate performance objectives rather than a means to deal
with internal issues between the managers. Even though 21% of the MNEs in
the sample listed internal objectives as the primary transfer pricing objective,
these results seem to suggest the importance of transfer pricing along other
dimensions. It may be difficult for respondents to pinpoint the general overall
effects of transfer pricing. Since transfer pricing may serve a variety of
strategic objectives, the resulting effects of such a tool may be difficult to
capture in a summary assessment.

Differences Across the Companies

To further investigate the link between transfer pricing and corporate
performance, a comparison of the characteristics of firms with a high
perceived influence of transfer pricing on corporate performance to those with
a low perceived influence was conducted. The objective of this analysis is to
determine if there are fundamental differences in the characteristics of firms
employing transfer pricing as a strategy as compared to firms attaching more
limited importance to transfer pricing. To concentrate on the most
representative measures of overall corporate performance, the sample was
divided into subgroups using executive responses to the influence of transfer
pricing on return on investment and on profitability relative to key
142

International competition. High influence firms were characterized by a response of 5, 6 or 7

Business to the question of the influence of transfer pricing on the measure of corporate
Review performance (see Table 4). Low response firms were characterized by
6,2 responses of 1, 2, or 3. Firms responding with a value of 4 were removed from
the sample to further delineate the influence groupings.
There are significant differences between the high and low groups on
several attributes. Using profitability relative to key competition as the
measure of corporate performance, the high influence firms tended to have
smaller sales and asset levels as compared to low influence firms. The use of
transfer pricing as means to manage the tax burden was also less important to
the high influence firms. Together, these responses suggest that the high
influence firms consider transfer pricing more important in influencing
profitability relative to key competition. The smaller sales and asset levels
imply that these finns may be relatively new entrants in particular markets, or
are smaller firms concerned with increasing profitability relative to key
industry leaders. This is also supported by less focus on employing transfer
pricing to manage the tax burden. These smaller firms may have less critical
tax situations as compared to the low influence firms. The high influence firms
may have more flexibility in making these decisions. They are also more likely
to have managers at the transfer point involved in the transfer pricing decision.
This is in contrast to having transfer pricing decisions made primarily at higher
corporate levels.
The comparisons using return on investment as a measure of corporate
performance differ somewhat from the above findings. For this comparison,
the high influence firms operate subsidiaries in more countries than did low
influence firms. This result is not surprising considering that finns operating in
a greater number of countries are exposed to a wider variety of tax and tariff
rates and increased complexities of local markets and social or political
factors. By necessity, these firms may be forced to consider transfer pricing as
more of a strategy in terms of corporate performance. In support of this notion,
executives in the high influence firms also indicated that transfer pricing was
more important to the firm today as compared to three years ago.

The Link Between Influence and the Effectiveness of Transfer Pricing

The concept of effectiveness is difficult to measure. However, a general
measure of success for any strategy is the extent to which the strategy
accomplishes the desired objective(s). Thus there is a need to consider the
effectiveness of transfer pricing. This involves the consideration of transfer
pricing as a strategy and removes the fixation on choosing the "correct"
transfer pricing method. To evaluate effectiveness, it is first necessary to
determine the extent to which transfer pricing is perceived to function as a
strategy. This was measured by the perceived influence of transfer pricing on
various measures of corporate performance. The previous discussion provides
support for the use of transfer pricing as a strategic tool. The differences
between high and low perceived influence groups also suggest the importance
of transfer pricing to the entire corporate entity in terms of performance.
 143

Since strategy is an internally-developed concept, it is reasonable to E x a m i n i n g the

evaluate the success of transfer pricing in terms of its effectiveness in Role of
contributing to support of the strategy. To investigate this notion, the Transfer
effectiveness of transfer pricing is examined by asking executives to indicate Pricing
the perceived effectiveness of transfer pricing in accomplishing strategic
objectives. Since firms seek different objectives through transfer pricing, a
summary measure of effectiveness was created. This summary measure
considers the effectiveness of the transfer pricing policy in achieving any
combination of a firm's major strategic objectives. The average takes into
account all of the objectives that the firm was trying to achieve, so that firms
concentrating on only one objective would be comparable to firms seeking
multiple objectives. For each objective listed in Fig. 2, respondents were asked
how effective the transfer pricing policy has been during the past two years in
meeting the objectives. The scale ranged from a value of 1 for not effective, to
a value of 7 for very effective. Respondents could also indicate not applicable
(0) as a response. The total of the scaled responses was then divided by the
number of scaled, non-zero responses to obtain an average value.
Comparisons were made by partitioning the sample firms into high or low
transfer price "effective" firms according to the calculated summary measure
of effectiveness. The goal is to determine if there are significant differences
between firms who perceive their transfer pricing strategy to be effective in
meeting objectives and firms who perceive their strategy to be ineffective. The
average measure allows comparability among firms seeking different
objectives. For this partition using the average measure, high effective firms
(denoted by HTPE) represent an average score of 5, 6, or 7 for effectiveness.
Low effective firms (LTPE) had an average measure of 4 or below. Since
average measures were employed, firms with a value of 4 remained in the
sample.
The results of this comparison provide support for the importance of the use
of transfer pricing. HTPE firms had a significantly higher average value for
intangibles than low effective firms. These firms also had a significantly
higher level of exports. Both of the factors suggest that these firms have more
of an opportunity to employ transfer pricing. Moreover, it is precisely in the
area of intangibles that firms appear to have the most discretion regarding
transfer pricing. This finding implies that HTPE firms may be particularly
successful at international transfer pricing of intangibles. Similarly, the higher
level of exports supports the notion that these firms are more "multinational"
and possess increased access to international transfer opportunities.
Not surprisingly, transfer pricing decisions for these HTPE firms also tended
to be made at the corporate level, rather than by the manager at the transfer
point. The transfer pricing decision is more centralized, and thus more
strategic, contributing to the success of the pricing strategy.
In a separate question, respondents were asked to evaluate how well current
transfer pricing has achieved the intended objectives overall. On a seven point
scale with a value of 1 indicating "needs improvement" and a value of 7
indicating "outstanding", the mean response was a value of 4.55. Thirty seven
144

International percent of the responses indicated a value of 6 or 7, with 33% answering with a
Business value of 2 or 3. Fourteen percent responded with a value of 4 and the
Review remaining 16% indicated a value of 5. Although this question does not
6,2 differentiate among the number or type of objectives sought by the firm in
terms of a transfer pricing policy, the relatively high mean response does seem
to indicate that MNEs perceive that the transfer pricing policy does indeed
contribute to achieving objectives. This is an initial step in considering
effectiveness.

Strategic Implications
The MNE is faced with the complex challenge of deciding how to compete in a
global economy. Although it has access to numerous advantages over a purely
domestic firm, the MNE is also exposed to a greater range of complications.
The most critical complication is using the wide range of actions available to
create a comprehensive plan which will accomplish the strategic objectives of
the firm. Not only must the MNE take advantage of the relevant strategies to
accomplish objectives, the strategies selected must also function effectively.
Transfer pricing can accomplish a variety of strategic objectives. In the past,
transfer pricing was viewed as an accounting technique and not as an active
management strategy. Technicians were also obsessed more with determining
the appropriate transfer pricing method, rather than considering how to use
transfer pricing in a strategy context.
This research points to the reality that an increasing number of executives
recognize the role of transfer pricing as an essential strategy for multinational
firms. Moreover, there is clear evidence that the firms using transfer pricing as
a strategy are encouraged with the results. The study results provide important
insights into how firms approach the issue of transfer pricing. Many of the
MNEs in the sample consider transfer pricing to function as a strategic tool.
The evidence indicates that transfer pricing contributes to overall corporate
performance, as measured by different indicators. MNEs employ transfer
pricing as an active component of strategy. More importantly, transfer pricing
is also viewed as an effective tool rather than merely a necessity. The
conclusion is that transfer pricing should play an active role in business
strategy.

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Received May 1996

Revised August 1996