Directory UMM :Data Elmu:jurnal:A:Accounting, Organizations and Society:Vol25.Issue7.Oct2000:
Accounting, Organizations and Society 25 (2000) 661±682
www.elsevier.com/locate/aos
Complementary arrangements of organizational factors and
outcomes of negotiated transfer price
Dipankar Ghosh
University of Oklahoma, Room 200, 397 W Brooks, Norman, OK, USA
Abstract
Since internal transfers of intermediate products between divisions of ®rms take place under a wide range of organizational factors and their arrangement, understanding transfer pricing involves a consideration of how these factors
are arranged; that is, do they complement or ®t with each other or not. The current research experimentally investigates
the impact of complementarity of sourcing (internal versus external) and compensation structure (based on division or
®rm pro®t) on transfer pricing in the case when such prices are negotiated between the trading divisions. The dependent
variables were perceived fairness of the transfer pricing policy, inter-divisional con¯ict, the economic outcome measure
of ®rm pro®t, and the time taken by the managers to negotiate an agreement (since time is an important economic
resource to the manager) and ®rm pro®t eciency. Overall, the results indicate that whether or not the arrangement of
the organizational factors was complementary had a considerable in¯uence on negotiated transfer prices. Speci®cally,
complementary arrangements signi®cantly increased perception of fairness, and reduced both con¯ict between the
trading divisions and the time taken to reach an agreement. However, the economic outcome of ®rm pro®t was
explained more by the negotiators' competitve behavior which occurs as a consequence of organizational factor
arrangements. # 2000 Published by Elsevier Science Ltd. All rights reserved.
Transfer price is at the heart of inter-pro®t center relations, and it should be eectively managed
to prevent the advantages of a multiple pro®t
center form of organization from being overwhelmed by the problems of inter-pro®t center
relations. The interdependence from sourcing,1 or
1
The term ``sourcing decision'' normally pertains to the
selection of a supplier by a buyer. Here it will also be used to
refer to customer selection by the seller. Incidentally, the extent
of sourcing should be re¯ective of the degree of asset speci®ty
associated with the transfer, a factor which has been found to
in¯uence transfer pricing outcomes (see, for example Spicer,
1988).
the extent to which products move from one division to another, necessitates a transfer price since
pro®t center managers are responsible for both
revenues and costs. Thus, sourcing is a critical
factor to consider in internal transfers (Bower &
Doz, 1979; Colbert & Spicer, 1995). Separately,
researchers contend that the relation between
transfer pricing, performance evaluation and
compensation of the division managers is dicult
to manage (Eccles, 1985) because divisional outcomes, often the basis for evaluating and compensating the manager, is aected by sourcing
(Spicer, 1988; Vancil, 1978). Hence, this research
0361-3682/00/$ - see front matter # 2000 Published by Elsevier Science Ltd. All rights reserved.
PII: S0361-3682(99)00060-4
662
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
examines whether mutual arrangements or complementarity of sourcing (internal versus external)
and compensation structure (based on division or
®rm pro®t) can help manage the transfer pricing
problem when the price is negotiated between the
divisions. As suggested by many researchers, the
results of this paper show that understanding the
transfer pricing problem and managing it eectively involves a consideration of organizational
setting in which the transfers take place (Holmstrom & Tirole, 1991; Spicer; Wagenhofer, 1994).
Negotiation is a very common method to set
transfer prices in US ®rms (Tang, 1992). Organizational settings are particularly important under
the circumstances since they aect managers'
behavior during negotiation (Lax & Sebenius,
1986; Putnam & Wilson,1982) and the subsequent
outcomes (Graham, 1985). Most accounting text
books discuss the transfer pricing problem without
reference to the broader issues of organizational
factors, and, instead focus on presenting alternative methods to set the price (see, e.g. Maher,
1997). Prior research has generally considered
transfer pricing as an isolated contracting problem
without reference to the organizational factors.
Hence, their results are not insightful since they
apply equally to trade between two ®rms as well as
to trade between two units of the same ®rm
(Holmstrom & Tirole, 1991). And, as discussed
later, when prior research did include organizational factors to examine the transfer pricing problem it was done so without considering how or
whether these factors are complementary.
To get dierent organizational settings in this
study, complementarity of the independent variables ± sourcing and compensation structure ± was
manipulated between-subjects (i.e. a 22 research
design). Research on the behavioral outcomes of
transfer pricing emphasizes the importance of
fairness of the transfer pricing policy and interdivisional con¯ict over transfer prices (Eccles,
1985; Grabski, 1985). Thus, fairness and con¯ict
are two of the dependent variables. Another
important criterion for evaluating a company's
transfer pricing policies is whether these policies
positively aect the economic outcome measure of
®rm pro®t (Eccles, 1985); thus, it is a variable in
this study as in many other transfer pricing studies
(e.g. Chalos & Haka, 1990; Ghosh, 1994). The last
variable examined here is the time taken by the
negotiating managers to reach an agreement since
managers' time is a major economic resource
(Hitt, Hoskisson & Ireland, 1990) and empirical
research ®nds that managers expend a considerable amount of time in arriving at a transfer price
(Eccles, 1985).
The results indicate that negotiation of transfer
price bene®ts from the complementary arrangements of sourcing and compensation structure.
Speci®cally, complementarity increased the perception that the negotiated transfer pricing policy
is fair and reduced con¯ict between the trading
divisions. Complementarity also reduced the time
taken by the negotiators to reach an agreement.
This ®nding is consistent with prior research that
noncomplementarity of organizational factors
increases transaction ``cost'' (i.e. managers' time)
of bargaining (Milgrom & Roberts, 1990; Rubenstein, 1982). Separately, prior research has shown
that faster (and more stable) negotiated agreements occur in settings where the outcomes are
considered to be fair by the two parties (Benton &
Druckman, 1973; Pruitt & Syna, 1985). And,
®nally, regarding ®rm pro®t, it was better
explained by the dyadic negotiators' competitive
or cooperative behavior. Speci®cally, ®rm pro®t
was the highest from more competitive behavior,
the least from more cooperative behavior and in
between the two from more collaborative (i.e.
simultaneous competitive and cooperative) behavior. However, as discussed later, these behaviors
occur as a consequence of sourcing and compensation structure arrangements. Overall, the results
of this study con®rm the importance of interdependence from sourcing and compensation
structure as co-variates and that both of these
organizational factors are necessary and their
complementarities are sucient to understand the
outcomes of negotiated transfer prices.
The remainder of the paper is organized as follows. The next section develops the research
hypotheses. Section 3 discusses the research
method. Data analysis is presented in Section 4.
The last section summarizes the results and concludes with a discussion of the implication of the
results and avenues for future research.
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
663
1. Hypothesis Development
1.2. Background Ð transfer pricing
1.1. Background ± complementarity
Despite the abundance of the literature, transfer
pricing remains a contentious problem. The traditional approach to transfer pricing, based on the
unitary view of the ®rm and rooted in neo-classical economics, considers pro®t maximization as
the sole objective of the ®rm. But it was noted long
ago that neo-classical models had little to oer for
addressing the transfer pricing problem and that a
multi-disciplinary organizational approach Ð
behavioral, economic and other approaches Ð
was the course to follow to resolve the problem
(Whinston, 1964). An organization is a coalition
of participants with diverse and often mutually
exclusive interests and objectives both ®nancial
and non-®nancial: thus, the emphasis should be on
pro®t satis®cing (Cyert & March, 1963). In this
context, transfer prices are the outcome of a longrun but not endless negotiation process; hence,
con¯ict and notion of fairness necessarily exists
and how can they be mitigated should be of concern of the transfer pricing policy (Emmanuel &
Messaoud, 1994).
Watson and Baumler (1975) was an early
attempt to address the transfer pricing problem in
an organizational context. They suggested that
negotiated transfer price is an appropriate aid to
integrate pro®t centers to achieve higher ®rm
pro®ts and resolve interdivisional con¯ict. However, they neglected two organizational co-variates
which impact outcomes of negotiated transfer prices ± divisional managers' compensation and
interdependence between the trading divisions
(Ackelsburg & Yukl; 1979; Grabski, 1985).
Recent extensions to the organizational
approach include the works by Eccles (1985) and
Spicer (1988). Both suggest that the transfer pricing policy should take into consideration the
degree of interdependence between the pro®t centers from sourcing. Eccles also emphasize that
close attention be paid to the issue of fairness of
the policy Ð or the interplay between transfer pricing, evaluation and compensation Ð and the consequent transfer pricing con¯ict. He also raises an
important issue which has not been considered in
the transfer pricing literature, namely, the magnitude of time spent by managers in negotiating the
Complementary factors are part of a system of
mutually enhancing elements such that doing
more of any of these factors increases the attractiveness of doing more of the other factors in the
system (Milgrom & Roberts, 1990). Thus, such
factors are always jointly necessary for a comprehensive description and analysis (Bohr, 1958). The
concept of complementarity has widespread
applications. For example, it is pervasive in engineering and economics because it is synonymous
with the notion of system equilibrium; to illustrate, the balance of supply and demand is central
to all economic systems (Ferris & Pang, 1997).
Complementarity is also a central component of
the interpersonal theory of personality and refers
to the extent to which the behavior of one participant elicits speci®c behavior from the other participant (Carson, 1969); thus, friendly behavior
elicits friendly behavior (Tracey, 1994). Research
on the economics of modern management ®nds
that investments in information and production
technologies cannot stimulate productivity and
growth without a number of complementary
developments (Topkis, 1995), such as the introduction of more ¯exible workplaces, the delegation
of more responsibility to labor, and skills enhancement among both managers and their employees
(Harrison, 1996; Helper, 1998). And ®nally,
researchers have shown that complementarity in
organizational design leads to optimization of
®rms' pro®t function (Athey & Stern, 1998).
Complementaries arise naturally in diverse
models of optimal decision-making in a ®rm
(Topkis, 1995). The key to the use and notion of
complementarity is identifying the policies or factors
as complementary precisely when doing more of any
of them increases the attractiveness of doing more of
the others. Milgrom and Roberts (1990) argue that
there are extensive complementarities between the
various functions in ®rms which can reduce their
net transaction costs of internal governance and
bargaining, but only the more pro®t-making ®rms
exploit these complementarities (see Milgrom,
Qian & Roberts, 1991).
664
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
price and the concerns they have about how long
it takes them to reach an agreement.
In general, a large hierarchical organization is
described as a set of systems of simultaneous
competition and cooperation which involve managers with diverse preferences. On the one hand,
managers must cooperate in pursuit of common
organizational goals, yet they have to compete for
limited resources, status and career advancement.
Thus, transfer pricing policies should recognize
the inherent mixed-motive nature of organizations
(Kochan & Verma, 1983). However, although the
organizational approach to negotiated transfer
pricing has identi®ed some of the factors which
aect the outcome of the price (Borkowski, 1990;
Chalos & Haka, 1990; Luft & Libby, 1997), the
literature provides little insight on how to align these
factors in a composite fashion in mixed-motive
organizations. To partly alleviate this problem,
this research investigates whether the concept of
complementarity can provide a framework to help
align these factors and assess an organization's
transfer pricing policy. Sourcing and the compensation structure are the two more important factors
aecting transfer pricing outcomes. Thus, their
complementarity on negotiation outcomes is initially
examined since the basic argument of complementarity when restricted to just two of the
relevant variables provides a useful introduction
to the concept (Milgrom & Roberts, 1995).
Sourcing can be either primarily internal or primarily external. Internal sourcing often vertically
combines technologically distinct production, selling and other economic processes within the ®rm
(Porter, 1980; Spicer, 1988). Thus, it often entails
relatively higher dependency between the trading
divisions. In contrast, external sourcing suggests
each division act autonomously with a strategy
that is independent of other divisions' strategies.
Thus, it often results in relatively lower dependency between trading divisions and each division
enjoys an autonomous status in the organization
(Eccles & White, 1988).
A ®rm's compensation plan signi®cantly in¯uences
the motivation of organizational members (Schwab,
1973) and also stimulates behavior between negotiating divisions by in¯uencing the aspiration
levels of bargainers (Pruitt & Lewis, 1975). A
compensation plan can be structured many ways
(see Milkovich & Wigdor, 1991). One structure is
a combination of base salary and a bonus based
on division pro®t, or ®rm pro®t, or sometimes
both (Gerhart & Milkovich, 1992; Vancil, 1978).
Bonuses are eective motivators because there is a
salient link between performance and ®nancial
rewards (Basu, Lal, Srinivasan & Staelin, 1985).
In general, the compensation structure within a
multidivisional ®rm must complement other organizational factors (e.g. sourcing) in order to realize
the bene®ts associated with that factor (Day, 1984;
Hill & Hoskisson, 1987). Further, compensation
structure entails a con®guration of the basis of
evaluation and decision rights (Jensen & Meckling, 1976; Simons, 1994), the latter in this
research determined by the extent of sourcing.
Prior research cautions that the pricing policy
must ensure that the eects of compensation
structure and sourcing are consistent (Eccles,
1985).2 Hence, one needs to understand the implications of their complementarity on perceptions and
behavior of negotiators determining transfer prices.
1.3. Hypotheses
1.3.1. Fairness of the transfer pricing policy
Research on the behavioral eects of transfer
pricing policies always emphasized the importance
of fairness. Shillinglaw and McGahran (1993), for
example, identi®ed the problem of fairness as one
of the most important criteria in the design of a
transfer pricing system (also see Luft & Libby,
1997). Eccles (1985) states that the problem of
fairness is at the core of managing the transfer
pricing problem.
Judgment of fairness is in¯uenced by the surrounding environment (Leventhal, 1980), such as
policies, and their outcomes (Miceli, 1993; Miceli &
Lane, 1991). Thus, if managers believe that the
transfer pricing policy results in performance measures, compensation and outcomes that are unfair,
then they will perceive the policy to be unfair
2
Jensen and Meckling (1976) argue that organizational
structure has three dimensions Ð performance evaluation,
reward and decision rights Ð and they all have to be considered simutaneously.
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
(Eccles, 1983; Grabski, 1985). In organizations,
fairness is closely bound to power, position (i.e.,
autonomy or independence) and its compensation
system, and organizational design must attempt to
complement them (James, 1993). For example, the
compensation system should be®t the level of independence of the organizational member to ensure
perceptions of fairness of treatment from the organization (James). Complementary organizational
designs not only in¯uence perceptions of fairness,
but absence thereof actually has a direct negative
impact on perceived job fairness (Walker, Gilbert &
Ford, 1977).
Trading divisions with primarily internal sourcing suggest cooperative behavior should occur
among organizational members (Lawrence &
Lorsch, 1967; Ouchi, 1979). Meanwhile, a compensation structure based on the division managers' contributions to ®rm pro®t also encourages
cooperative behavior (Welbourne & GomezMejia, 1991). The nature of both the factors
re¯ects a state of dependency between the trading
division. So, the complement for a division with
primarily internal sourcing is the division manager's compensation based on ®rm performance.
This is fairness based on ``shared fate'' since a
manager's compensation depends on how well the
other managers in the ®rm have fared. In contrast,
trading divisions with primarily external sourcing
usually has an autonomous relation between them
(Spicer, 1988). At the same time, a compensation
structure based on division pro®t induces competitive behavior (Welbourne & Gomez-Mejia). Now
since both factors point to a state of greater independencies for the trading divisions, the complement of divisions with primarily external sourcing
should be to compensate the managers on their
divisions' performance. This is deemed fair when
the performance of the other division or the company as a whole does not aect their compensation when their own division's objectives have
been achieved (Eccles, 1985). Fairness here is
similar to the impartial spectator of the marketplace in Adam's Smith's economic theory,
whereby individuals are compensated based on the
extent to which they achieve their own self-interest. The ®rst hypothesis is now stated based on the
above discussion:
665
H1: A negotiated transfer pricing policy should be
perceived as more fair when the arrangements
of sourcing and compensation structure are
complementary (i.e. they are both dependent
or independent in nature) compared to when the
arrangements of sourcing and compensation are
noncomplementary (i.e. one factor is dependent and the other is independent in nature).
1.3.2. Con¯ict
Prior
research
suggests
that
noncomplementarity among organizational factors is
a direct antecedent of job con¯ict (Churchill, Ford
& Walker, 1990). Con¯ict in an organizational
context is de®ned as ``attitudes toward the other
division's executives which have an adverse eect
on the ongoing relationships between the divisions'' (Ackelsburg & Yukl, 1979, p. 389). It is an
aective state of an individual characterized by
perceived negative consequences (Lambert, 1979;
Smith, Carroll & Ashford, 1995). In organizations,
con¯ict is about power and politics measured by
the degree of divisional autonomy over decisions
or achieving outcomes (March, 1988). This
encompasses control over resources and is referred
to as ``boundary management'' or ``boundary
control'' (Pfeer, 1981) since the quest for autonomy requires control of the division's boundary
transactions. Dependency is a major cause of
con¯ict because one party may feel that its own
goals are being blocked, or interfered with; that is,
control over boundary transactions is curtailed
(Thompson, 1967). Con¯ict is thus inevitable in
organizations with divergence of preferences. For
example, James (1993) points out: (i) positions in
organizations that give their incumbents higher
levels of independence from others but at the same
time make them dependent on others for cooperation promotes infraction; and (ii) since high
dependency necessitates high levels of cooperation, compensation structure based on individual
performance is quite disruptive under the circumstances. That is, noncomplementary organizational arrangements causes con¯ict. As discussed
earlier, the complement of a division with internal
sourcing is the division manager's compensation
based on the performance of the whole company
(i.e. a dependent or cooperative behavior mode),
666
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
while the complement of divisions with external
sourcing is the divisional managers being compensated on the performance of their divisions (i.e.
an independent or competitive behavior mode).
Noncomplementarity sends one expectation through
sourcing and another one through compensation
structure. Inconsistent preference expectations
result in anxiety and frustration, which leads to
con¯ict (Pfeer & Salancik, 1978; Thomas, 1992).
Thus, since internal (external) sourcing and compensation structure based on ®rm pro®t (division
pro®t) complement each other since they are both
dependent (independent) in nature, con¯ict
between trading divisions negotiating the transfer
price should be lesser for these organizational
arrangements. The second hypothesis is:
outcomes. As discussed earlier, complementarity
of internal sourcing and compensation based on
®rm pro®t should result in cooperative behavior
since both the factors are dependent in nature.
Similarly, complementarity of external sourcing
and compensation based on division pro®t should
result in competitive behavior since both the factors have independent characteristics. However, in
case of noncomple-mentarity between sourcing
and compensation structure (i.e. one factor is
dependent while the other is independent in nature), managers may adopt a mixed-motive or collaborative behavior which is a complex
combination of both competitive and cooperative
behavior (Walton & McKersie, 1965). Accordingly, the following hypothesis is stated:
H2: In negotiating transfer prices, a complementary
arrangement of sourcing and compensation
structure (i.e. they are both dependent or independent in nature) should have lesser con¯ict
compared to when there is a noncomplementary arrangement of sourcing and compensation structure (i.e. one factor is dependent
and the other is independent in nature).
H3: Firm pro®t will be the most from competitive
behavior, the least from cooperative behavior,
with ®rm pro®t from collaborative behavior
coming in between the two.
1.3.3. Firm pro®t
This is an important outcome variable of transfer pricing (Ghosh, 1994; Spicer, 1988). The question is what organizational type, competitive or
cooperative, will derive optimal negotiator outcomes? Pruitt (1981) argues that self-interested
behavior often motivates parties to seek integrative
solutions, thereby creating additional value that
might be overlooked in the absence of a struggle
to claim value. Sebenius (1992) states that though
``many people seek common ground and believe
that dierences divide us, it is often the dierences
among negotiators that constitute the raw material for creating value'' (p. 29). In other words, the
aggressive pursuit of con¯icting and independent
goals by two parties lead to constructive outcomes
because competitive bargaining, with the sole
objective to claim value, may signal priorities and
may dislodge bargainers from adopting a rigid posture (Carnevale & Pruitt, 1992; Wilson, 1989). Thus,
prior research seems to suggest that competitive
behavior during negotiation leads to higher overall
1.3.4. Negotiator's time
Time is a scarce, but valuable commodity for
most types of entities, and this construct has been
studied by scholars in number of dierent disciplines. It is regarded as a major economic commodity for managers (Hitt et al., 1990) and
inappropriate usage of time can negatively aect
an organization. For example, when managers
spend too much time on acquisitions, mergers,
spinos, etc., organization performance (i.e.,
pro®t) suers because there is not much time for
other regular activities (Hill, Kelley, Agle, Hitt &
Hoskisson, 1992). To some extent, transactioncost analysis also recognizes the role of time (Williamson, 1975). Thus, some researchers argue that
time represents a ®nite duration available to managers to manage internal and external exchanges
(Lusch, Brown & Brunswick, 1992).
Studies of bargaining recognize the non-negligible costs from continuing to negotiate, primarily
through a longer period of time to arrive at a settlement or sometimes through the exchange of
more proposals (Rapoport, Erev & Zwick, 1995;
Rubenstein, 1982). Anecdotal evidence in Eccles
(1985) suggests that the duration of the transfer
price negotiation process can be signi®cant in
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
®rms and that managers are concerned with the
magnitude of these durations and the factors that
aect it. For example, one divisional general
manager reported spending 50% of his time in his
®rst three months on issues related to transfer
price negotiation (Eccles, 1985, p.167). Another
manager, explaining a recent change in policy
which had reduced the amount of time for haggling over transfer prices, said, ``People recognized
that it was an absolute waste of time for the corporation when people argued about transfer prices. We wanted to get on with running the
business'' (p. 195).
When individuals operate as agents within an
organization, their behavior and decision-making
process are in¯uenced by organizational designs
(Frederick, 1983). As discussed before, complementarity of sourcing and compensation structure would result in consistent expectations whereas
their noncomplementarities would result in inconsistent expectations causing managers to adopt a
mixed-motive bargaining behavior. This would
extend the duration of the bargaining process and
consume more of the managers' time to reach an
agreement (cf. Stonich, 1988; Thomas, 1992). This
suggests the last hypothesis:
H4: In negotiating transfer prices, a complementary
arrangement of sourcing and compensation
structure (i.e. they are both dependent or
independent in nature) should result in lesser
time to come to an agreement compared to
when there is a noncomplementary arrangement of sourcing and compensation structure
(i.e. one factor is dependent and the other is
independent in nature).
2. Research method
2.1. Overview
Each negotiator in a dyad assumed the role of a
division manager in a manufacturing ®rm, either
selling (hereafter referred to as S) electric motors
as a subcomponent (Manager Ð Motors Division)
or buying motors (hereafter referred to as B) as a
subcomponent (Manager Ð Fans Division). Each
667
division manager had private information which
consisted of a pro®t schedule matrix (Table 1A for
S; Table 1B for B). From all the possible combinations in a price-quantity matrix, S and B were
required to negotiate a price/quantity agreement.
In the tables, transfer prices are listed on the left
side and quantities across the top; entries in each
cell represent division pro®t arising only from
internal transfer for all arrangements of sourcing
and compensation structure. Also, the payos
were symmetrical across both S and B.
2.2. Independent variables
2.2.1. Sourcing
Internal sourcing diers from external sourcing
``...primarily in terms of interdependence'' (Smith,
Carroll & Ashford, 1995, p. 10). Thus, the sourcing decision was operationalized in terms of
interdependency between the buying and selling
divisions (Spicer, 1988; Vancil, 1978). However,
empirical evidence of the percent of internal
transfer is sparse. Eccles' (1985) survey found that
internal transfers ranged from 30 to 90% of a
division's input or output. Vancil reports that the
transferred amount varied up to 75% of cost of
goods sold. In the current study, when divisions
use internal sourcing, about 75% of either division's pro®t was impacted by internal transactions;
the remaining 25%, the ®xed pro®t component,
came from external transactions. Under external
sourcing, the percentages were reversed; that is,
only 25% of either division's pro®t was impacted
by internal transactions, whereas 75% of the
pro®t (®xed) came from external transactions.
As stated before, the proportion of divisional
pro®t (internal sourcing: 25%; external sourcing:
75%) from the negotiated transfer pricing was
from Panel A or B of Table 1. The proportion of
the ®xed pro®t amount from external sales was
then added to the pro®t from transfer pricing to
obtain the total divisional pro®t. This ®xed pro®t
amount, which was about 75% of divisional pro®t
for the internal sourcing manipulation and about
25% of divisional pro®t for the external sourcing
manipulation, was determined based on the average pro®t from internal transfers obtained in the
pilot studies.
668
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
Table 1
Pro®t schedule for (A) Motors Division (seller) and (B) Fans Division (buyer) from internal transfera
Quantity
(A)
25
30
35
40
45
50
55
60
Selling price $
5.50
24.00
6.00
34.00
6.50
44.00
7.00
54.00
7.50
64.00
8.00
74.00
8.50
84.00
9.00
94.00
9.50
104.00
30.00
42.50
55.00
67.50
80.00
92.50
105.00
117.50
130.00
36.00
51.00
66.00
81.00
96.00
111.00
126.00
141.00
156.00
43.75
61.25
78.75
96.25
113.75
131.25
148.75
166.25
183.75
50.00
70.00
90.00
110.00
130.00
150.00
170.00
190.00
210.00
56.25
78.75
101.25
123.75
146.25
168.75
191.25
213.75
236.25
55.00
80.00
105.00
130.00
155.00
180.00
205.00
230.00
255.00
60.50
88.00
115.50
143.00
170.50
198.00
225.50
253.00
280.50
66.00
96.00
126.00
156.00
186.00
216.00
246.00
276.00
306.00
(B)
Buying price $
5.50
104.00
6.00
94.00
6.50
84.00
7.00
74.00
7.50
64.00
8.00
54.00
8.50
44.00
9.00
34.00
9.50
24.00
130.00
117.50
105.00
92.50
80.00
67.50
55.00
42.50
30.00
156.00
141.00
126.00
111.00
96.00
81.00
66.00
51.00
36.00
183.75
166.25
148.75
131.25
113.75
96.25
78.75
61.25
43.75
210.00
190.00
170.00
150.00
130.00
110.00
90.00
70.00
50.00
236.25
213.75
191.25
168.75
146.25
123.75
101.25
78.75
56.25
255.00
230.00
205.00
180.00
155.00
130.00
105.00
80.00
55.00
280.50
253.00
225.50
198.00
170.50
143.00
115.50
88.00
60.50
306.00
276.00
246.00
216.00
186.00
156.00
126.00
96.00
66.00
a
20
Entries in each cell represent total divisional pro®t from internal transfer.
2.2.2. Compensation structure
This was de®ned here in terms of the basis of
evaluation Ð division pro®t versus ®rm pro®t
(Jensen & Meckling, 1976). For internal sourcing
where 75% of divisional pro®t was from transfer
pricing, the earnings percentage was three. When
negotiators' compensation was based on division
pro®t, actual earnings for each player in a dyad
was 3% of their division's pro®t, but if it was
based on ®rm pro®t (sum of the two divisional
pro®ts), each player shared 3% of their dyadic or
®rm pro®t. On the other hand, for external sourcing where 25% of divisional pro®t was from
transfer pricing, the earnings percentage was one.
If compensation was based on division pro®t, each
dyadic player received 1% of their division's pro®t
as earnings, but if it was based on ®rm pro®t, each
player shared 1% of their dyadic or ®rm pro®t.
The earnings percentage was adjusted so that, at
the optimum, the compensation paid to subjects in
each of the four cells was identical. Appendix 1
includes part of the instructions to the subjects
explaining their compensation structure.3
The 22 research design for the two independent variables resulted in four cells: (1) internal
sourcing-®rm pro®t; (2) internal sourcing-division
pro®t; (3) external sourcing-®rm pro®t; and (4)
external sourcing-division pro®t. As stated earlier,
the arrangements of sourcing and compensation
structure are complementary in cells #1 (both factors are dependent in nature or `DD') and #4 (both
factors are independent in nature or `II'). In the other
two cells, the arrangements are noncomplementary:
3
For brevity sake, only instructions to subjects role-playing
as sellers are included in the Appendix.
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
sourcing is `dependent' and compensation structure
is `independent' in cell #2 (or `DI'), while sourcing
is `independent' and compensation structure is
`dependent' in cell #3 (or `ID').
2.3. Dependent variables
2.3.1. Fairness
In general, fairness is aected by both perceptions about outcomes and perceptions about the
process or policies which aect the outcomes
(Miceli, 1993). These two aspects seem to parallel
the notion of fairness about transfer pricing policy
(Eccles, 1985; Vancil, 1978), namely, (i) the fairness of the transfer price per se, and (ii) how that
pricing policy impacts the divisional manager's
compensation structure. Therefore, the following
two questions were posed to the subjects:
1. Do you think that the agreed upon transfer
prices and quantities are apt to bene®t only one
division and not the other division in the ®rm?
2. To what extent did you feel that the basis for
your performance evaluation, on which your
monetary compensation was based, was fair to
you?
Reverse coding of question one was appropriately handled in the computation of the fairness
score. The total score from the two questions was
used as a measure of perceived fairness for each
dyadic subject, with a higher score indicating
greater perceived fairness.
2.3.2. Con¯ict
This was measured in two ways: (i) The ®rst
used the Rahim Organizational Con¯ict Inventory
#1 (ROCI-1), designed to measure the self-report
of con¯icts arising from dyadic interaction. The
instrument has six questions framed to assess a
669
subject's perceptions of his or her relationship
with the other subject in the dyad. The instrument
uses a ®ve-point Likert scale to measure the level
of con¯ict. The minimum score on a question is 1,
and the maximum is 5; so the total score from the
instrument can range from a minimum of 6 to a
maximum of 30. A higher score represents a
higher perception of individual con¯ict in a dyad
(Rahim, 1983). In this experiment, the instrument's Cronbach is 0.79 compared to 0.81
reported by Rahim. Interdivisional con¯ict was
measured by summing the responses to the six
questions for each negotiator in a dyad. However,
asking about perceived con¯ict may not be the
same as observing outcome behavior of con¯ict.
(ii) The second measure of con¯ict is a more direct
measure, namely, the absolute values of the difference between divisional pro®ts (Ghosh, 1994;
Lax & Sebenius, 1986). Since negotiators have a
general aversion to unequal outcomes (Luft &
Libby, 1997; Thomas,1992), a 50/50 split of the
total pro®t from intra-®rm negotiation indicates
compromise and reconciliation of both parties'
interests (Pruitt, 1983). Thus, it is logical to
assume that a greater dierence in divisional
pro®ts is associated with higher dyadic con¯ict.
2.3.3. Firm pro®t
This was the sum of the divisional pro®ts from
transfer pricing only for each of the three periods
that the prices were negotiate.
2.3.4. Negotiator's time
This was the time taken in minutes to come to
an agreement by the two negotiators in each of the
three periods.
2.4. Experimental procedure
A total of 104 undergraduate business students
enrolled in an upper-division accounting class
served as subjects. All of them participated in the
study simultaneously. They formed 52 negotiating
dyads and were equally distributed among the
four cells. The dyadic subjects interacted with each
other anonymously through a computer network.
The main experiment consisted of each dyad engaging in three distinct negotiations, each of 10-minute
670
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
periods.4 All relevant information was automatically recorded throughout the experiment.
Subjects received continuous feedback on the time
remaining during each period and the negotiation
was terminated if the subjects were unable to come
to an agreement within the allotted time of 10
minutes. To avoid opportunistic behavior in the
last period, the subjects were not told the number
of periods. In each period, the negotiation process
consisted of oers and counter-oers that terminated either as an agreement if an oer was
accepted or as a disagreement if no oer was
accepted within 10 minutes. The opening oer in
each period alternated between buyer and seller to
avoid giving a ®rst-oer advantage. When a
transaction took place, the computer informed
each subject of their pro®t for that period and
their compensation. At the end of each period, the
computer also indicated the total cumulative
compensation earned. A prompt then indicated
the start of the next period.
The experiment had three stages and lasted
about 2 hours. In the ®rst stage, the subjects read
the instructions and then participated in a twoperiod practice game designed to verify their
understanding of the trading procedures and the
available information. However, the subjects did
not receive any compensation. The second stage
was the main experiment; it had three periods and
the subjects received compensation. In the third
stage, the subjects were administered a two-part
debrie®ng questionnaire. In part one, the ROCI-1
instrument was administered to each dyadic subject to measure con¯ict attitudes toward his or her
dyadic negotiation partner. Also, the subjects were
asked how they perceived certain aspects of the
project. Part two collected information about each
subject's background.
4
Pilot studies indicated that 10 minutes was sucient duration for subjects in a dyad to reach an agreement. Also, the
negotiated outcomes at the end of the fourth period were very
similar to the outcomes after three periods. Therefore, to keep
the duration of the total experiment within the available time of
120 minutes, the negotiation process was iterated over three
periods.
3. Results
3.1. Post-experiment questionnaire and descriptive
statistics
The subjects were randomly assigned to one of the
four cells arising from the treatment manipulation
of sourcing and compensation structure, and
within each cell, as either a buyer or a seller.
Analyses of each subject's division pro®t, con¯ict
(ROCI-1) and fairness scores indicated that they were
not aected by any of the following non-theoretical
variables: buyer and seller classi®cation, gender,
graduating major, semester standing, work
experience, computer knowledge, or transfer pricing knowledge. Hence, for hypotheses testing, the
buyer and seller classi®cation was collapsed across
subjects. Table 2 shows the descriptive statistics
for all the dependent variables by treatment,
sourcing and compensation structure. As discussed earlier (Section 2.3.1), their arrangements
resulted in two complementary cells (`DD' and
`II') and two noncomplementary cells (`DI' and
`ID').
Subjects' perceptions of competitive/cooperative
behavior during negotiation were also evaluated
via a rating scale in the debrie®ng questionnaire
with higher scores indicating more competitive
behavior. The subjects were asked (Note: scale
reversed for half the subjects): Your partner's
behavior was more cooperative or more competitive during the negotiation process?
The scale was scored as `1' for cooperative and
`10' for competitive. Subjects in cell ``DD'' indicated a score of 3.27, while those in cell ``II'' had a
score of 7.64. Subjects in cells ``DI'' and ``ID'' had
scores of 5.31 and 5.38, respectively. Schee's test
shows that all the scores were signi®cantly dierent from each other (at P=0.0001) except those
from cells ``DI'' and ``ID.''
Other information also suggests that negotiators'
behavior in the complementary and noncomplementary cells were very dierent (see ``Miscellaneous,'' Table 2). For example, the dierence
671
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
Table 2
Descriptive statistics
Compensation structure
Sourcing
Compensation based on ®rm pro®t
Compensation based on division pro®t
Internal
Cell#1 (13 dyads/26 subjects) or ``DD''
Cell#2 (13 dyads/26 subjects) or ``DI''
Dependent variables
Fairness
Con¯ict
ROC-1
Div.pro®t di.
Firm pro®t ($)
Time (min)
Mean
Dependent variable
16.36
1.55
15.46
6.18
316.22
8.04
2.12
4.94
15.11
0.27
Miscellaneous (averages)
Possible pro®t-opening oer
Individual negotiator pro®t
Dierence
S.D. of pro®t from oers and counter-oers
# of rounds for agreement
External
S.D.
$162.67
158.11
$4.56
5.56
4.48
Cell#3 (13 dyads/26 subjects) or ``ID''
Dependent variables
Fairness
Con¯ict
ROC-1
Div. pro®t di.
Firm pro®t ($)
Time (min)
Mean
12.83
18.69
10.75
330.73
9.30
Miscellaneous (averages)
Possible pro®t-opening oer
Individual negotiator pro®t
Dierence
S.D. of pro®t from oers and counter-oers
# of rounds for agreement
between possible pro®ts from the opening oer
and the actual pro®ts from the ®nal agreement
were much greater in cells ``DI'' ($14.71) and
``ID'' ($13.52) than in cells ``DD'' ($4.56) and ``II''
($7.03); thus, in the noncomplementary cells the
slope of convergence was steeper. Also, ¯uctuations in the oers and counteroers in the noncomplementary cells were, more as evidenced by
the higher standard deviations of possible pro®ts
from oers and counteroers in these cells, and the
cell negotiators took more rounds (note: a round is
Fairness
Con¯ict
OC-1
Div. pro®t di.
Firm pro®t ($)
Time (min)
Mean
S.D.
13.46
1.44
18.73
10.95
324.03
9.24
2.24
5.92
8.14
0.08
Miscellaneous (averages)
Possible pro®t-opening oer
Individual negotiator pro®t
Dierence
S.D. of pro®t from oers and counter-oers
# of rounds for agreement
$176.72
162.01
$14.71
9.14
5.38
Cell #4 (13 dyads/26 subjects) or ``II''
S.D.
Dependent variables
1.19
Fairness
2.38
4.54
5.58
0.07
Con¯ict
ROC-1
Div. pro®t di.
Firm pro®t ($)
Time (min)
$178.89
165.37
$13.52
8.86
5.44
Mean
S.D.
16.17
1.43
14.69
5.98
344.31
8.50
1.57
3.45
6.36
0.11
Miscellaneous (averages)
Possible pro®t-opening oer
Individual negotiator pro®t
Dierence
S.D. of pro®t from oers and counter-oers
# of rounds for agreement
$179.19
172.16
$7.03
5.75
5.01
an oer and the counteroer or agreement) to
agree to a transfer price. Finally, ®rm pro®ts from
transfer pricing for negotiation periods one and
three were separately compared. In the ``DD'' (``II'')
cell, ®rm pro®t increased from $305.08 ($333.17) in
period one to $326.41 ($355.93) in period three, or
an improvement of 6.99% (6.83%). In contrast,
during the same period, cell ``DI'' ®rm pro®t
increased only from $324.43 to $325.23 (i.e. by
0.2%) while cell ``ID'' ®rm pro®t decreased marginally from $331.80 to $330.14 (i.e. by 0.5%).
672
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
3.2. Test of hypotheses
3.2.1. Fairness of transfer pricing policy
Hypothesis H1 predicted that a negotiated
transfer pricing policy should be perceived as
more fair when there is a complementary arrangement of sourcing and compensation structure
compared to when their arrangements are noncomplementary. The dependent variable was the
perceived fairness score collected from individual
negotiators in a dyad with higher scores indicating
greater perceived fairness. An ANOVA procedure
was used for the statistical analysis of H1. The
arrangements of independent variables had two
levels ± complementary and noncomplementary.
The analysis indicates (refer to part A of Table 3)
that the ANOVA model is signi®cant (F=126.71;
P=0.0001). To get an insight of this result, the
means of perceived fairness under all the dierent
arrangements of sourcing and compensation
structure were compared. The results (refer to part
B of Table 3) show that subjects perceived the
pricing policy to be signi®cantly more fair (at
P=0.01) in the case of complementary arrangements (i.e. cells `DD' and `II') than in the case of
noncomplementary arrangements (i.e. `DI' and
`ID'). Further, perceived fairness from the complementary cells (i.e. cells`DD' and `II') was not
signi®cantly dierent from each other. Similarly,
the fairness scores from the noncomplementary
cells (i.e. cells `DI' and `ID') were also not signi®cantly dierent from each other. In summary,
the results support hypothesis H1.
3.2.2. Con¯ict
Hypothesis H2 states that during negotiation of
transfer prices, a complementary arrangement (of
sourcing and compensation structure) should have
lesser con¯ict compared to when there is a noncomplementary arrangement. As stated earlier,
con¯ict was measured in two dierent ways; thus,
separate ANOVA analyses were done for the two
con¯ict measures. The independent variables had
two levels, as described earlier.
Table 3
Complementary arrangements of organizational factors aecting negotiated transfer prices and its impact on perceived fairness of the
transfer pricing policy (for H1)
A. Analysis of variance (n=104 subjects)
Source
df
SS (111)
Mean2
F value
P value
R2
Model
1
253.906
253.906
126.71
0.0001
0.55
B. Comparisons of cell means Ð Schee's test (n=26 subjects per cell)
Cells compareda
DD and DI
ID and II
DD and ID
DI and II
DD and II
DI and ID
Means of cells compared
Cell
Mean
Cell
Mean
Absolute dierence
between means
DD
ID
DD
DI
DD
DI
16.36
12.83
16.36
13.46
16.36
13.46
DI
II
ID
II
II
ID
13.46
16.17
12.83
16.17
16.17
12.83
2.90*b
3.34
3.53
2.71
0.19
0.63
a
Variable de®nitions are as follows: DD=Complementary arrangement of sourcing and compensation when both factors are
dependent on nature. DI=Noncomplementary arrangement of a dependent (sourcing) and an independent (compensation) factor.
ID=Noncomplementary arrangement of a dependent (compensation) and an independent (sourcing) factor. II=Complementary
arrangement of sourcing and compensation when both factors are independent in nature.
b
*Signi®cant at 0.01.
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
3.2.2.1. ROCI-1. The dependent variable was the
sum of the con¯ict scores for each negotiator in a
dyad with higher scores indicating greater con¯ict.
The analysis indicates (refer to part A of Table 4)
that the ANOVA model is signi®cant (F=78.14;
P=0.0001). Comparisons of the cell means of
con¯ict (refer to part B of Table 4) show that it
was signi®cantly less in the case of complementary
arrangements (i.e. cells `DD' and `II') compared
to noncomplementary arrangements (i.e. cells
`DI' and `ID'). Further, con¯ict scores in the two
complementary cells were not signi®cantly dierent from each other, as were the con¯ict scores
from the noncomplementary cells.
3.2.2.2. Divisional profit difference. A higher score
on this dependent variable, measured for each
dyad, would suggest higher con¯ict. The analysis
was a repeated measures ANOVA where Period
was used as a repeated-measures factor with three
levels, one each for the periods the transfer price
was negotiated. The results in Table 5 (Parts A
and B) indicate that con¯ict between the trading
divisions was lower from complementary organizational arrangements took. These results, there-
673
fore, parallel those from the con¯ict responses
using ROCI-1. In conclusion, the above results
provide evidence in support of hypothesis H2.
3.2.3. Firm pro®t
Hypothesis 3 predicted that ®rm pro®t will be
the most from competitive behavior (or cell `II'),
the least from cooperative behavior (or cell `DD'),
with ®rm pro®t from collaborative behavior (or
cells `DI' and `ID'), coming in between the two.
Analysis in the ``Post-experimental Questionnaire'' section (p. 20) showed that negotiator
behavior was more competitive in cell `II', more
cooperative in cell `DD', and between competitive
and cooperative in cells `DI' and `ID'. Thus, the
independent variable for this analysis was a ``cell''
with four levels. The dependent variable was the
sum of the two divisions' pro®ts from negotiated
transfer prices only (i.e. a dyadic measure). The
analysis was a repeated-measures ANOVA with
Period as the repeated-measures variable with
three levels. The results (refer to part A of Table 6)
indicate the ANOVA model is signi®cant
(F=20.13; P=0.0001). Comparison of cell means
(refer to part B of Table 6) show that ®rm pro®t
Table 4
Complementary arrangements of organizational factors aecting negotiated transfer prices and its impact on con¯ict measured using
ROCI-1 (for H2)a
A. Analysis of variance (n=104 subjects)
Source
df
SS(111)
Mean2
F value
P value
R2
Model
3
343.471
343.471
78.14
0.0001
0.43
B. Comparisons of cell means Ð Schee's test (n=26 subjects in each cell)
Cells compared
DD and DI
ID and II
DD and ID
DI and II
DD and II
DI and ID
Means of cells compared
Cell
Mean
Cell
Mean
Absolute dierence
between means
DD
ID
DD
DI
DD
DI
15.46
18.69
15.46
18.73
15.46
18.73
DI
II
ID
II
II
ID
18.73
www.elsevier.com/locate/aos
Complementary arrangements of organizational factors and
outcomes of negotiated transfer price
Dipankar Ghosh
University of Oklahoma, Room 200, 397 W Brooks, Norman, OK, USA
Abstract
Since internal transfers of intermediate products between divisions of ®rms take place under a wide range of organizational factors and their arrangement, understanding transfer pricing involves a consideration of how these factors
are arranged; that is, do they complement or ®t with each other or not. The current research experimentally investigates
the impact of complementarity of sourcing (internal versus external) and compensation structure (based on division or
®rm pro®t) on transfer pricing in the case when such prices are negotiated between the trading divisions. The dependent
variables were perceived fairness of the transfer pricing policy, inter-divisional con¯ict, the economic outcome measure
of ®rm pro®t, and the time taken by the managers to negotiate an agreement (since time is an important economic
resource to the manager) and ®rm pro®t eciency. Overall, the results indicate that whether or not the arrangement of
the organizational factors was complementary had a considerable in¯uence on negotiated transfer prices. Speci®cally,
complementary arrangements signi®cantly increased perception of fairness, and reduced both con¯ict between the
trading divisions and the time taken to reach an agreement. However, the economic outcome of ®rm pro®t was
explained more by the negotiators' competitve behavior which occurs as a consequence of organizational factor
arrangements. # 2000 Published by Elsevier Science Ltd. All rights reserved.
Transfer price is at the heart of inter-pro®t center relations, and it should be eectively managed
to prevent the advantages of a multiple pro®t
center form of organization from being overwhelmed by the problems of inter-pro®t center
relations. The interdependence from sourcing,1 or
1
The term ``sourcing decision'' normally pertains to the
selection of a supplier by a buyer. Here it will also be used to
refer to customer selection by the seller. Incidentally, the extent
of sourcing should be re¯ective of the degree of asset speci®ty
associated with the transfer, a factor which has been found to
in¯uence transfer pricing outcomes (see, for example Spicer,
1988).
the extent to which products move from one division to another, necessitates a transfer price since
pro®t center managers are responsible for both
revenues and costs. Thus, sourcing is a critical
factor to consider in internal transfers (Bower &
Doz, 1979; Colbert & Spicer, 1995). Separately,
researchers contend that the relation between
transfer pricing, performance evaluation and
compensation of the division managers is dicult
to manage (Eccles, 1985) because divisional outcomes, often the basis for evaluating and compensating the manager, is aected by sourcing
(Spicer, 1988; Vancil, 1978). Hence, this research
0361-3682/00/$ - see front matter # 2000 Published by Elsevier Science Ltd. All rights reserved.
PII: S0361-3682(99)00060-4
662
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
examines whether mutual arrangements or complementarity of sourcing (internal versus external)
and compensation structure (based on division or
®rm pro®t) can help manage the transfer pricing
problem when the price is negotiated between the
divisions. As suggested by many researchers, the
results of this paper show that understanding the
transfer pricing problem and managing it eectively involves a consideration of organizational
setting in which the transfers take place (Holmstrom & Tirole, 1991; Spicer; Wagenhofer, 1994).
Negotiation is a very common method to set
transfer prices in US ®rms (Tang, 1992). Organizational settings are particularly important under
the circumstances since they aect managers'
behavior during negotiation (Lax & Sebenius,
1986; Putnam & Wilson,1982) and the subsequent
outcomes (Graham, 1985). Most accounting text
books discuss the transfer pricing problem without
reference to the broader issues of organizational
factors, and, instead focus on presenting alternative methods to set the price (see, e.g. Maher,
1997). Prior research has generally considered
transfer pricing as an isolated contracting problem
without reference to the organizational factors.
Hence, their results are not insightful since they
apply equally to trade between two ®rms as well as
to trade between two units of the same ®rm
(Holmstrom & Tirole, 1991). And, as discussed
later, when prior research did include organizational factors to examine the transfer pricing problem it was done so without considering how or
whether these factors are complementary.
To get dierent organizational settings in this
study, complementarity of the independent variables ± sourcing and compensation structure ± was
manipulated between-subjects (i.e. a 22 research
design). Research on the behavioral outcomes of
transfer pricing emphasizes the importance of
fairness of the transfer pricing policy and interdivisional con¯ict over transfer prices (Eccles,
1985; Grabski, 1985). Thus, fairness and con¯ict
are two of the dependent variables. Another
important criterion for evaluating a company's
transfer pricing policies is whether these policies
positively aect the economic outcome measure of
®rm pro®t (Eccles, 1985); thus, it is a variable in
this study as in many other transfer pricing studies
(e.g. Chalos & Haka, 1990; Ghosh, 1994). The last
variable examined here is the time taken by the
negotiating managers to reach an agreement since
managers' time is a major economic resource
(Hitt, Hoskisson & Ireland, 1990) and empirical
research ®nds that managers expend a considerable amount of time in arriving at a transfer price
(Eccles, 1985).
The results indicate that negotiation of transfer
price bene®ts from the complementary arrangements of sourcing and compensation structure.
Speci®cally, complementarity increased the perception that the negotiated transfer pricing policy
is fair and reduced con¯ict between the trading
divisions. Complementarity also reduced the time
taken by the negotiators to reach an agreement.
This ®nding is consistent with prior research that
noncomplementarity of organizational factors
increases transaction ``cost'' (i.e. managers' time)
of bargaining (Milgrom & Roberts, 1990; Rubenstein, 1982). Separately, prior research has shown
that faster (and more stable) negotiated agreements occur in settings where the outcomes are
considered to be fair by the two parties (Benton &
Druckman, 1973; Pruitt & Syna, 1985). And,
®nally, regarding ®rm pro®t, it was better
explained by the dyadic negotiators' competitive
or cooperative behavior. Speci®cally, ®rm pro®t
was the highest from more competitive behavior,
the least from more cooperative behavior and in
between the two from more collaborative (i.e.
simultaneous competitive and cooperative) behavior. However, as discussed later, these behaviors
occur as a consequence of sourcing and compensation structure arrangements. Overall, the results
of this study con®rm the importance of interdependence from sourcing and compensation
structure as co-variates and that both of these
organizational factors are necessary and their
complementarities are sucient to understand the
outcomes of negotiated transfer prices.
The remainder of the paper is organized as follows. The next section develops the research
hypotheses. Section 3 discusses the research
method. Data analysis is presented in Section 4.
The last section summarizes the results and concludes with a discussion of the implication of the
results and avenues for future research.
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
663
1. Hypothesis Development
1.2. Background Ð transfer pricing
1.1. Background ± complementarity
Despite the abundance of the literature, transfer
pricing remains a contentious problem. The traditional approach to transfer pricing, based on the
unitary view of the ®rm and rooted in neo-classical economics, considers pro®t maximization as
the sole objective of the ®rm. But it was noted long
ago that neo-classical models had little to oer for
addressing the transfer pricing problem and that a
multi-disciplinary organizational approach Ð
behavioral, economic and other approaches Ð
was the course to follow to resolve the problem
(Whinston, 1964). An organization is a coalition
of participants with diverse and often mutually
exclusive interests and objectives both ®nancial
and non-®nancial: thus, the emphasis should be on
pro®t satis®cing (Cyert & March, 1963). In this
context, transfer prices are the outcome of a longrun but not endless negotiation process; hence,
con¯ict and notion of fairness necessarily exists
and how can they be mitigated should be of concern of the transfer pricing policy (Emmanuel &
Messaoud, 1994).
Watson and Baumler (1975) was an early
attempt to address the transfer pricing problem in
an organizational context. They suggested that
negotiated transfer price is an appropriate aid to
integrate pro®t centers to achieve higher ®rm
pro®ts and resolve interdivisional con¯ict. However, they neglected two organizational co-variates
which impact outcomes of negotiated transfer prices ± divisional managers' compensation and
interdependence between the trading divisions
(Ackelsburg & Yukl; 1979; Grabski, 1985).
Recent extensions to the organizational
approach include the works by Eccles (1985) and
Spicer (1988). Both suggest that the transfer pricing policy should take into consideration the
degree of interdependence between the pro®t centers from sourcing. Eccles also emphasize that
close attention be paid to the issue of fairness of
the policy Ð or the interplay between transfer pricing, evaluation and compensation Ð and the consequent transfer pricing con¯ict. He also raises an
important issue which has not been considered in
the transfer pricing literature, namely, the magnitude of time spent by managers in negotiating the
Complementary factors are part of a system of
mutually enhancing elements such that doing
more of any of these factors increases the attractiveness of doing more of the other factors in the
system (Milgrom & Roberts, 1990). Thus, such
factors are always jointly necessary for a comprehensive description and analysis (Bohr, 1958). The
concept of complementarity has widespread
applications. For example, it is pervasive in engineering and economics because it is synonymous
with the notion of system equilibrium; to illustrate, the balance of supply and demand is central
to all economic systems (Ferris & Pang, 1997).
Complementarity is also a central component of
the interpersonal theory of personality and refers
to the extent to which the behavior of one participant elicits speci®c behavior from the other participant (Carson, 1969); thus, friendly behavior
elicits friendly behavior (Tracey, 1994). Research
on the economics of modern management ®nds
that investments in information and production
technologies cannot stimulate productivity and
growth without a number of complementary
developments (Topkis, 1995), such as the introduction of more ¯exible workplaces, the delegation
of more responsibility to labor, and skills enhancement among both managers and their employees
(Harrison, 1996; Helper, 1998). And ®nally,
researchers have shown that complementarity in
organizational design leads to optimization of
®rms' pro®t function (Athey & Stern, 1998).
Complementaries arise naturally in diverse
models of optimal decision-making in a ®rm
(Topkis, 1995). The key to the use and notion of
complementarity is identifying the policies or factors
as complementary precisely when doing more of any
of them increases the attractiveness of doing more of
the others. Milgrom and Roberts (1990) argue that
there are extensive complementarities between the
various functions in ®rms which can reduce their
net transaction costs of internal governance and
bargaining, but only the more pro®t-making ®rms
exploit these complementarities (see Milgrom,
Qian & Roberts, 1991).
664
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
price and the concerns they have about how long
it takes them to reach an agreement.
In general, a large hierarchical organization is
described as a set of systems of simultaneous
competition and cooperation which involve managers with diverse preferences. On the one hand,
managers must cooperate in pursuit of common
organizational goals, yet they have to compete for
limited resources, status and career advancement.
Thus, transfer pricing policies should recognize
the inherent mixed-motive nature of organizations
(Kochan & Verma, 1983). However, although the
organizational approach to negotiated transfer
pricing has identi®ed some of the factors which
aect the outcome of the price (Borkowski, 1990;
Chalos & Haka, 1990; Luft & Libby, 1997), the
literature provides little insight on how to align these
factors in a composite fashion in mixed-motive
organizations. To partly alleviate this problem,
this research investigates whether the concept of
complementarity can provide a framework to help
align these factors and assess an organization's
transfer pricing policy. Sourcing and the compensation structure are the two more important factors
aecting transfer pricing outcomes. Thus, their
complementarity on negotiation outcomes is initially
examined since the basic argument of complementarity when restricted to just two of the
relevant variables provides a useful introduction
to the concept (Milgrom & Roberts, 1995).
Sourcing can be either primarily internal or primarily external. Internal sourcing often vertically
combines technologically distinct production, selling and other economic processes within the ®rm
(Porter, 1980; Spicer, 1988). Thus, it often entails
relatively higher dependency between the trading
divisions. In contrast, external sourcing suggests
each division act autonomously with a strategy
that is independent of other divisions' strategies.
Thus, it often results in relatively lower dependency between trading divisions and each division
enjoys an autonomous status in the organization
(Eccles & White, 1988).
A ®rm's compensation plan signi®cantly in¯uences
the motivation of organizational members (Schwab,
1973) and also stimulates behavior between negotiating divisions by in¯uencing the aspiration
levels of bargainers (Pruitt & Lewis, 1975). A
compensation plan can be structured many ways
(see Milkovich & Wigdor, 1991). One structure is
a combination of base salary and a bonus based
on division pro®t, or ®rm pro®t, or sometimes
both (Gerhart & Milkovich, 1992; Vancil, 1978).
Bonuses are eective motivators because there is a
salient link between performance and ®nancial
rewards (Basu, Lal, Srinivasan & Staelin, 1985).
In general, the compensation structure within a
multidivisional ®rm must complement other organizational factors (e.g. sourcing) in order to realize
the bene®ts associated with that factor (Day, 1984;
Hill & Hoskisson, 1987). Further, compensation
structure entails a con®guration of the basis of
evaluation and decision rights (Jensen & Meckling, 1976; Simons, 1994), the latter in this
research determined by the extent of sourcing.
Prior research cautions that the pricing policy
must ensure that the eects of compensation
structure and sourcing are consistent (Eccles,
1985).2 Hence, one needs to understand the implications of their complementarity on perceptions and
behavior of negotiators determining transfer prices.
1.3. Hypotheses
1.3.1. Fairness of the transfer pricing policy
Research on the behavioral eects of transfer
pricing policies always emphasized the importance
of fairness. Shillinglaw and McGahran (1993), for
example, identi®ed the problem of fairness as one
of the most important criteria in the design of a
transfer pricing system (also see Luft & Libby,
1997). Eccles (1985) states that the problem of
fairness is at the core of managing the transfer
pricing problem.
Judgment of fairness is in¯uenced by the surrounding environment (Leventhal, 1980), such as
policies, and their outcomes (Miceli, 1993; Miceli &
Lane, 1991). Thus, if managers believe that the
transfer pricing policy results in performance measures, compensation and outcomes that are unfair,
then they will perceive the policy to be unfair
2
Jensen and Meckling (1976) argue that organizational
structure has three dimensions Ð performance evaluation,
reward and decision rights Ð and they all have to be considered simutaneously.
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
(Eccles, 1983; Grabski, 1985). In organizations,
fairness is closely bound to power, position (i.e.,
autonomy or independence) and its compensation
system, and organizational design must attempt to
complement them (James, 1993). For example, the
compensation system should be®t the level of independence of the organizational member to ensure
perceptions of fairness of treatment from the organization (James). Complementary organizational
designs not only in¯uence perceptions of fairness,
but absence thereof actually has a direct negative
impact on perceived job fairness (Walker, Gilbert &
Ford, 1977).
Trading divisions with primarily internal sourcing suggest cooperative behavior should occur
among organizational members (Lawrence &
Lorsch, 1967; Ouchi, 1979). Meanwhile, a compensation structure based on the division managers' contributions to ®rm pro®t also encourages
cooperative behavior (Welbourne & GomezMejia, 1991). The nature of both the factors
re¯ects a state of dependency between the trading
division. So, the complement for a division with
primarily internal sourcing is the division manager's compensation based on ®rm performance.
This is fairness based on ``shared fate'' since a
manager's compensation depends on how well the
other managers in the ®rm have fared. In contrast,
trading divisions with primarily external sourcing
usually has an autonomous relation between them
(Spicer, 1988). At the same time, a compensation
structure based on division pro®t induces competitive behavior (Welbourne & Gomez-Mejia). Now
since both factors point to a state of greater independencies for the trading divisions, the complement of divisions with primarily external sourcing
should be to compensate the managers on their
divisions' performance. This is deemed fair when
the performance of the other division or the company as a whole does not aect their compensation when their own division's objectives have
been achieved (Eccles, 1985). Fairness here is
similar to the impartial spectator of the marketplace in Adam's Smith's economic theory,
whereby individuals are compensated based on the
extent to which they achieve their own self-interest. The ®rst hypothesis is now stated based on the
above discussion:
665
H1: A negotiated transfer pricing policy should be
perceived as more fair when the arrangements
of sourcing and compensation structure are
complementary (i.e. they are both dependent
or independent in nature) compared to when the
arrangements of sourcing and compensation are
noncomplementary (i.e. one factor is dependent and the other is independent in nature).
1.3.2. Con¯ict
Prior
research
suggests
that
noncomplementarity among organizational factors is
a direct antecedent of job con¯ict (Churchill, Ford
& Walker, 1990). Con¯ict in an organizational
context is de®ned as ``attitudes toward the other
division's executives which have an adverse eect
on the ongoing relationships between the divisions'' (Ackelsburg & Yukl, 1979, p. 389). It is an
aective state of an individual characterized by
perceived negative consequences (Lambert, 1979;
Smith, Carroll & Ashford, 1995). In organizations,
con¯ict is about power and politics measured by
the degree of divisional autonomy over decisions
or achieving outcomes (March, 1988). This
encompasses control over resources and is referred
to as ``boundary management'' or ``boundary
control'' (Pfeer, 1981) since the quest for autonomy requires control of the division's boundary
transactions. Dependency is a major cause of
con¯ict because one party may feel that its own
goals are being blocked, or interfered with; that is,
control over boundary transactions is curtailed
(Thompson, 1967). Con¯ict is thus inevitable in
organizations with divergence of preferences. For
example, James (1993) points out: (i) positions in
organizations that give their incumbents higher
levels of independence from others but at the same
time make them dependent on others for cooperation promotes infraction; and (ii) since high
dependency necessitates high levels of cooperation, compensation structure based on individual
performance is quite disruptive under the circumstances. That is, noncomplementary organizational arrangements causes con¯ict. As discussed
earlier, the complement of a division with internal
sourcing is the division manager's compensation
based on the performance of the whole company
(i.e. a dependent or cooperative behavior mode),
666
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
while the complement of divisions with external
sourcing is the divisional managers being compensated on the performance of their divisions (i.e.
an independent or competitive behavior mode).
Noncomplementarity sends one expectation through
sourcing and another one through compensation
structure. Inconsistent preference expectations
result in anxiety and frustration, which leads to
con¯ict (Pfeer & Salancik, 1978; Thomas, 1992).
Thus, since internal (external) sourcing and compensation structure based on ®rm pro®t (division
pro®t) complement each other since they are both
dependent (independent) in nature, con¯ict
between trading divisions negotiating the transfer
price should be lesser for these organizational
arrangements. The second hypothesis is:
outcomes. As discussed earlier, complementarity
of internal sourcing and compensation based on
®rm pro®t should result in cooperative behavior
since both the factors are dependent in nature.
Similarly, complementarity of external sourcing
and compensation based on division pro®t should
result in competitive behavior since both the factors have independent characteristics. However, in
case of noncomple-mentarity between sourcing
and compensation structure (i.e. one factor is
dependent while the other is independent in nature), managers may adopt a mixed-motive or collaborative behavior which is a complex
combination of both competitive and cooperative
behavior (Walton & McKersie, 1965). Accordingly, the following hypothesis is stated:
H2: In negotiating transfer prices, a complementary
arrangement of sourcing and compensation
structure (i.e. they are both dependent or independent in nature) should have lesser con¯ict
compared to when there is a noncomplementary arrangement of sourcing and compensation structure (i.e. one factor is dependent
and the other is independent in nature).
H3: Firm pro®t will be the most from competitive
behavior, the least from cooperative behavior,
with ®rm pro®t from collaborative behavior
coming in between the two.
1.3.3. Firm pro®t
This is an important outcome variable of transfer pricing (Ghosh, 1994; Spicer, 1988). The question is what organizational type, competitive or
cooperative, will derive optimal negotiator outcomes? Pruitt (1981) argues that self-interested
behavior often motivates parties to seek integrative
solutions, thereby creating additional value that
might be overlooked in the absence of a struggle
to claim value. Sebenius (1992) states that though
``many people seek common ground and believe
that dierences divide us, it is often the dierences
among negotiators that constitute the raw material for creating value'' (p. 29). In other words, the
aggressive pursuit of con¯icting and independent
goals by two parties lead to constructive outcomes
because competitive bargaining, with the sole
objective to claim value, may signal priorities and
may dislodge bargainers from adopting a rigid posture (Carnevale & Pruitt, 1992; Wilson, 1989). Thus,
prior research seems to suggest that competitive
behavior during negotiation leads to higher overall
1.3.4. Negotiator's time
Time is a scarce, but valuable commodity for
most types of entities, and this construct has been
studied by scholars in number of dierent disciplines. It is regarded as a major economic commodity for managers (Hitt et al., 1990) and
inappropriate usage of time can negatively aect
an organization. For example, when managers
spend too much time on acquisitions, mergers,
spinos, etc., organization performance (i.e.,
pro®t) suers because there is not much time for
other regular activities (Hill, Kelley, Agle, Hitt &
Hoskisson, 1992). To some extent, transactioncost analysis also recognizes the role of time (Williamson, 1975). Thus, some researchers argue that
time represents a ®nite duration available to managers to manage internal and external exchanges
(Lusch, Brown & Brunswick, 1992).
Studies of bargaining recognize the non-negligible costs from continuing to negotiate, primarily
through a longer period of time to arrive at a settlement or sometimes through the exchange of
more proposals (Rapoport, Erev & Zwick, 1995;
Rubenstein, 1982). Anecdotal evidence in Eccles
(1985) suggests that the duration of the transfer
price negotiation process can be signi®cant in
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
®rms and that managers are concerned with the
magnitude of these durations and the factors that
aect it. For example, one divisional general
manager reported spending 50% of his time in his
®rst three months on issues related to transfer
price negotiation (Eccles, 1985, p.167). Another
manager, explaining a recent change in policy
which had reduced the amount of time for haggling over transfer prices, said, ``People recognized
that it was an absolute waste of time for the corporation when people argued about transfer prices. We wanted to get on with running the
business'' (p. 195).
When individuals operate as agents within an
organization, their behavior and decision-making
process are in¯uenced by organizational designs
(Frederick, 1983). As discussed before, complementarity of sourcing and compensation structure would result in consistent expectations whereas
their noncomplementarities would result in inconsistent expectations causing managers to adopt a
mixed-motive bargaining behavior. This would
extend the duration of the bargaining process and
consume more of the managers' time to reach an
agreement (cf. Stonich, 1988; Thomas, 1992). This
suggests the last hypothesis:
H4: In negotiating transfer prices, a complementary
arrangement of sourcing and compensation
structure (i.e. they are both dependent or
independent in nature) should result in lesser
time to come to an agreement compared to
when there is a noncomplementary arrangement of sourcing and compensation structure
(i.e. one factor is dependent and the other is
independent in nature).
2. Research method
2.1. Overview
Each negotiator in a dyad assumed the role of a
division manager in a manufacturing ®rm, either
selling (hereafter referred to as S) electric motors
as a subcomponent (Manager Ð Motors Division)
or buying motors (hereafter referred to as B) as a
subcomponent (Manager Ð Fans Division). Each
667
division manager had private information which
consisted of a pro®t schedule matrix (Table 1A for
S; Table 1B for B). From all the possible combinations in a price-quantity matrix, S and B were
required to negotiate a price/quantity agreement.
In the tables, transfer prices are listed on the left
side and quantities across the top; entries in each
cell represent division pro®t arising only from
internal transfer for all arrangements of sourcing
and compensation structure. Also, the payos
were symmetrical across both S and B.
2.2. Independent variables
2.2.1. Sourcing
Internal sourcing diers from external sourcing
``...primarily in terms of interdependence'' (Smith,
Carroll & Ashford, 1995, p. 10). Thus, the sourcing decision was operationalized in terms of
interdependency between the buying and selling
divisions (Spicer, 1988; Vancil, 1978). However,
empirical evidence of the percent of internal
transfer is sparse. Eccles' (1985) survey found that
internal transfers ranged from 30 to 90% of a
division's input or output. Vancil reports that the
transferred amount varied up to 75% of cost of
goods sold. In the current study, when divisions
use internal sourcing, about 75% of either division's pro®t was impacted by internal transactions;
the remaining 25%, the ®xed pro®t component,
came from external transactions. Under external
sourcing, the percentages were reversed; that is,
only 25% of either division's pro®t was impacted
by internal transactions, whereas 75% of the
pro®t (®xed) came from external transactions.
As stated before, the proportion of divisional
pro®t (internal sourcing: 25%; external sourcing:
75%) from the negotiated transfer pricing was
from Panel A or B of Table 1. The proportion of
the ®xed pro®t amount from external sales was
then added to the pro®t from transfer pricing to
obtain the total divisional pro®t. This ®xed pro®t
amount, which was about 75% of divisional pro®t
for the internal sourcing manipulation and about
25% of divisional pro®t for the external sourcing
manipulation, was determined based on the average pro®t from internal transfers obtained in the
pilot studies.
668
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
Table 1
Pro®t schedule for (A) Motors Division (seller) and (B) Fans Division (buyer) from internal transfera
Quantity
(A)
25
30
35
40
45
50
55
60
Selling price $
5.50
24.00
6.00
34.00
6.50
44.00
7.00
54.00
7.50
64.00
8.00
74.00
8.50
84.00
9.00
94.00
9.50
104.00
30.00
42.50
55.00
67.50
80.00
92.50
105.00
117.50
130.00
36.00
51.00
66.00
81.00
96.00
111.00
126.00
141.00
156.00
43.75
61.25
78.75
96.25
113.75
131.25
148.75
166.25
183.75
50.00
70.00
90.00
110.00
130.00
150.00
170.00
190.00
210.00
56.25
78.75
101.25
123.75
146.25
168.75
191.25
213.75
236.25
55.00
80.00
105.00
130.00
155.00
180.00
205.00
230.00
255.00
60.50
88.00
115.50
143.00
170.50
198.00
225.50
253.00
280.50
66.00
96.00
126.00
156.00
186.00
216.00
246.00
276.00
306.00
(B)
Buying price $
5.50
104.00
6.00
94.00
6.50
84.00
7.00
74.00
7.50
64.00
8.00
54.00
8.50
44.00
9.00
34.00
9.50
24.00
130.00
117.50
105.00
92.50
80.00
67.50
55.00
42.50
30.00
156.00
141.00
126.00
111.00
96.00
81.00
66.00
51.00
36.00
183.75
166.25
148.75
131.25
113.75
96.25
78.75
61.25
43.75
210.00
190.00
170.00
150.00
130.00
110.00
90.00
70.00
50.00
236.25
213.75
191.25
168.75
146.25
123.75
101.25
78.75
56.25
255.00
230.00
205.00
180.00
155.00
130.00
105.00
80.00
55.00
280.50
253.00
225.50
198.00
170.50
143.00
115.50
88.00
60.50
306.00
276.00
246.00
216.00
186.00
156.00
126.00
96.00
66.00
a
20
Entries in each cell represent total divisional pro®t from internal transfer.
2.2.2. Compensation structure
This was de®ned here in terms of the basis of
evaluation Ð division pro®t versus ®rm pro®t
(Jensen & Meckling, 1976). For internal sourcing
where 75% of divisional pro®t was from transfer
pricing, the earnings percentage was three. When
negotiators' compensation was based on division
pro®t, actual earnings for each player in a dyad
was 3% of their division's pro®t, but if it was
based on ®rm pro®t (sum of the two divisional
pro®ts), each player shared 3% of their dyadic or
®rm pro®t. On the other hand, for external sourcing where 25% of divisional pro®t was from
transfer pricing, the earnings percentage was one.
If compensation was based on division pro®t, each
dyadic player received 1% of their division's pro®t
as earnings, but if it was based on ®rm pro®t, each
player shared 1% of their dyadic or ®rm pro®t.
The earnings percentage was adjusted so that, at
the optimum, the compensation paid to subjects in
each of the four cells was identical. Appendix 1
includes part of the instructions to the subjects
explaining their compensation structure.3
The 22 research design for the two independent variables resulted in four cells: (1) internal
sourcing-®rm pro®t; (2) internal sourcing-division
pro®t; (3) external sourcing-®rm pro®t; and (4)
external sourcing-division pro®t. As stated earlier,
the arrangements of sourcing and compensation
structure are complementary in cells #1 (both factors are dependent in nature or `DD') and #4 (both
factors are independent in nature or `II'). In the other
two cells, the arrangements are noncomplementary:
3
For brevity sake, only instructions to subjects role-playing
as sellers are included in the Appendix.
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
sourcing is `dependent' and compensation structure
is `independent' in cell #2 (or `DI'), while sourcing
is `independent' and compensation structure is
`dependent' in cell #3 (or `ID').
2.3. Dependent variables
2.3.1. Fairness
In general, fairness is aected by both perceptions about outcomes and perceptions about the
process or policies which aect the outcomes
(Miceli, 1993). These two aspects seem to parallel
the notion of fairness about transfer pricing policy
(Eccles, 1985; Vancil, 1978), namely, (i) the fairness of the transfer price per se, and (ii) how that
pricing policy impacts the divisional manager's
compensation structure. Therefore, the following
two questions were posed to the subjects:
1. Do you think that the agreed upon transfer
prices and quantities are apt to bene®t only one
division and not the other division in the ®rm?
2. To what extent did you feel that the basis for
your performance evaluation, on which your
monetary compensation was based, was fair to
you?
Reverse coding of question one was appropriately handled in the computation of the fairness
score. The total score from the two questions was
used as a measure of perceived fairness for each
dyadic subject, with a higher score indicating
greater perceived fairness.
2.3.2. Con¯ict
This was measured in two ways: (i) The ®rst
used the Rahim Organizational Con¯ict Inventory
#1 (ROCI-1), designed to measure the self-report
of con¯icts arising from dyadic interaction. The
instrument has six questions framed to assess a
669
subject's perceptions of his or her relationship
with the other subject in the dyad. The instrument
uses a ®ve-point Likert scale to measure the level
of con¯ict. The minimum score on a question is 1,
and the maximum is 5; so the total score from the
instrument can range from a minimum of 6 to a
maximum of 30. A higher score represents a
higher perception of individual con¯ict in a dyad
(Rahim, 1983). In this experiment, the instrument's Cronbach is 0.79 compared to 0.81
reported by Rahim. Interdivisional con¯ict was
measured by summing the responses to the six
questions for each negotiator in a dyad. However,
asking about perceived con¯ict may not be the
same as observing outcome behavior of con¯ict.
(ii) The second measure of con¯ict is a more direct
measure, namely, the absolute values of the difference between divisional pro®ts (Ghosh, 1994;
Lax & Sebenius, 1986). Since negotiators have a
general aversion to unequal outcomes (Luft &
Libby, 1997; Thomas,1992), a 50/50 split of the
total pro®t from intra-®rm negotiation indicates
compromise and reconciliation of both parties'
interests (Pruitt, 1983). Thus, it is logical to
assume that a greater dierence in divisional
pro®ts is associated with higher dyadic con¯ict.
2.3.3. Firm pro®t
This was the sum of the divisional pro®ts from
transfer pricing only for each of the three periods
that the prices were negotiate.
2.3.4. Negotiator's time
This was the time taken in minutes to come to
an agreement by the two negotiators in each of the
three periods.
2.4. Experimental procedure
A total of 104 undergraduate business students
enrolled in an upper-division accounting class
served as subjects. All of them participated in the
study simultaneously. They formed 52 negotiating
dyads and were equally distributed among the
four cells. The dyadic subjects interacted with each
other anonymously through a computer network.
The main experiment consisted of each dyad engaging in three distinct negotiations, each of 10-minute
670
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
periods.4 All relevant information was automatically recorded throughout the experiment.
Subjects received continuous feedback on the time
remaining during each period and the negotiation
was terminated if the subjects were unable to come
to an agreement within the allotted time of 10
minutes. To avoid opportunistic behavior in the
last period, the subjects were not told the number
of periods. In each period, the negotiation process
consisted of oers and counter-oers that terminated either as an agreement if an oer was
accepted or as a disagreement if no oer was
accepted within 10 minutes. The opening oer in
each period alternated between buyer and seller to
avoid giving a ®rst-oer advantage. When a
transaction took place, the computer informed
each subject of their pro®t for that period and
their compensation. At the end of each period, the
computer also indicated the total cumulative
compensation earned. A prompt then indicated
the start of the next period.
The experiment had three stages and lasted
about 2 hours. In the ®rst stage, the subjects read
the instructions and then participated in a twoperiod practice game designed to verify their
understanding of the trading procedures and the
available information. However, the subjects did
not receive any compensation. The second stage
was the main experiment; it had three periods and
the subjects received compensation. In the third
stage, the subjects were administered a two-part
debrie®ng questionnaire. In part one, the ROCI-1
instrument was administered to each dyadic subject to measure con¯ict attitudes toward his or her
dyadic negotiation partner. Also, the subjects were
asked how they perceived certain aspects of the
project. Part two collected information about each
subject's background.
4
Pilot studies indicated that 10 minutes was sucient duration for subjects in a dyad to reach an agreement. Also, the
negotiated outcomes at the end of the fourth period were very
similar to the outcomes after three periods. Therefore, to keep
the duration of the total experiment within the available time of
120 minutes, the negotiation process was iterated over three
periods.
3. Results
3.1. Post-experiment questionnaire and descriptive
statistics
The subjects were randomly assigned to one of the
four cells arising from the treatment manipulation
of sourcing and compensation structure, and
within each cell, as either a buyer or a seller.
Analyses of each subject's division pro®t, con¯ict
(ROCI-1) and fairness scores indicated that they were
not aected by any of the following non-theoretical
variables: buyer and seller classi®cation, gender,
graduating major, semester standing, work
experience, computer knowledge, or transfer pricing knowledge. Hence, for hypotheses testing, the
buyer and seller classi®cation was collapsed across
subjects. Table 2 shows the descriptive statistics
for all the dependent variables by treatment,
sourcing and compensation structure. As discussed earlier (Section 2.3.1), their arrangements
resulted in two complementary cells (`DD' and
`II') and two noncomplementary cells (`DI' and
`ID').
Subjects' perceptions of competitive/cooperative
behavior during negotiation were also evaluated
via a rating scale in the debrie®ng questionnaire
with higher scores indicating more competitive
behavior. The subjects were asked (Note: scale
reversed for half the subjects): Your partner's
behavior was more cooperative or more competitive during the negotiation process?
The scale was scored as `1' for cooperative and
`10' for competitive. Subjects in cell ``DD'' indicated a score of 3.27, while those in cell ``II'' had a
score of 7.64. Subjects in cells ``DI'' and ``ID'' had
scores of 5.31 and 5.38, respectively. Schee's test
shows that all the scores were signi®cantly dierent from each other (at P=0.0001) except those
from cells ``DI'' and ``ID.''
Other information also suggests that negotiators'
behavior in the complementary and noncomplementary cells were very dierent (see ``Miscellaneous,'' Table 2). For example, the dierence
671
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
Table 2
Descriptive statistics
Compensation structure
Sourcing
Compensation based on ®rm pro®t
Compensation based on division pro®t
Internal
Cell#1 (13 dyads/26 subjects) or ``DD''
Cell#2 (13 dyads/26 subjects) or ``DI''
Dependent variables
Fairness
Con¯ict
ROC-1
Div.pro®t di.
Firm pro®t ($)
Time (min)
Mean
Dependent variable
16.36
1.55
15.46
6.18
316.22
8.04
2.12
4.94
15.11
0.27
Miscellaneous (averages)
Possible pro®t-opening oer
Individual negotiator pro®t
Dierence
S.D. of pro®t from oers and counter-oers
# of rounds for agreement
External
S.D.
$162.67
158.11
$4.56
5.56
4.48
Cell#3 (13 dyads/26 subjects) or ``ID''
Dependent variables
Fairness
Con¯ict
ROC-1
Div. pro®t di.
Firm pro®t ($)
Time (min)
Mean
12.83
18.69
10.75
330.73
9.30
Miscellaneous (averages)
Possible pro®t-opening oer
Individual negotiator pro®t
Dierence
S.D. of pro®t from oers and counter-oers
# of rounds for agreement
between possible pro®ts from the opening oer
and the actual pro®ts from the ®nal agreement
were much greater in cells ``DI'' ($14.71) and
``ID'' ($13.52) than in cells ``DD'' ($4.56) and ``II''
($7.03); thus, in the noncomplementary cells the
slope of convergence was steeper. Also, ¯uctuations in the oers and counteroers in the noncomplementary cells were, more as evidenced by
the higher standard deviations of possible pro®ts
from oers and counteroers in these cells, and the
cell negotiators took more rounds (note: a round is
Fairness
Con¯ict
OC-1
Div. pro®t di.
Firm pro®t ($)
Time (min)
Mean
S.D.
13.46
1.44
18.73
10.95
324.03
9.24
2.24
5.92
8.14
0.08
Miscellaneous (averages)
Possible pro®t-opening oer
Individual negotiator pro®t
Dierence
S.D. of pro®t from oers and counter-oers
# of rounds for agreement
$176.72
162.01
$14.71
9.14
5.38
Cell #4 (13 dyads/26 subjects) or ``II''
S.D.
Dependent variables
1.19
Fairness
2.38
4.54
5.58
0.07
Con¯ict
ROC-1
Div. pro®t di.
Firm pro®t ($)
Time (min)
$178.89
165.37
$13.52
8.86
5.44
Mean
S.D.
16.17
1.43
14.69
5.98
344.31
8.50
1.57
3.45
6.36
0.11
Miscellaneous (averages)
Possible pro®t-opening oer
Individual negotiator pro®t
Dierence
S.D. of pro®t from oers and counter-oers
# of rounds for agreement
$179.19
172.16
$7.03
5.75
5.01
an oer and the counteroer or agreement) to
agree to a transfer price. Finally, ®rm pro®ts from
transfer pricing for negotiation periods one and
three were separately compared. In the ``DD'' (``II'')
cell, ®rm pro®t increased from $305.08 ($333.17) in
period one to $326.41 ($355.93) in period three, or
an improvement of 6.99% (6.83%). In contrast,
during the same period, cell ``DI'' ®rm pro®t
increased only from $324.43 to $325.23 (i.e. by
0.2%) while cell ``ID'' ®rm pro®t decreased marginally from $331.80 to $330.14 (i.e. by 0.5%).
672
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
3.2. Test of hypotheses
3.2.1. Fairness of transfer pricing policy
Hypothesis H1 predicted that a negotiated
transfer pricing policy should be perceived as
more fair when there is a complementary arrangement of sourcing and compensation structure
compared to when their arrangements are noncomplementary. The dependent variable was the
perceived fairness score collected from individual
negotiators in a dyad with higher scores indicating
greater perceived fairness. An ANOVA procedure
was used for the statistical analysis of H1. The
arrangements of independent variables had two
levels ± complementary and noncomplementary.
The analysis indicates (refer to part A of Table 3)
that the ANOVA model is signi®cant (F=126.71;
P=0.0001). To get an insight of this result, the
means of perceived fairness under all the dierent
arrangements of sourcing and compensation
structure were compared. The results (refer to part
B of Table 3) show that subjects perceived the
pricing policy to be signi®cantly more fair (at
P=0.01) in the case of complementary arrangements (i.e. cells `DD' and `II') than in the case of
noncomplementary arrangements (i.e. `DI' and
`ID'). Further, perceived fairness from the complementary cells (i.e. cells`DD' and `II') was not
signi®cantly dierent from each other. Similarly,
the fairness scores from the noncomplementary
cells (i.e. cells `DI' and `ID') were also not signi®cantly dierent from each other. In summary,
the results support hypothesis H1.
3.2.2. Con¯ict
Hypothesis H2 states that during negotiation of
transfer prices, a complementary arrangement (of
sourcing and compensation structure) should have
lesser con¯ict compared to when there is a noncomplementary arrangement. As stated earlier,
con¯ict was measured in two dierent ways; thus,
separate ANOVA analyses were done for the two
con¯ict measures. The independent variables had
two levels, as described earlier.
Table 3
Complementary arrangements of organizational factors aecting negotiated transfer prices and its impact on perceived fairness of the
transfer pricing policy (for H1)
A. Analysis of variance (n=104 subjects)
Source
df
SS (111)
Mean2
F value
P value
R2
Model
1
253.906
253.906
126.71
0.0001
0.55
B. Comparisons of cell means Ð Schee's test (n=26 subjects per cell)
Cells compareda
DD and DI
ID and II
DD and ID
DI and II
DD and II
DI and ID
Means of cells compared
Cell
Mean
Cell
Mean
Absolute dierence
between means
DD
ID
DD
DI
DD
DI
16.36
12.83
16.36
13.46
16.36
13.46
DI
II
ID
II
II
ID
13.46
16.17
12.83
16.17
16.17
12.83
2.90*b
3.34
3.53
2.71
0.19
0.63
a
Variable de®nitions are as follows: DD=Complementary arrangement of sourcing and compensation when both factors are
dependent on nature. DI=Noncomplementary arrangement of a dependent (sourcing) and an independent (compensation) factor.
ID=Noncomplementary arrangement of a dependent (compensation) and an independent (sourcing) factor. II=Complementary
arrangement of sourcing and compensation when both factors are independent in nature.
b
*Signi®cant at 0.01.
D. Ghosh / Accounting, Organizations and Society 25 (2000) 661±682
3.2.2.1. ROCI-1. The dependent variable was the
sum of the con¯ict scores for each negotiator in a
dyad with higher scores indicating greater con¯ict.
The analysis indicates (refer to part A of Table 4)
that the ANOVA model is signi®cant (F=78.14;
P=0.0001). Comparisons of the cell means of
con¯ict (refer to part B of Table 4) show that it
was signi®cantly less in the case of complementary
arrangements (i.e. cells `DD' and `II') compared
to noncomplementary arrangements (i.e. cells
`DI' and `ID'). Further, con¯ict scores in the two
complementary cells were not signi®cantly dierent from each other, as were the con¯ict scores
from the noncomplementary cells.
3.2.2.2. Divisional profit difference. A higher score
on this dependent variable, measured for each
dyad, would suggest higher con¯ict. The analysis
was a repeated measures ANOVA where Period
was used as a repeated-measures factor with three
levels, one each for the periods the transfer price
was negotiated. The results in Table 5 (Parts A
and B) indicate that con¯ict between the trading
divisions was lower from complementary organizational arrangements took. These results, there-
673
fore, parallel those from the con¯ict responses
using ROCI-1. In conclusion, the above results
provide evidence in support of hypothesis H2.
3.2.3. Firm pro®t
Hypothesis 3 predicted that ®rm pro®t will be
the most from competitive behavior (or cell `II'),
the least from cooperative behavior (or cell `DD'),
with ®rm pro®t from collaborative behavior (or
cells `DI' and `ID'), coming in between the two.
Analysis in the ``Post-experimental Questionnaire'' section (p. 20) showed that negotiator
behavior was more competitive in cell `II', more
cooperative in cell `DD', and between competitive
and cooperative in cells `DI' and `ID'. Thus, the
independent variable for this analysis was a ``cell''
with four levels. The dependent variable was the
sum of the two divisions' pro®ts from negotiated
transfer prices only (i.e. a dyadic measure). The
analysis was a repeated-measures ANOVA with
Period as the repeated-measures variable with
three levels. The results (refer to part A of Table 6)
indicate the ANOVA model is signi®cant
(F=20.13; P=0.0001). Comparison of cell means
(refer to part B of Table 6) show that ®rm pro®t
Table 4
Complementary arrangements of organizational factors aecting negotiated transfer prices and its impact on con¯ict measured using
ROCI-1 (for H2)a
A. Analysis of variance (n=104 subjects)
Source
df
SS(111)
Mean2
F value
P value
R2
Model
3
343.471
343.471
78.14
0.0001
0.43
B. Comparisons of cell means Ð Schee's test (n=26 subjects in each cell)
Cells compared
DD and DI
ID and II
DD and ID
DI and II
DD and II
DI and ID
Means of cells compared
Cell
Mean
Cell
Mean
Absolute dierence
between means
DD
ID
DD
DI
DD
DI
15.46
18.69
15.46
18.73
15.46
18.73
DI
II
ID
II
II
ID
18.73