Introduction

In the literature on multinational enterprises (MNEs) it has been recognized that an MNE encountering differing tax and tariff schedules can shift profits to low-tax countries by altering transfer prices (Copithorne, 1971; Horst, 1971). There are two crucial assumptions in the literature on transfer pricing: First, the MNE's price or quantity decisions are made at a central level; second, the MNE exercises monopoly power in national markets. Many MNEs, however, delegate decision-making, such as output price decisions, to national affiliates. This is common in the automobile industry, where the parent company, which is the producer, determines the export price (transfer price) to importing foreign affiliates, but leaves the responsibility of deciding on the final price to consumers to the importing affiliate. Moreover, in most industries, including the automobile and oil industries, MNEs interact with other firms. Hence the monopoly-power assumption in the conventional literature is often violated. The purpose of this study is to analyze whether or not an MNE's transfer-pricing policy, which is decided upon at a central level, changes if the foregoing two assumptions are relaxed.

It is well known in the industrial-organization literature that a principal can gain extra benefit by hiring an agent and giving that agent an incentive to maximize something other than the welfare of the principal. Thus, if an MNE's affiliates face oligopolistic competition, it may be beneficial to the MNE to direct the incentives away from maximizing the MNE's global profits; provided that the MNE's competitors in the national markets react favorably.