Specific Investment Under Negotiated Transfer Pricing: An Efficiency Result

In our model of negotiated transfer pricing, divisional managers can make specific investments that enhance the value of intrafirm trade. However, these investments are irreversible and must be made before divisional managers have enough information to determine the desired intrafirm transfer. We find that a system of negotiated transfer pricing will lead to efficient outcomes provided the divisions can sign fixed-price contracts priorto making their investment decisions. While these contracts are likelyto be renegotiated afterthe relevant information becomes known, they nonetheless provide the divisions with effective protection for their specific investments.