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Compensation and Transfer Pricing in a Principal-Agent Model

David Besanko and David S. Sibley
International Economic Review
Vol. 32, No. 1 (Feb., 1991), pp. 55-68
DOI: 10.2307/2526931
Stable URL: http://www.jstor.org/stable/2526931
Page Count: 14
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Compensation and Transfer Pricing in a Principal-Agent Model
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Abstract

This paper studies transfer prices and compensation mechanisms in a principal-agent model with moral hazard and private information by the agent. Production requires unobservable effort by the agent and a purchased input. In general it is optimal for the principal to create an internal market for the input and charge the agent a tax or subsidy which differs from the market price. Conditions are found under which the optimal compensation function is given by the difference between a nonlinear "revenue" function depending only on output and a nonlinear transfer pricing function which depends only on the amount of the purchased input.

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