Academic journal article Journal of Managerial Issues

The Outcome Saliency Effect on Negotiated Transfer Prices

Academic journal article Journal of Managerial Issues

The Outcome Saliency Effect on Negotiated Transfer Prices

Article excerpt

An important criterion for evaluating a company's transfer pricing policies is whether they positively affect profits. Some research has examined whether "alternative transfer pricing mechanisms can enhance profit (Ghosh, 1994). However, a more common approach is to examine the role of managers' incentive schemes and competitive behavior in maximizing profit (Chalos and Haka, 1990). Evidence of profit maximization under competitive incentive schemes exists in the bargaining literature. Elevated bargainer aspiration levels or higher motivation for serf-interested behavior, both of which coincide with higher expected payoffs, lead to higher bargaining profits (Pruitt, 1981). Transfer pricing literature also demonstrates the positive impact of competitive behavior on divisional profit when the prices are negotiated between trading divisions (Chalos and Haka, 1990). The rationale for incentives and competitive behavior affecting negotiator profit is that they affect negotiator's risk preferences (Bottom, 1998); increased risk is associated with increases in the negotiators' share of the predicted payoff.

Research recognizes that risk preference is an important aspect of negotiation (Osborne, 1985). Notably, in a multi-period bargaining game, players become increasingly risk-averse. The intuition underlying this observation is that risk aversion leads to the marginal increase in profit associated with a slightly more aggressive offer (a higher seller offer or a lower buyer offer) being weighted less heavily than a possible loss. Thus, risk-averse negotiators make offers closer to their true values than their counterparts with higher risk preferences (Chatterjee and Samuelson. 1983; Bottom, 1998).

More recent research in negotiation (see Bazerman et al., 2000) explores how negotiators' perception or construct of the negotiation situation (power, deadlines, etc.) affects the outcomes. These perceptions are said to significantly influence negotiation outcomes and enhance negotiation profit beyond those obtained through negotiators' risk preference or competitive behavior (Thompson, 1998). Also, recent research suggests the need to consider how negotiation structure affects transfer prices (Kachelmeier and Towry, 2002). Thus, the current study examines the effect of a perceived negotiation situation via salience of the optimal payoff in a multi-period bargaining setting when transfer price is negotiated between the trading divisions. For comparison purposes (and consistent with game-theoretic models), the study also examines the role of risk on these negotiations.

The results indicate that, as expected, both risk preference and negotiation situation (i.e., outcome salience) affect negotiator effectiveness (i.e., divisional profit). Importantly, over multiple periods, outcome salience improves negotiator effectiveness over and above the effect from risk preference alone. Further, effectiveness of a risk-averse (risk-neutral) negotiator in the outcome salience condition is as high as the effectiveness of a risk-neutral (risk-seeking) negotiator in the control condition. Given the ease of enhancing the transfer price via outcome saliency, managers and researchers may rethink strategies for shaping negotiators' perceived bargaining situations.

The remainder of the paper is organized as follows. The next section develops the research hypotheses. Then the research method is discussed, followed by the data analysis.

The last section summarizes the results and provides some conclusions.

THEORY AND DEVELOPMENT OF HYPOTHESES

Individual Difference: Risk Preference

Bargaining is a fundamental economic interaction in organizations. Risk-taking propensity, of the managers' negotiating transfer prices is an important individual trait because negotiators' effectiveness (i.e., divisional profit) is a function of their risk preferences (Osborne, 1985; Ghosh, 1996). Uncertainty about the other division manager's reservation price and behavior, which may cause the negotiation to break down, is a natural element in bargaining. …

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