Transfer Price Negotiation in the Presence of Unequal Bargaining Power: The Effect of a Peer Evaluation Scheme on Inter-divisional Profit Distribution

This study examines how managers balance economic incentives and inter-divisional equity considerations during transfer price negotiations. Our experiment shows that both buyers and sellers are willing to give up a significant amount of their profits to pursue a more equitable outcome (one that results in greater inter-divisional profit equalisation). We also find that incorporating peer evaluation schemes into negotiators' formal incentive plans has both economic and social-psychological impacts on negotiation behaviour, resulting in even greater inter-divisional profit equalisation. While this outcome may seem ‘fairer’ to the individual managers, from the firms' perspective profit equalisation can obscure divisional performance, potentially leading to resource allocation inefficiencies.