Transfer Prices: A Financial Perspective

The arguments for and against transfer pricing schemes so far have focused on profit‐seeking approaches based on tax differentials, or on evasion of government enforced goods and fund flow restrictions. This article shifts to a value‐seeking framework where transfer prices act as strategic tools that may enhance value for the multinational with a foreign affiliate by exploiting financial and/or tax arbitrage that also lead to ownership arbitrage. The results show that there is an optimal level of transfer price depending on the specific exchange rate distribution when the cost structure allows for a penalty for overcharging. Moreover, this article introduces a new form of tax arbitrage benefit of transfer prices that is based on present value of tax shields.