Monitoring and Coordination in MNCs

Implications for Transfer Pricing and Intra-Firm Trade

The ability of multinational corporations (MNCs) to shift profits among divisions has been often perceived as an attempt to avoid taxes. We investigate how two factors-(i) the asymmetry of information between the headquarters and the affiliate`s managers about local cost conditions and (ii) the limited ability of the headquarters to monitor and control the level of effort exerted by the subsidiary`s managers-affect the MNC`s efficiency and the level of international trade that is conducted via intra-firm trade. Our results imply that transfer price deviations from benchmark standards need not imply that MNCs manipulate transfer Prices to avoid taxes but rather reflect the MNC`s attempt to coordinate internal activities.