Bargaining Behavior in a Transfer Pricing Experiment

Abstract The purpose of this study was to determine the effects of market threat capacity, external incentives, and time horizons on bargaining behavior in a transfer price simulation. Each subject played the role of a divisional manager. Market threat capacity was the option held by one negotiator to sell or buy his or her product in an external market. Incentives were based either entirely on a division′s profit or on both the divisional profits and the firmwide profits. Time horizon was manipulated at two levels—a single round of bargaining or a multiple round setting, the length of which was not specified to the subjects. Uncertainty regarding threat capacity reduced the frequency of cooperative bargaining. Contrary to expectations, subjects paid according to divisional profits cooperated more frequently than subjects paid on a joint basis of division and firm profits. Subjects did not become more cooperative over three rounds of negotiating, but the rate of cooperative behavior was affected by whether subjects expected to negotiate multiple or single rounds with the same person. The results indicate the importance of a multiple negotiation time horizon, threat capacity, and incentives on negotiation behavior.