Transfer Pricing for Developing Countries - An Incentive Compatible Approach

Profit shifting in transfer pricing arises due to the informational advantage of the multinational enterprise (MNE) with its cost structure. This paper explores the possibility of designing a tariff structure as an incentive compatible instrument to elicit a truthful response from the firm regarding its cost structure. Under perfectly competitive markets, incentive compatible tariffs exist and are also used in analysing pooling and separating equilibria. The paper can be extended to include other instruments such as APAs. Other extensions can be in the direction of including multiple governments competing for investment by a given MNE in the context of a multiple principals and single agent.