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#2 Ghosh, D. and Boldt, M. N., 2006. The Effect of Framing and Compensation Structure On Seller's Negotiated Transfer Price PDF
#2 Ghosh, D. and Boldt, M. N., 2006. The Effect of Framing and Compensation Structure On Seller's Negotiated Transfer Price PDF
Dipankar Ghosh
Associate Professor of Accounting
University of Oklahoma
Margaret N. Boldt
Associate Professor of Accounting
Southern Illinois University Edwardsville
The outcomes of negotiated trans- Prior accounting research (e.g.,
fer prices affect profit for the man- Lipe, 1993; Luft, 1994) has also found
agers involved and can also impact that the framing of problems affects
company profit when quantity, as well managers' judgments and prefer-
as price, is an element of the negoti- ences in other tasks and domains
ation. Thus, it is important for both (e.g., variance investigation and con-
companies and managers to under- tract choice). These studies have con-
stand the variables affecting negotia- sistently shown that the presentation
tion outcomes. Prior research in ne- of monetarily equivalent options in
gotiation (see Bazerman et ai., 2000) semantically different ways (i.e., gains
has investigated how negotiators' per- and losses, bonuses and penalties) af-
ceptions of the negotiation situation fects how managers frame problems
impacted outcomes. Further, these and make judgments. However, some
perceptions seem to influence out- research suggests the framing effect
comes and enhance negotiator profit is not consistent and research find-
over and above the effect of other im- ings may be limited by contextual and
portant variables in negotiation, like procedural variations (Levin et aL,
risk preference and competitive be- 1998). While Lipe (1993) proposes
havior (Thompson, 1998). Other re- that future framing studies examine
cent research has shown that making the role of motivation in general,
the optimal payoff salient to negotia- Ghosh and Boldt (2004) list compen-
tors increases negotiator effectiveness sation structure as a specific motiva-
beyond that obtained through risk tion variable that could potentially
preference alone (Ghosh and Boldt, limit the framing effect in negotia-
2004). tion.
(453)
454 GHOSH AND BOLDT
tive or negative framing of the profit H2: Seller's share of the profit will be
goal from transfer pricing is expected higher when bonus compensation based on
divisional profit is a larger percentage (i.e.,
to culminate in sellers claiming dif- high compensation) compared to when bo-
ferent shares of the profit available nus compensation based on divisional
from the transaction. Thus, the first profit is a smaller percentage (i.e., low com-
hypothesis is: pensation).
HI: Seller's share of the profit will be
higher when the profit goal is expressed in
terms of profit foregone (i.e., a negative Flexibility
frame) compared to when the goal is ex-
pressed in terms of profit made (i.e., a pos- Conflict, in general, is inevitable in
itive frame). organizations with divergence of pref-
erence among its members (Eccles,
Compensation Structure 1985). Not surprisingly, negotiation
research shows that conflict is a nat-
Managing the transfer pricing ural phenomenon when both the
problem can be difficult because the trading divisions are trying to en-
transfer price affects divisional profit hance their division performance
which, in turn, is typically the basis for (Eccles, 1985; Grabski, 1985; Ghosh,
evaluating and compensating the 2000).
manager (Eccles, 1985). Also, a firm's Negative goal framing is expected
compensation plan significantly in- to intensify the conflict problem.
fluences the motivation of organiza-
tional members (Schwab, 1973) and Some flexibility on the issue being ne-
stimulates behavior between negoti- gotiated reduces the level of conflict
ating divisions by influencing the bar- inherent in negotiation (Lax and Se-
gainers' aspiration level (Pruitt and benius, 1986; Thompson, 1998). Flex-
Lewis, 1975). Research in transfer ibility via concession on the price
pricing indicates that compensation (i.e., lower price for the seller and
structure (e.g., basis of the compen- higher price for the buyer) would
sation) is a pervasive issue in transfer mean adversely affecting divisional
pricing (Eccles, 1985; Grabski, 1985; profits. However, when the goal is
Vancil, 1978) and has a significant im- framed negatively (i.e., profit fore-
pact on outcomes of negotiated trans- gone), flexibility will be perceived as
fer pricing (Chalos and Haka, 1990; giving up even more profit. Thus, neg-
Ghosh, 2000). ative framing is expected to manifest
itself in reduced flexibility for sellers.
In the current study, sellers with a Thus, the third hypothesis is:
compensation structure that is more
H3: Sellers will be less flexible via conces-
dependent upon divisional profit sion on price when the profit goal is ex-
may perceive the earning of profit pressed in terms of profit foregone (i.e., a
from the transfer as a more important negative frame) compared to when the goal
goal than sellers whose compensation is expressed in terms of profit made (i.e., a
structure was less dependent upon di- positive frame).
visional profit. Based on the above, Similarly, compensation structure
sellers' shares of the profit available is also expected to have an effect on
from the transfer are expected to be flexibility. As stated above, the seller
larger when the bonus percentage may perceive the goal of earning di-
based on divisional profit is larger. visional profit as a more important
The second hypothesis is stated as: goal when divisional profit is a larger
Table 1
Decision Aid Data Provided to Participants
Quantity required
by Fans Division: 15.000 - 60,000 motors per year,
Average costpermotor: Up to 25,000 motors ($4,00 per motor + $100,000 fixed costs): $8,00
25.001 - 40,000 motors ($3,95 per motor + $148,000fixedcosts): $7,65
40,001 - 50,000 motors ($3,90 per motor + $197,500fixedcosts): $7,85
Above 50,001 motors ($3,85 per motor + $255,000fixedcosts): $8,10
(Note: These costs are for intemal transfer only. Additional marketing costs,
such as collection expenses, advertisements, sales personnel, etc, are not
included,)
Table 2
Descriptive Statistics - Means (Standard Deviations) for Dependent Variables
COMPENSATION STRUCTURE
Number of Observations 24 24
Number of Observations 24 24
Table 3
Framing and Profit
Sum of Mean
Source DF :Squares Square F Value Pr > F R-Square
Type Mean
Source DF mss Square F Value Pr>F
HO:LSMeanl = LSMean2
Framing ratio LSMEAN t Value Pr>ltl
Positive 0.37 7.88 <.OOO1
Negative 0.64
Table 4
Framing and Flexibility
Sum of Mean
Source DF Squares Square F Value Pr>F R-Square
Type Mean
Source DF inss Square F Value Pr>F
Compensation Structure
Low (i.e., 3%) High (i.e., 30%)
affecdng flexibility, and other inter- italize on the framing effect or other
personal variables, to understand the factors designed to shape managers'
complete effect on a company from percepdons of inter-divisional interac-
implemendng changes that would ca{> dons.
APPENDIX
(For Profit Made and Low Compensadon Structure Condidon)
INTRODUCTION
Assume that in a manufacturing firm, you are the manager of the Motors
Division producing electric motors. One of your motors, which consdtute about
25% of your divisional sales, is required to be sold internally to the other division
in the firm, namely the Fans Division, which uses it for one of their finished
products (exhaust fans). Your motor and the exhaust fan are standard industry
products. Hence, neither division has much flexibility to either pass on or recoup
additional product costs. The remainder of your sales (about 75%), which in-
cludes different types of motors, occurs in the open market. The demand and
the price for the motors on the external market are very stable; thus, profit to
your division from these sales is stable. Your divisional profit is, therefore, the
sum of the profit from internal transfers to the Fans Division and the fixed profit
from external sales.
Your compensadon has a fixed salary and a bonus based solely on the per-
formance of your division. Specifically, your bonus is 3% of your divisional profit
(sum of the profit from internal sales and the fixed profit from external sales).
The transfer price for selling the motors to the Fans Division is negodated
between you and the manager of the Fans Division and you can negodate what-
ever price is sadsfactory to both of you. The exact transfer price (for the quandty
involved) is important to both of you because it has a significant effect on both
divisions' profits. Both divisions are about the same size in terms of invested
capital, divisional profit and interdependencies. You are required to decide the
quandty and the price at which you will agree to transfer the motors to the Fans
Division for the year 2005. In making your decision, think ahout the extent of profit
your division would potentially make from the internal transfer. You will be provided
with the relevant information to help you in your decision.
YOUR COMPENSATION FROM THE NEGOTIATED TRANSFER PRICE
The following illustration may help you to understand how your compensadon
will be determined. Assume that based on the informadon provided, you agree
to sell 40,000 motors in a year at a price of $15.50 each at which level your
divisional profit from internal transfers will be $76,800. Assume that from your
external sales (75% of your division's sales) you earned a fixed profit of $242,600.
Therefore, your total divisional profit is $319,400 (i.e., $76,800 + $242,600), As
stated earlier, your bonus is 3% of your divisional profit of $319,400 or $9,582.
However, if your offered price for the quandty of transfer is unacceptable to the
manager of the Fans Division and is rejected, then you earn zero profit from
internal transfer. Your bonus then will be based only on the fixed profit from
external sales
The above figures, except for the bonus percentage (3%) and the proportion of
internal transfer (25%) to external sales (75%), are illustrative only and should not
be assumed to apply to the actual project,
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