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Strategic decentralization, bargaining, and transfer pricing in supply chain efficiency
Abstract Strategic Decentralization, Bargaining, and Transfer Pricing in Supply Chain Efficiency Dae-Hee Yoon 2008 This thesis examines the role of strategic decentralization, bargaining, and transfer pricing in supply chain efficiency. The first essay analyzes how strategic delegation using stock options can affect investment hold-up problems in vertical relationships. In vertical relationships, underinvestment problems can arise because sunk invest- ment costs are ignored in ex post negotiation. However, the delegation of bargaining rights to the upstream manager coupled with stock options makes the sunk invest- ment costs relevant costs from the manager's perspective. The sunk investment costs are now reversible depending on his exercise decision. Thus, under option-based com- pensation, the relevant investment costs create the upstream manager's bargaining power and thereby increase transaction price in negotiation. The resulting increased transaction price improves the upstream profit and the improved return on invest- ment induces greater investment by the upstream firm. Despite the higher induced transaction price, the downstream firm's profit can also improve because the greater induced investment enhances the viability of the supply chain. Such supply chain gains also naturally translate into gains in consumer surplus. The second essay investigates the role of decentralization and vertical licensing in a durable goods market. A monopolist in a durable goods market faces an over- investment problem in its R&D decision because it cannot commit to a value of a new investment in the future which makes its own product obsolete. This pa- per demonstrates that decentralization and vertical licensing can help address the overinvestment problem and increase a firm's profit. An internal conflict caused by decentralization is a natural commitment tool for the monopolist to keep its invest- ment level down. However, decentralization can also lower the investment too far. In such cases, permitting vertical licensing from the R&D division to a potential rival enables the firm to better manage its investment level. The competition induced by vertical licensing decreases the downstream division's profit but the advantage to the R&D division from added investment and an expanded market dominates. The result implies that often observed decentralization and licensing across rivals can be a means of overcoming the time inconsistency problem in a firm's R&D activities. The third essay shows the role of decentralization in coordinating market com- petition and vertical efficiency. There are many circumstances in which manufactur- ers provide inputs to wholesale customers only to subsequently compete with these wholesale customers in the retail realm. Such dual distribution arrangements com- monly suffer from excessive encroachment in that the manufacturer's ex post retail aggression is harmful ex ante because it undercuts potential wholesale profits. This paper demonstrates that with dual distribution, a manufacturer can benefit from decentralized control and the use of transfer prices above marginal cost. Though these arrangements often create coordination concerns, a moderate presence of such concerns permits the manufacturer to credibly convey to its wholesale customer that it will not excessively encroach on its retail territory. This, in turn, permits the man- ufacturer to reap greater wholesale profits. We also note that this force can point to a silver lining in arm's length (parity) requirements on transfer pricing in that they can solidify commitments to a particular retail posture. Strategic Decentralization, Bargaining, and Transfer Pricing in Supply Chain Efficiency A Dissertation Presented to the Faculty of the Graduate School of Yale University in Candidacy for the Degree of Doctor of Philosophy by Dae-Hee Yoon Dissertation Director: Professor Shyam Sunder December 2008 UMI Number: 3342736 Copyright 2008 by Yoon, Dae-Hee All rights reserved. INFORMATION TO USERS The quality of this reproduction is dependent upon the quality of the copy submitted. Broken or indistinct print, colored or poor quality illustrations and photographs, print bleed-through, substandard margins, and improper alignment can adversely affect reproduction. In the unlikely event that the author did not send a complete manuscript and there are missing pages, these will be noted. Also, if unauthorized copyright material had to be removed, a note will indicate the deletion. ® UMI UMI Microform 3342736 Copyright 2009 by ProQuest LLC. All rights reserved. This microform edition is protected against unauthorized copying under Title 17, United States Code. ProQuest LLC 789 E. Eisenhower Parkway PO Box 1346 Ann Arbor, Ml 48106-1346 Copyright © 2008 by Dae-Hee Yoon All rights reserved. Contents Abstract i Dedication 1 Acknowledgements 2 1 Introduction 3 1.1 Decentralization 5 1.2 Supply Chains and Its Implication for Accounting 6 1.3 Strategic Delegation 8 1.4 Bargaining in Supply Chains 9 1.4.1 Nash Bargaining 9 1.4.2 Example 12 1.5 Organization of Dissertation 15 2 Using Stock Options to Make Sunk Costs Decision-Relevant: Alle- viating the Upstream Underinvestment Problem 16 2.1 Model 21 2.2 Benchmark: Integration 23 2.3 Non-Integration 26 2.3.1 The Short Run 27 2.3.2 The Long Run and Pareto Gain 31 u 2.4 Example 37 2.5 Conclusion 40 3 Decentralization and Vertical Licensing: Mitigating the overinvest- ment problem in a durable goods market 42 3.1 Setup 48 3.1.1 Model 48 3.1.2 Benchmark: The First-Best Solution 50 3.2 Centralization 52 3.3 Decentralization 53 3.4 Licensing and Duopoly 56 3.4.1 Horizontal Licensing under Centralization 57 3.4.2 Vertical Licensing under Decentralization 58 3.4.3 Endogenous Upgrade Level 62 3.5 Example 64 3.6 Conclusion 66 4 Friction in Related Party Trade when a Rival is also a Customer 1 67 4.1 Model 71 4.2 Results 72 4.2.1 Centralization 72 4.2.2 Decentralization 74 4.2.3 Centralization vs. Decentralization 76 4.2.4 Negotiated Pricing 83 4.2.5 Arm's Length Pricing Restrictions 86 4.3 Conclusion 89 ^his is a joint work with Professor Anil Arya and Professor Brian Mittendorf. in 5 Conclusion 91 6 Appendices 94 6.1 Appendix A: Proofs of Propositions in Chapter 2 94 6.2 Appendix B: Proofs of Propositions in Chapter 3 102 6.3 Appendix C: Proofs of Propositions in Chapter 4 107 IV List of Figures 1.1 Nash Bargaining Solution 11 2.1 The Sequence of Events 27 2.2 The Sequence of Events in the Long Run 31 2.3 The Investment Levels 38 2.4 Profit of the Upstream Firm 38 2.5 Profit of the Downstream Firm 39 2.6 Pareto Gain 39 3.1 The Sequence of Events 50 3.2 The Sequence of Events under Vertical Licensing 59 3.3 The Investment Levels 64 3.4 The Firm's Profit 64 3.5 Endogenous Upgrade and the Firm's Profit 65 4.1 The net benefit of decentralization in terms of wholesale profit (top), retail profit (bottom), and total profit (middle) as a function of k. . . 79 4.2 The net gain from the decentralization as a function of the bargaining power 86 v List of Tables 2.1 Example 38 VI [...]... willing to pay for the input from the upstream Then, a firm's profit increases because the gains from the wholesale profit dominate the costs of transfer pricing distortion in retail markets The remainder of this chapter explains the related literature in decentralization, supply chains, strategic delegation, and bargaining 1.1 Decentralization The effect of decentralization in an organization and. .. role of accounting in supply chains Rajan and Baiman (2002) investigate the effect of information sharing in buyer-supplier relationships They show that a buyer's information sharing of innovation can enhance production efficiency, but it can also induce a supplier's misappropriation of the shared information Such a trade-off determines the level of information exchange in supply chains Kulp (2002)... that in a durable good market channel discord can mitigate the overproduction problem 1.2 Supply Chains and Its Implication for Accounting While the accounting research on divisional relationships in a firm (e.g., transfer pricing and capital budgeting) has been extensively done, the role of accounting information in supply chains has been overlooked until recently One may think that the results in divisional... in supply chains But it is not necessarily the case The important difference between supply chains and divisional relationships is goal congruence In divisional relationships, a divisional manager's payoff is aligned with a firm's goal and the decision making can be coordinated with relative ease via compensation and transfer pricing by headquarters On the other hand, supply chains consist of two independent... perspective because the sunk investment costs are now reversible depending on his exercise decision The relevant costs increase a manager's bargaining power in the negotiation with a buyer and thereby a transaction price and a supplier's profit increase The improved transaction price increases the supplier's investment level and can achieve Pareto gain in the supply chain In this supply chain, the manager's option-based... accounting earnings fixation in a vertical relationship They show 7 that the higher demand of downstream under earnings fixation increases the rents of upstream which lift the investment incentive, thereby mitigating an investment hold-up problem On the other hand, this thesis investigates the role of accounting information in mitigating conflicts in supply chains via a manager's compensation and an internal... bargaining in enhancing supply chain efficiency Chapter 2 examines how strategic delegation coupled with stock options increases a firm's bargaining power using sunk costs Chapter 3 investigates the role of decentralization and vertical licensing in overcoming the overinvestment in a durable goods market Chapter 4 shows that the friction due to decentralization can be a way of coordinating market competition... publicly observable commitment to an absorption costing system can be a strategic device to achieve softened competition in duopoly 8 1.4 Bargaining in Supply Chains Bargaining is prevalent in everyday life and it is prominent in business Employment contracts, mergers and acquisitions, and especially procurement contracts are all the result of bargaining To predict the equilibrium of this common practice,... a manufacturer and a supplier are two independent entities with different objectives Each of these entities focuses on maximization of its own profit rather than supply chain efficiency As a result of the different objectives, their bargaining process for procurement contract cannot avoid conflicts which can cause inefficiency in supply chains To mitigate the inefficiency in supply chains, various contracts... anticipating this consequence, naturally makes a lower investment than is ideal for the supply chain In detail, the short run case and the long run case are examined separately First, in the short run, the upstream investment level is presumed fixed and only the bargaining decision is under the manager's control Then, the compensation structure determines the supply chain efficiency through the bargaining . Abstract Strategic Decentralization, Bargaining, and Transfer Pricing in Supply Chain Efficiency Dae-Hee Yoon 2008 This thesis examines the role of strategic decentralization, bargaining, and transfer. on transfer pricing in that they can solidify commitments to a particular retail posture. Strategic Decentralization, Bargaining, and Transfer Pricing in Supply Chain Efficiency A Dissertation. Acknowledgements 2 1 Introduction 3 1.1 Decentralization 5 1.2 Supply Chains and Its Implication for Accounting 6 1.3 Strategic Delegation 8 1.4 Bargaining in Supply Chains 9 1.4.1 Nash Bargaining 9 1.4.2