Sequential Mechanism in The Transfer Pricing roblem

Abstract.

We consider a model where division managers in a decentralized firm are not informed about their own production costs. They become informed only during the production process. It turns out that applying the Grove mechanism step by step does not yield incentive compatibility via dominant strategies. We therefore introduce a modified sequential mechanism where, in every stage, the division managers send messages to the planner. The agents are not informed in every stage, about each other's messages. We will show that the mechanism is truthtelling via dominant strategies and efficient. Furthermore, if the agents are informed at every stage about each other's messages, then the mechanism is truthtelling via strategies that are not dominant but survive iterative elimination of weakly dominated strategies. The Ronen-McKinney mechanism one produces similar results and, in addition, preserves the division manager's autonomy.

Keywords: Transfer Pricing, Mechanism Design, Decentralization, Capacity.

Classification: C69, C79, D81, D82, L22, M11.