the effect of framing and negotiation partner’s objective.pdf

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Accounting, Organizations and Society 33 (2008) 704–717

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The effect of framing and negotiation partner’s objectiveon judgments about negotiated transfer prices

Linda Chang, Mandy Cheng, Ken T. Trotman *

School of Accounting, The University of New South Wales, Sydney 2052, Australia

Abstract

A common approach to set transfer prices is via intra-firm negotiation. However, Luft and Libby [Luft, J. L., &Libby, R. (1997). Profit comparisons, market prices and managers’ judgments about negotiated transfer prices. The

Accounting Review, 72(2), 217–229] found that because of the existence of self-serving biases, negotiating managers havedifferent expectations regarding what constitutes a ‘fair’ transfer price, leading to a less efficient negotiation process. Inthis study, we examine two factors that are expected to affect managers’ transfer price negotiation judgments, namely,framing as a gain or as a loss and the negotiation partner’s objective (whether the partner’s objective involves high orlow concern-for-others). We propose that these two factors affect managers’ perceptions of the negotiation context, andthus the way they interpret the economic and social consequences of accounting information. Our results show that aloss frame (compared to a gain frame) exacerbates managers’ self-serving biases and increases the ‘transfer price expec-tation gap’ between buyers and sellers. Further, in our experiment where market price is higher than equal-profit price,we find that managers’ transfer price expectations are lower (and deviate more from the prevailing market price) whenthey are negotiating with a partner with high concern-for-others than with a partner with low concern-for-others. Wediscuss the broader implications of these results for the design of management accounting systems.Crown Copyright � 2008 Published by Elsevier Ltd. All rights reserved.

Introduction

Negotiation is a common method used by firmsto set transfer prices (Ghosh, 2000). Even where anexternal market exists, transfer price negotiation is

0361-3682/$ - see front matter Crown Copyright � 2008 Published bdoi:10.1016/j.aos.2008.01.002

* Corresponding author. Tel.: +61 2 9385 5831; fax: +61 29662 4491.

E-mail address: [email protected] (K.T. Trotman).

a potentially useful control mechanism, allowing abalance between economic considerations andbroader social concerns by interdependent divi-sions (Kachelmeier & Towry, 2002). These transferprice negotiations are important to managers asthey influence both their own and other divisionalprofits. Previous research has shown that thesetransfer prices are affected by both economicfactors (market prices) and behavioural factorsincluding fairness (Luft & Libby, 1997).

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L. Chang et al. / Accounting, Organizations and Society 33 (2008) 704–717 705

In the current study, we examine whether theimpact of accounting information on managers’transfer price expectations are moderated by theway accounting information is framed (either aspotential gains or potential losses) and the man-ager’s perception of the other negotiation party’sobjective (whether their partner’s objectiveinvolves high or low concern-for-others). Theseexpectations are important as they directly affectthe costs and outcomes of negotiations (Ghosh,2000; Luft & Libby, 1997; Trotman, Wright, &Wright, 2005).

Previous negotiation literature has shown theimportance of ‘fairness’ during negotiation andthat participants’ estimates of a fair price displaya ‘self-serving bias’ (or egocentrism). The self-serv-ing bias refers to the cognitive bias arising from anindividual’s tendency to view an outcome morefavourable to them as being fairer when resolvingconflicts1 (Thompson & Loewenstein, 1992). Spe-cifically, where an active external market exists,and the market price is greater than a price thatwould lead to both divisions receiving an equalprofit, a seller will generally consider the marketprice to be a fairer transfer price as it results in ahigher profit for the selling division. The buyer,however, would view the transfer price that allowsprofit to be equally shared between the two divi-sions as a fairer price (Luft & Libby, 1997).

Both Luft and Libby (1997) and Kachelmeierand Towry (2002) found that where market pricediffered from the equal-profit price, managers basedtheir transfer price judgments on both the marketprice and the equal-profit price. Furthermore, bothstudies found that sellers and buyers placed differ-ent weights on these two reference points when for-mulating judgments. Specifically, due to self-serving biases, sellers’ transfer price expectationswere closer to the market price than that of the buy-ers, while buyers’ expectations were closer to theequal-profit price. One likely effect of a ‘transferprice expectation gap’ between buyers and sellers

1 This is in contrast with ‘self-interest’, which refers to anegotiator’s motivation to advance their own outcomes. Indi-viduals with a high level of self-interest do not necessarily havea biased view of what constitutes a fair outcome; rather, theyare motivated to achieve a favourable outcome for themselves.

is a prolonged and inefficient negotiation process.While this may be avoided by the intervention oftop management to mediate any inter-divisionaldispute, such an approach would undermine theautonomy of decentralised divisional managers.Instead, if we have a better understanding of thosefactors that influence managers’ transfer price judg-ments, we may be able to overcome managers’biases by re-designing the negotiation process.

Prior research in psychology suggests that thekey to understanding how managers make negoti-ation judgments is to examine the way in whichmanagers define their negotiation context, andtheir perception of variables that are critical andendogenous to the negotiation process (Bazerman,Curhan, Moore, & Valley, 2000; Ghosh & Boldt,2004; Kristensen & Garling, 1997; Neale & Bazer-man, 1992). Neale and Bazerman (1992) in partic-ular have argued that:

‘‘Rather than focus only on external factors[to the negotiation process], it may be mostuseful to view situations from an interpretiveperspective. It may not be the objective,external aspects of the situation that directlyaffect negotiator judgment; instead, it may bethe way that the negotiator perceives these

features and uses those perceptions to inter-

pret and screen information.” (Neale & Bazer-man, 1992, p. 161, emphasis added).

Two factors that are of particular interest in thecurrent study are the goal frame adopted by man-agers, which affects the way managers perceive thenegotiation outcome, and the negotiation part-ner’s objective (also called ‘social concern’) whichaffects the way managers perceive the negotiationpartner. Both of these variables are found to beimportant in the psychology and economics litera-ture (e.g. Kahneman & Tversky, 1979; Lewicki,Saunders, & Barry, 2005; Neale & Bazerman,1992; Roth, 1995), but are generally controlledfor rather than manipulated in prior accountingstudies. For example, both Luft and Libby(1997) and Kachelmeier and Towry (2002)adopted a consistent positive goal frame in all theirtreatments, and controlled for negotiation part-ners’ objectives by telling their participants that apositive relationship existed between negotiators.

706 L. Chang et al. / Accounting, Organizations and Society 33 (2008) 704–717

We extend these earlier studies by examiningthe impact of these variables on managers’ self-serving biases in a transfer pricing setting. Thereare benefits in studying these two variables simul-taneously. We suggest that the reason the lossframe affects negotiation judgments is because itcauses managers to become more concerned abouttheir own outcome (not to incur any furtherlosses), exacerbating their self-serving bias. Theirnegotiation partner’s objective also is expected toinfluence the level of concern managers have fortheir own outcome. For example, a perception thatthe negotiation partner has high concern-for-oth-ers causes managers to be more willing to giveup some of their divisional profit and accept a lessfavourable transfer price. By using both cognitiveand social lenses together, we attempt to obtaina more unified understanding of how the negotia-tion process works and eventually, how to over-come barriers to effective negotiation.

The study of these variables is important becauseof their implications both for transfer pricing andfor their impact more generally on systems and pro-cesses in decentralised organisations that use man-agement accounting information. Transfer pricenegotiations, in particular, allow business unit man-agers to utilise and share their local knowledge(Dikoli & Vaysman, 2006) and maintain inter-divi-sional coordination while preserving autonomy(van Helden, van der Meer-Kooistra, & Scapens,2001). The cost of negotiation, however, is not neg-ligible, and the negotiation approach to transferprice determination is only recommended whenthe cost of bargaining is relatively low (Dikoli &Vaysman, 2006).2 A number of accounting studies(e.g. Kachelmeier & Towry, 2002; Luft & Libby,1997) have demonstrated that the self-serving biasis one factor that can reduce the accuracy of manag-

2 In addition, while the perception of a ‘fairer’ outcome canresult in a more positive feeling at the end of the negotiationprocess (Lewicki et al., 2005), this perception may have negativeconsequences for firms as divisions use ‘profit equality’ as anargument for ‘fairer’ outcomes. As the gap between equal-profitprice and market price grows bigger, the pursuit of profitequality may give rise to an ‘internal socialism’ problem wherefirms inefficiently try to equalise divisional performance (Bolton& Scharfsein, 1998). The resultant impact is the distortion ofprofits as a result of managers’ pursuit of profit equality.

ers’ transfer price judgments and thus potentiallyincrease the time and costs of negotiation. Anunderstanding of framing and negotiation partner’sobjective also has wider implications for the man-agement accounting literature and these implica-tions are included in our ‘Discussion’ section.

In summary, our study makes a number of sig-nificant contributions to the accounting literature.First, we extend the Luft and Libby’s (1997)results by investigating the influence of managers’perception of the negotiation context on transferprice judgments. We specifically address the roleof framing and the negotiation partner’s objective.The first factor is directly controllable by manage-ment accountants. For example, managementaccountants can produce reports based on alterna-tive negotiating reference points to support aseller–manager involved in a transfer price negoti-ation. When the market price is used as a referencepoint, the management accounting reports arelikely to highlight the potential loss in profit asthe negotiated transfer price falls below the marketprice (Perera, McKinnon, & Harrison, 2003). Thiswill lead to the negotiating manager adopting aloss frame. Alternatively, the reports can use prod-uct costs as a reference point, focusing on the gainsin profit as the negotiated transfer price movesabove the product costs (Colbert & Spicer, 1995).This is likely to cause the negotiating manager toadopt a gain frame.

Second, the importance of social considerationswas highlighted by both Luft and Libby (1997) andKachelmeier and Towry (2002) when they foundevidence of the effect of fairness concerns on trans-fer price judgments. Building on this research, wedemonstrate, in a situation where market pricesare above equal-profit prices, that managers expectthe final transfer price to be lower when they aredealing with a partner with high concern-for-othersthan when negotiating with a partner with low con-cern-for-others.3 This is because managers tend to

3 In this study, we use an example where market price isabove the equal-profit price and therefore concern-for-othersresults in transfer prices below market prices. We note thatdirection of the difference between market price and transferprice would reverse if the market price given in an experimentwas lower than the equal-profit price.

4 The prevailing market price is often perceived as a fairtransfer price because it is the result of ‘impartial’ market forcesof supply and demand. On the other hand, a fair price can alsobe defined as one that provides equal profit to both negotiatingdivisions (i.e. the equal-profit price). The concept of equal-profit price is likely to be particularly salient in the internaltransfer price negotiation process, where the negotiating man-agers belong to the same company, and inter-divisional equitybecomes an important concern.


reciprocate the perceived social concerns of theirnegotiation partner. The lower price, however, isalso further from the market price which has impli-cations for production divisions that depend on thetransfer price and may have longer term implica-tions if managers are put under increased pressureto reach profit targets. Deviations from the marketprice also have potential negative implications onintra-organisational resource allocation (Bolton &Scharfsein, 1998). As noted by Sprinkle (2003), itis important to study the extent to what socialmotives, and other aspects of a firm’s informationsystems, interact with the more formal accountingsystems to affect managerial behaviour. Our resultsimply that these two factors significantly influencethe way managers make use of accounting informa-tion when making transfer price judgments.

Third, our study extends the existing literatureby examining the impact of the above variableson two dimensions of transfer pricing judgments:a reservation price and a price premium (i.e. thedifference between the reservation price and theestimated transfer price). Our results show that aloss frame increases the sellers’ reservation price,and thus eventually their final transfer price judg-ment. In contrast, negotiation partner’s objectivedid not affect reservation price judgment, butrather, we found that sellers who perceived theirpartner to have a high level of concern-for-otherswere more willing to accept a lower price premium.

Finally, inter-divisional negotiation (such astransfer price negotiations) is an important controlmechanism that balances divisional autonomywith inter-divisional coordination (van Heldenet al., 2001). Our study extends the growing litera-ture on improving negotiation outcomes inaccounting/auditing situations (Bame-Aldred &Kida, 2007; Gibbins, McCracken, & Salterio,2005; Gibbins, Salterio, & Webb, 2001; Ng &Tan, 2003; Trotman et al., 2005) to the manage-ment accounting arena, and in doing so, contrib-utes to our understanding of the challenges facedby decentralised organisations.

Literature review and hypotheses development

Conventional economic arguments suggest thattransfer price judgments should be based on ‘eco-

nomically rational’ concerns such as the marketprice, transaction costs and the division’s coststructure (e.g. Colbert & Spicer, 1995). However,prior literature in psychology has demonstratedthat negotiators do not always act ‘rationally’.Rather, they suffer from a number of judgmentalbiases, such as anchoring their decisions on irrele-vant information, and the escalation of commit-ment (e.g. Bazerman & Neale, 1992; Neale &Bazerman, 1992; Northcraft & Neale, 1987).

In the accounting literature, Luft and Libby(1997) have shown that, during transfer price nego-tiation, sellers’ estimates of negotiated transferprices tend to be significantly higher than those ofbuyers, particularly when the market price is higherthan the equal-profit price. Luft and Libby (1997)argue that their finding demonstrates the existenceof a ‘self-serving bias’, which causes managers tooverweigh the negotiation outcome that is mostbeneficial to them (Luft & Libby, 1997; Thompson& Loewenstein, 1992). Thus, where more than onedefinition of a ‘fair’ transfer price exists (e.g. in theLuft & Libby, 1997 study, where market price washigher than the equal-profit price),4 negotiatingmanagers will interpret fairness in ways that favourtheir position, such that the transfer price estimatesby sellers are significantly higher than the transferprice estimates by buyers. Before developing ourhypotheses we first replicate the baseline conditionestablished in Luft and Libby (1997) on the differ-ence in transfer price judgments between sellersand buyers resulting from the self-serving bias.

H1: Sellers’ estimated final transfer prices arehigher than buyers’ estimated final transferprices.

‘Frames’ are subjective cognitive systemsthrough which individuals evaluate and make sense

6 As we do not manipulate or provide information about thenegotiation partner’s frame, buyers and sellers may not be


of situations they are in. Different frames adoptedcan lead individuals to pursue or avoid subsequentactions (Lewicki et al., 2005). Traditionally, negoti-ation literature has focused on the effect of ‘riskpreference framing’ (Bottom & Studt, 1993; Kahn-eman & Tversky, 1979; Neale & Bazerman, 1985;Thaler, 1992) – a framing effect characterised by achoice between outcome certainty and a more riskyalternative. The underlying decision valence is thenmanipulated, such that a loss frame is representedby uncertainties surrounding a negative conse-quence, and a gain frame is represented by uncer-tainty surrounding a positive consequence.5

For example, Neale and Bazerman (1985) inves-tigated the risk frame in a management/unionnegotiation by either telling the participants thatany concessions made by the company will resultin significant financial losses (loss frame), or anyconcessions from the union will result in significantfinancial gains (gain frame). All impasses were tobe referred to an arbitrator, and as the arbitrator’sfinal decision was unknown, this presented theparticipants with a risk element. Inter alia, theyfound that compared to negotiators with gainframes, negotiators with loss frames were morelikely to have their agreements determined by thearbitrator (i.e. they chose the riskier option). Theyalso found that compared to gain framed negotia-tors, loss framed negotiators were less likely tomake concessions.

In this study, we examine the framing role ofaccounting information, and how this affects man-agers’ transfer price judgments. Our focus is onusing accounting information to frame the negoti-ation goal. We propose that because managers aremore concerned with avoiding losses than increas-ing gains both buyers and sellers are more likely tofocus on maximising their divisional profit whengiven a loss frame compared to a gain frame. This

5 While the major emphasis in the framing literature hascentred on the standard risky choice framing affect introducedby Kahneman and Tversky (1979) and Tversky and Kahneman(1981), Levin et al. (1998) developed a typology to distinguishbetween risky choice framing, attribute framing and goalframing. Levin, Schneider, and Gaeth (1998) suggest that thedifferent operational definitions of framing have effects that relyon different psychological processes.

greater concern for achieving their own outcome islikely to further increase the transfer price judge-ment gaps between buyers and sellers.

Prior literature on motivated reasoning suggeststhat a higher level of motivation to achieve an out-come can lead people to overestimate the probabil-ity that a favourable outcome will eventuate(Brownstein, 2003). Further, motivated reasoningalso distorts people’s perception of others, suchthat they tend to expect others to behave in away that results in favourable outcomes (Kunda,1990). In the context of a negotiation, we predictthat the loss framed managers’ greater concernfor maximising their divisional profit will causethem to overestimate the likelihood that their part-ner will take their view of what constitutes a fairprice, and thus agree on a transfer price morefavourable to them. Specifically, sellers (buyers)with a loss frame are more likely to believe thattheir partner will agree on a higher (lower) pricebeing a fair transfer price, compared to sellers witha gain frame. As such, we predict that a loss framewill increase negotiators’ self-serving biases.

In addition, as loss framed managers becomemore motivated to achieve a better outcome, theymay be more willing to incur greater bargainingcosts compared to gain framed managers. In theabsence of any information about their partner’snegotiation frame (and thus the level of their part-ner’s motivation), the loss framed managers are alsolikely to expect their willingness to incur greaterbargaining costs will lead to a more favourable out-come. As such, we predict that the transfer pricejudgement gap between buyers and sellers is greaterunder the loss frame than the gain frame condition.6

making the same transfer price predictions. For example, theseller in the loss frame is predicting the price that a loss framedseller and a buyer with unknown or neutral frame willnegotiate, whereas the buyer in the loss frame is predictingthe price that a loss framed buyer and a seller with an unknownor neutral frame will negotiate. Even if both buyers and sellersassume the same (e.g. neutral) frame for their negotiationpartner, the differences in transfer price predictions by sellersand buyers are still not necessarily all self-serving bias and may,in fact, be partially due to the lack of information about theirnegotiation partner’s frame.

7 The reciprocity principle has also recently been introducedinto the audit literature in audit–client negotiations (Sanchez,Agoglia, & Hatfield, 2007; Tan & Trotman, 2007).


H2: The difference in estimated final transferprice between buyers and sellers is smaller wheninformation provided to negotiating managersis framed as gains rather than losses.

A number of prior studies have suggested thatsocial concerns influence transfer price negotiationjudgments (e.g. Kachelmeier & Towry, 2002;Luft & Libby, 1997). Both Luft and Libby (1997)and Kachelmeier and Towry (2002) found thatwhile economic rationality would dictate thatnegotiators should expect market-based transferprices, negotiators have an aversion to unequalprofits. While they attributed this aversion tonegotiators’ concerns about profit sharing andensuring both divisions receive satisfactory profits,the impact of social concern was not directlytested. In this study, we seek to directly examinethe effects social concerns have on transfer pricejudgements.

We propose that managers’ concerns aboutunequal profits and therefore their transfer pricejudgments may be affected by the perception theyhave of their negotiation partner (i.e. the otherparty to the negotiation process). In particular,during negotiation, managers would try to gaugetheir partner’s objective, and then combine thisinformation with their own negotiation objectivewhen formulating their transfer price judgments(e.g. Carroll, Bazerman, & Maury, 1988; Lewickiet al., 2005).

An established framework used to explain anegotiator’s objective is the ‘dual concern model’(e.g. Lewicki et al., 2005; Pruitt, 1983; Sorenson,Morse, & Savage, 1999). This framework postu-lates that a negotiator’s objective is influenced bytwo independent types of concerns: concern fortheir own outcomes (‘concern-for-self’) and con-cern for the other party’s outcomes (‘concern-for-others’). Our focus in the current study is ona manager’s perception of their partner’s degreeof concern-for-others. Our manipulation of thisvariable is consistent with large variations of con-cern-for-others in transfer pricing situations; forexample, the level of concern for the profits ofother divisions is likely to vary in organisationsthat are quasi-markets compared to quasi-families(Eccles, 1985, pp. 273–278).

Following the suggestion in previous research(Kachelmeier & Towry, 2002; Luft & Libby,1997), in situations where the market price ishigher than the equal-profit prices, that this con-cern-for-others results in transfer prices belowmarket prices, we predict that when the level ofconcern-for-others is stronger, both buyer andseller will expect the price to be lower. We notethat this prediction only holds for situations wherethe market price is higher than the equal-profitprice, which is the case in our experiment.

The above prediction particularly applies whenthe level of concern is similar for both negotiatorsin the pair. While we only manipulate the level ofconcern-for-others for the negotiation partner, wesuggest this is likely to result in a similar level ofconcern for the negotiating manager for two rea-sons. First, the psychology literature refers to the‘reciprocity’ principle as a social norm by whichan individual who acts in a certain way will expecta similar return action (e.g. Maxwell, Nye, & Max-well, 2003).7 The norm of reciprocity thereforeestablishes expectations about how one is tobehave in social interactions (Maxwell et al.,2003). Prior research has consistently found thatnegotiators have a tendency to reciprocate negotia-tion motives of their negotiation partners (Maxwellet al., 2003). Therefore, negotiating managers whoperceive that their negotiating partner has highconcern-for-others will reciprocate with a similarobjective, showing high concern for profit sharing,In contrast, negotiating managers who perceivethat their partner has low concern-for-others areexpected to reciprocate by showing low concernfor profit sharing.

Second, organisations differ in the types ofemployee behaviours that are considered accept-able. For example, our low concern-for-othersmanipulation would be acceptable in some organ-isations but clearly unacceptable in other organisa-tions. By informing a participant about thenegotiation partner’s concerns-for-others we alsotell participants something about the culture ofthe organisation. Specifically, our manipulation


of concern-for-others involves providing partici-pants with a memo from their negotiation partner.In the low concern-for-others treatment, the memoincludes references to ‘maximising profit of mydivision’ which also communicates to the otherparty that this is accepted practice in this organisa-tion. In contrast, in the high concern-for-otherstreatment, the culture encourages both divisionsto receive satisfactory profits and therefore bothparties would expect a lower price.

H3: Managers’ estimated transfer prices arelower when they are negotiating with a partnerwith high concern-for-others than when theyare negotiating with a partner with low con-cern-for-others.

Research methods

Research designA controlled laboratory experiment was con-

ducted to test the proposed hypotheses, using a2 � 2 � 2 between-subjects design. The three inde-pendent variables were the negotiating manager’srole (participants acting as either a buyer or aseller), goal frame (gain frame or loss frame) andthe negotiation partner’s objective (high or lowconcern-for-others).

Experimental task

The experimental task was modified8 from Luftand Libby’s (1997) instrument, where participantsassumed the role of a manager who is responsiblefor negotiating a transfer price of component‘Parts’. ‘Parts’ are components sold by the PartsDivision to the Assembly Division, which can thenbe processed further by the Assembly Division and

8 Two main modifications were made to the Luft and Libby(1997) instrument to accommodate two of our variables ofinterest (discussed in more detail later). A pilot test was thenconducted (with 21 undergraduate accounting students) toensure that our modifications were understood by our partic-ipants and that the independent manipulated variables had theintended effects. As a result of the pilot test, and discussionswith pilot test participants post-experiment, further minormodifications were made.

then sold to an external customer. As the two divi-sions are autonomous, both divisional managersare free to negotiate a mutually acceptable transferprice or to trade externally at the prevailing mar-ket price (which was set at $70 per unit).9 The coststructures of the two divisions were designed suchthat the equal-profit price was $50.10 Included inthe task was a profit schedule illustrating the profitimplications of a range of transfer prices for bothparties (between $20 where the profit for sellerswas zero, and $80 per unit, where the profit forbuyers was zero). Both buyers and sellers werethen asked to predict the final negotiated transferprice and the sellers’ reservation price.

Independent variables

The negotiation role was manipulated by ran-domly assigning participants either to the role of‘Parts Manager’ (i.e. seller) or ‘Assembly Man-ager’ (i.e. buyer). The goal frame was operationa-lised by ‘framing’ the instructions provided in theinstrument either as a gain frame or a loss frame.Specifically, instructions provided to Assemblymanagers (the buyers) assigned a gain frame wereas follows:

‘‘As you can see from the table, for every $5decrease in transfer price you stand to gain$5000 profit. For example, by negotiating atransfer price of $55, your profit is $25,000.But if you negotiate a lower transfer price,say, $50, your profit is $30,000, which meansthat you have gained $5000 profit. In otherwords, as you settle for a lower transferprice, you stand to gain profit for your divi-sion in $5000 increments.”

9 The current task focuses on a ‘distributive’ (‘fixed pie’)negotiation task, that is, the managers are negotiating in a win–lose situation where their goals are in direct conflict.10 Specifically, based on Luft and Libby’s (1997) scenario, the

value of the shipment of ‘Parts’ to the Assembly Division was$80 per unit; while the value (or cost) to the Parts Division was$20 per unit. This means that the profit for the Assemblydepartment was ($80 less negotiated transfer price); while theprofit for the Parts Division was (transfer price less $20). Thus,at a transfer price of $50 per unit, both divisions would obtain aprofit of $30 per unit.

A: Profit schedule for Assembly managers (i.e. buyers)/Gain frame information

Transfer price for Parts 80 75 70 65 60 55 50 45 40 35 30 25 20

PARTS profit ($000) 60 55 50 45 40 35 30 25 20 15 10 5 0

ASSEMBLY profit ($000) 0 5 10 15 20 25 30 35 40 45 50 55 60

B: Profit schedule for Assembly managers (i.e. buyers)/Loss frame information

Transfer price for Parts 20 25 30 35 40 45 50 55 60 65 70 75 80

PARTS profit ($000) 0 5 10 15 20 25 30 35 40 45 50 55 60

ASSEMBLY profit ($000) 60 55 50 45 40 35 30 25 20 15 10 5 0

Fig. 1. Sample profit schedules provided to experimental participants.

11 Luft and Libby (1997) pointed out that negotiated transferprice is a more sensitive measure of potential conflict, whilereservation price is more sensitive to managers’ mistakenjudgments about their negotiation partner. As we are primarilyinterested in the former (i.e. the effect of managers’ perceptionon their expectations of how the ‘negotiation conflict’ would beresolved), our primary analysis will focus on estimated finaltransfer prices.


For participants assigned a loss frame, thedescription explained how every $5 change in thetransfer price would result in the division losing

$5000. Further, participants were also providedwith a schedule of profit framed either as profitincreases or profit decreases as the transfer pricechanged (refer to Fig. 1).

To manipulate the negotiation partner’s objec-

tive, participants were provided with a fictitiousmemo indicating their negotiation partner’s levelof concern-for-others. Participants assigned tothe ‘high concern-for-others’ conditions were givena memo stressing their partner’s desire for mutualconcession and maximising profit for both divi-sions. In contrast, participants in the ‘low con-cern-for-others’ conditions were given a memoemphasising their partner’s desire to maximiseprofit for their own division only and their unwill-ingness to make concessions. For example, thememo from a partner with low concern-for-othershighlighted their intention to ‘‘. . .achieve the bestprofit for my division . . . if you are unwilling tomake concessions, I am prepared to tradeexternally.”

Dependent variablesWe measured the dependent variable, manag-

ers’ estimated negotiation prices, by asking partic-ipants to predict the final transfer price of thenegotiation process. In addition, participants werealso asked to indicate the expected lowest pricethat sellers would likely to be willing to accept

(i.e. seller’s reservation price).11 Consistent withLuft and Libby (1997), to minimise the timerequired for data collection we did not ask partic-ipants to estimate buyers’ reservation price.

Participants

One hundred and twenty-eight participants vol-unteered to participate in this experiment. All par-ticipants were enrolled in a Master of Commercedegree or Master of Business Technology at oneAustralian university, and each had at least twoyears of full time work experience. However, 32participants failed one or more post-experimentmanipulation tests and were later excluded fromthe analysis, resulting in 96 usable responses. Thecell sizes for each of the eight treatment group var-ied between 11 and 15 (see Table 1).

Manipulation check and post-test measures

After participants completed the negotiationtask, they were given three manipulation checks.The first asked participants to indicate what rolethey played in the negotiation (i.e. whether they

Table 1Means (standard deviation) of estimated final transfer price ($)

Partner’s objective Frame total Total

High concern-for-others Low concern-for-others

Gain frame Loss frame Total Gain frame Loss frame Total Gain frame Loss frame

Sellers 58.64 61.92 60.42 62.50 65.50 64.30 60.48 63.84 62.40(7.10) (8.04) (7.65) (9.50) (6.96) (7.89) (8.35) (7.44) (7.93)n = 11 n = 13 n = 24 n = 10 n = 15 n = 25 n = 21 n = 28 n = 49

Buyers 57.69 52.73 55.42 60.30 56.92 58.39 58.83 55.00 56.87(8.32) (10.57) (9.55) (7.51) (10.52) (9.29) (7.91) (10.53) (9.44)n = 13 n = 11 n = 24 n = 10 n = 13 n = 23 n = 23 n = 24 n = 47

Column total 58.13 57.71 57.92 61.40 61.52 61.47 59.61 59.76 59.69(7.63) (10.21) (8.92) (8.41) (9.56) (9.01) (8.01) (9.95) (9.09)n = 24 n = 24 n = 48 n = 20 n = 28 n = 48 n = 44 n = 52 n = 96

Table 2ANOVA model for estimated transfer price – H1 and H2

DF MS F p

Negotiator’s role 1 644.11 8.71 0.00a

Partner’s objective 1 298.70 4.04 0.02Frame 1 6.22 0.08 0.39Role * objective 1 0.60 0.01 0.46Role * Frame 1 315.05 4.26 0.02b

Objective * frame 1 2.49 0.03 0.43Role * objective * frame 1 5.16 0.07 0.40Error 88 73.93

Negotiator role – participants acting as either a buyer or aseller.Partner’s objective – either high or low concern-for-others.Frame – accounting information presented in either a gain or a

loss goal frame.a The significant main effect of negotiator’s role provides

support for H1.b The significant interaction effect between frame and role

provides support for H2.


were acting as a Parts manager or an Assemblymanager). The second asked participants to indi-cate whether their negotiation partners were inter-ested in maximising both divisions’ profits, or onlytheir own division’s profit. The third asked partic-ipants to indicate whether the case material statedthat ‘‘for every $5 increase in transfer price youstand to lose $5000 profit”, or ‘‘for every $5decrease in transfer price you stand to gain$5000 profit”.12

Results

Hypothesis testing

The descriptive statistics for estimated transferprice are summarised in Table 1, and a 2 � 2 � 2ANOVA model, with estimated transfer price asthe dependent variable, is presented in Table 2.As can be seen from Table 1, and consistent withH1, the average estimated transfer price washigher for sellers (62.40) than for buyers (56.87).This difference (the main effect of role) is statisti-cally significant (F = 8.71, p = 0.00), thus H1 issupported.

H2 predicted that the difference in estimatedtransfer prices between buyers and sellers wouldbe smaller when potential negotiation outcomesare framed as gains rather than losses. The descrip-

12 56% of the manipulation test errors related to the framingeffect. All statistical tests were re-run after including partici-pants who failed the manipulation tests, and all resultsremained statistically the same.

tive statistics in Table 1 further indicate that thedifference in estimated transfer prices between sell-ers and buyers under the gain frame condition(60.48 � 58.83 = 1.65) was lower than that underthe loss frame condition (63.84 � 55.00 = 8.84).This difference is shown in Table 2 as a significantinteraction effect between role and goal frame(F = 4.26, p = 0.02), thus H2 is supported.

H3 examined the effect of the negotiation part-ner’s objective on managers’ transfer price judg-ments. In H3, we expected the negotiationpartner’s objective to have a main effect, whereboth buyers’ and sellers’ transfer price expecta-tions would be lower if they were negotiating with


a partner with high concern-for-others than if witha partner who had low concern-for-others. Theoverall ANOVA model as shown in Table 2confirmed our expectation (significant main effectfor negotiation partner’s objective, F = 4.04, p =0.02) thus, H3 is supported.

Additional analysis

We also conducted additional analyses to delin-eate the effect of goal framing and the negotiationpartner’s objective on two elements of managers’transfer price judgments: the reservation priceand the difference between the reservation priceand the estimated transfer price (which we referto as ‘price premium’). The reservation price (alsoknown as the resistance point) represents the min-imal price sellers are willing to accept from thetransaction (e.g. for sellers, this means the minimalacceptable price – Lewicki et al., 2005). In con-trast, the price premium reflects the extent to whichnegotiators expect to achieve their desired out-come. That is, the price premium incorporatesnegotiators’ anticipation of the concession theywill make during the offer–counteroffer process innegotiation. The descriptive statistics of thesetwo variables are shown in Tables 3 and 4.

Table 3Additional analysis – sellers’ reservation prices

Partner exhibits high concern-for-others

Panel A: Means (standard deviation) of sellers’ reservation prices

Gain frame 52.27(7.20)n = 11

Loss frame 56.15(8.20)n = 13

Total 54.38(7.85)n = 24

DF

Panel B: ANOVA model a (dependent variable = sellers’ reservation pPartner’s objective 1Frame 1Partner’s objective * frame 1Error 43

a Two outliers were excluded from this analysis. One outlier was exhigher than the expected transfer price. A second outlier was exclustandard deviations away from the mean.

Table 3 Panel A indicates that on average sell-ers’ reservation price was $54.04, which was higherthan the equal-profit price of $50.00 (significantwith one-sample t-test, t = 2.464, p = 0.01). Thisis consistent with our expectation that sellers ingeneral would not consider the equal-profit priceas a fair outcome of negotiation. Instead, theirminimum acceptable price was significantly higher.

Table 3 (Panel A) also shows that compared totheir gain frame counterparts, sellers in the lossframe condition reported a higher reservationprice ($56.54 vs. $50.71). The main effect for goalframe in the ANOVA reported in Table 3 PanelB shows that this difference is statistically signifi-cant (F = 6.33, p = 0.02). Consistent with our ear-lier argument, this finding suggests that a lossframe focuses individuals on a goal of avoidingnegative consequences, thus increasing their ‘resis-tance point’ to an unfavourable transfer price,which results in a higher expected reservationprice. Neither negotiation partner’s objective(F = 0.01, p = 0.94) or the interaction with fram-ing (F = 1.06, p = 0.31) are significant for reserva-tion price.

Table 4 reports the descriptive statistics andANOVA results for the sellers’ price premium. A

Partner exhibits low concern-for-others Total

49.00 50.71(16.13) (12.07)n = 10 n = 2156.87 56.54(12.51) (10.55)n = 15 n = 2853.72 54.04(14.29) (11.48)n = 25 n = 49

MS F p

rice)0.56 0.01 0.94

641.74 6.33 0.02107.86 1.06 0.31101.40

cluded because the subject reported a reservation price that wasded because the reported reservation price was greater than 3

Table 4Additional analysis – sellers’ price premium

Partner exhibits high concern-for-others Partner exhibits low concern-for-others Total

Panel A: Descriptive statistics – sellers’ transfer price premium

Gain frame 6.36 13.50 9.76(6.36) (10.55) (9.15)n = 11 n = 10 n = 21

Loss frame 5.77 8.63 7.30(6.41) (8.09) (7.37)n = 13 n = 15 n = 28

Total 6.04 10.58 8.36(6.25) (9.27) (8.18)n = 24 n = 25 n = 49

DF MS F p

Panel B: ANOVA model a (dependent variable = price premium)Partner’s objective 1 166.08 3.24 0.08Frame 1 107.29 2.10 0.16Partner’s objective * frame 1 129.70 2.53 0.12Error 43 51.21

a Price premium = (sellers’ reservation price – transfer price estimate).


marginally significant main effect of the negotia-tion partner’s objective (F = 3.24, p = 0.08) sug-gests that sellers who were negotiating with ahigh concern-for-others partner expected to giveup a greater share of divisional profit during thenegotiation process and thus predicted a lowerprice premium compared to those who were nego-tiating with a partner with low concern-for-others.Neither framing (F = 2.10, p = 0.16) or the inter-action (F = 2.53, p = 0.12) are significant.13

Together, these results show that the goal frameand the negotiation partner’s objective have differ-ent effects on different aspects of managers’ trans-fer price judgments. Specifically, as individuals aremore resistant to avoiding losses than increasinggains, a loss frame increases the sellers’ reservationprice and eventually, their final estimated transferprice. On the other hand, the negotiation partner’sconcern-for-others provides the sellers with anindication of the potential offers/counteroffers dur-ing transfer price negotiation, thus influencing theprice premium the sellers expect on top of theirreservation price.

13 Due to the relatively small sample size, however, thestatistical inferences of our additional analysis should beinterpreted with care.

Summary and discussion

In this study, we examined whether managers’perceptions of potential negotiation outcomes(framed either as potential gains or potentiallosses) and of their negotiation partner (exhibitinghigh or low concern-for-others) affected self-serv-ing biases and consequently their transfer pricejudgments. We found that compared to a gainframe, a loss frame exacerbates managers’ self-serving biases and increases the transfer priceexpectation gap between buyers and sellers.

Further, we found that the negotiation part-ner’s objective had a significant impact on sellers’transfer price judgments. Consistent with the‘norm of reciprocity’, our results show that, in sit-uations where market prices are higher than equal-profit prices, managers reciprocated their partner’sconcerns and expected lower transfer prices whentheir negotiation partner exhibited high concern-for-others, and expected higher transfer priceswhen their negotiation partner exhibited low con-cern-for-others. This finding is particularly inter-esting as sellers in our experiment had relativelystrong bargaining power but these sellers did notexploit their bargaining power by demanding hightransfer prices regardless of their partner’s level ofconcern-for-others. Instead, we found that sellers

14 Framing is also important in capital investment analysis asfinancial outcomes can be presented in terms of profits or losses(e.g. Moreno, Kida, & Smith, 2002).


were sensitive to their partner’s objective, and weremore willing to accept a less advantageous out-come if their partner showed high concern-for-others.

The additional analysis suggests that goal fram-ing and the negotiation partner’s objective havedifferent impacts on managers’ negotiation judg-ments. When we decompose the transfer pricejudgments into two subcomponents: the reserva-tion price and a price premium, we found thatthe loss frame resulted in managers reporting ahigher reservation price. On the other hand, man-agers’ perception of their partner’s objective hadsignificant impact on their price premiums.

Our study has important implications for bothresearchers and practitioners. Prior research hasshown that negotiating managers suffer from self-serving biases, which result in a significant differ-ence in expected transfer prices between buyersand sellers. We extended this line of research byexamining how these differences in transfer priceexpectations are affected by managers’ perceptionsof the negotiation context. Understanding manag-ers’ transfer price expectations is important, as dif-ferences in expectations between buyers and sellerscan lead to prolonged disputes and thus a costlynegotiation process (Luft & Libby, 1997).

Our findings that the provision of loss framedinformation increases the buyer–seller expectationgap can also have a significant impact on organisa-tions. We note that systems and processes usingmanagement accounting can either inadvertentlyor by design cause managers to adopt differentframes. For example, practitioner literature oftenadvocates the use of customer profitability infor-mation to support customer negotiation (Kaplan& Cooper, 1998) and negotiators may be given a‘‘price menu” listing a range of service levels andtheir associated costs (Kaplan & Anderson,2007). In such circumstances, managementaccounting information can be presented in away that induces either a gain frame or a lossframe. Specifically, management accountingreports can either describe the incremental costincreases with each service level (e.g. incrementalcost of $500 every time a customer requests anadditional sales visit), or the incremental cost sav-ings (e.g. incremental costs savings of $500 per

sales visit reduced). The former is likely to inducea loss frame and the latter a gain frame.14

The practitioner’s ‘self-help’ literature on nego-tiation often discusses the importance of buildingrapport and affiliation at the negotiation table(Fisher & Shapiro, 2005). Our study providesempirical support for the importance of communi-cating a positive objective. Our results show thatmanagers expect a lower transfer price (closer tothe equal-profit price) when they perceive thattheir negotiation partners have high concern-for-others. Our results imply that showing highconcern-for-others (as opposed to showing lowconcern-for-others) can be effective in persuadingnegotiation opponents (especially sellers) to con-sider their perceptions.

Our additional analysis suggests that managers’perceptions of the negotiation outcomes and oftheir negotiation partners affect different aspectsof the negotiation process. This finding enhancesour understanding of how to ‘de-bias’ managers’self-biased transfer price judgments. By framingthe profit information differently we can encouragesellers to set a lower reservation price, and at thesame time, organisations can also attempt to pro-mote greater ‘concern-for-others’ among sellers sothat they are more likely to accept a lower ‘pre-mium’ on top of their reservation price. For exam-ple, incentive schemes that focus too much on the‘stick’ rather than the ‘carrot’ may increase dis-trust (Fehr & Gachter, 2000), potentially heightenmanagers’ concern-for-self relative to their con-cern-for-others, and thus reduce managers’ will-ingness to reciprocate positively duringnegotiation.

Similar to earlier studies on transfer price nego-tiation (Luft & Libby, 1997; Kachelmeier &Towry, 2002), our results demonstrate a strongdesire by participants to take fairness into accountwhen making transfer price judgments, such thatregardless of their role or the treatment, the resul-tant transfer price judgment is different from theexternal market price. On the other hand, Boltonand Scharfsein (1998) argue that the pursuit of


‘internal socialism’ can be costly, as decentralisedfirms sometimes try to equalise divisional profitat the expense of resource allocation efficiencies.Our results show that internal socialism is alsolikely to arise from inter-divisional negotiations,potentially adding to the costs of internaltransactions.

An understanding of framing and negotiationpartner’s objective has wider implications than justtransfer pricing given that other inter-divisionalnegotiation is common in decentralised organisa-tions. For example, a production manager mayneed to negotiate inventory management anddelivery policies with the marketing division; anda research and development (R&D) manager inone division may need to negotiate with the R&D manager in another division over resource allo-cation issues in collaborative projects (Coletti,Sedatole, & Towry, 2005).

The impact of these variables on negotiationsalso has implications for organisation design.For example, larger self-serving biases result inbigger errors in judging the outcome a bargainingpartner will accept in the end. These higher self-serving biases have been shown to have a nega-tive impact on reaching an agreement and createmore impasses (Babcock & Loewenstein, 1997;Gelfand et al., 2002). Consequently, as decentra-lised organisations rely more on negotiationbetween peers, if the setting is one where largeself-serving biases are likely to be present, thesedecentralised organisations will not work as effec-tively. They will require greater interventionsfrom headquarters and more hierarchical decisionmaking, thus making decentralisation more costlyand less effective.

Acknowledgment

We gratefully acknowledge a research grantfrom the Australian Research Council and thehelpful comments from Joan Luft, Sue Haka,Kim Langfield-Smith, Anne Lillis, Steve Salte-rio, Jane Baxter, Brian Burfitt and HabibMahama, as well as seminar participants at Uni-versity of Cincinnati, University of Melbourne,2006 AFAANZ Conference and 2005 EAAConference.

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