Tranfer Pricing and Agency Theory

Tranfer Pricing and Agency Theory

Performance management:

It is composed by objectives, that are achieved through programs, that are supported by technologies. There are different to objectives to achieve in single departments and areas: 1. Cost reduction

2. Quality improvement

3. Capacity improvement

Since there are a lot of objectives, we say that performance management is discursive. To manage the achievement of meeting these obj there are different programs: 1. Lean production (for cost reduction)

2. Total Quality Management, Manufacturing Excellence (for quality improvement) 3. Demand Chain Planning (capacity improvement)

Since all the objectives can be reached with different programs, we say that performance management is programmatic. Management technologies = managing accounting techniques. There are different costing systems/technologies implemented to support the programs: 1. Target costing, Activity Based Costing, Kaizen Costing 2. 6sigma

3. S&OP Process

We thus say that performance management is also technological.

Accounting numbers foster control at a distance. Everything becomes a number in the accounting report: we reduce the complexity of a real world in a 3D form into some 2D accounting reports. These 2D reports lead to “amplification”, caused by the fact that: * reports are mobile/transportable

* reports are combinable between each other in order to provide a more complete picture of the reality * numbers make everything manageable.

How are 2D reports used?

They can come from both paper and computer resources. They are used in every strategy: * Pricing strategy: they implement it through some cost analysis: if we look at the cost of a product, we would find that a significant part of the cost is constituted by R&D costs, that are fixed costs substained before the product is introduced therefore when the product is introduced it has high priced. Once the product is introduced, there will be low variable costs -> after the fixed costs have been covered by high prices, the price will decrease: for ex. iPhones. * Ex. Messi was moved from the left side of the soccer field to the right one because 2D reports were showing higher levels of scoring and passing successfully. In the old days we know that the process of producing a product is: R&D -> Distribution -> Production -> Costumer services. We are speaking of total product cost: they were pricing only the cost of production: raw materials, labor, indirect costs. Nowadays, we use the Activity Based Costing: we should calculate the cost of activities in each step of the process and include them all in the price.

AGENCY THEORY:

Everybody act in their own interest to maximize their utility. There are always two options to maximize utility: in the same indifferent curve, it’s all about switching preferences to obtain the same utility. In an organization: we have two kind of people: principals (resources owners) and agents (managers). They will both act to maximize their utility: * principals want to increase the share price -> to reach it they need to increase cash flows and profitability. * agents want an increase in their salary, improvement in working conditions, take home company properties or they don’t want to undertake investments. There is some lack of alignment between the interests of principals and agents. The agency theory says that to make sure that the interests are aligned, we need a contract. In a contract, there are many stipulations, especially performance measures (EVA, ROI, ROA). These performance measures are linked to compensations -> managers will act in such a way to improve cash flows and therefore the share price (which was the main interest of the principals) in order to gain higher compensations. There are two important problems:

* Adverse selection: they will be hidden information by agents before contracts are signed: before the contracting, agents have better private information than principals (ex. prospective employees exaggerate their abilities when being interviewed). * Moral hazard: it happens after the contracts are signed, since agents are willing to cheat in order to obtain higher compensations because the principal cannot readily observe deviations -> manipulation: agents have incentives to manipulate accounting reports. (ex. obtaining higher profits leads to a bonus for the agents: how do they manipulate the accounting reports to show profits? -> shirking: “move” sales order