The effect of framing and compensation structure on seller's negotiated transfer price.

The outcomes of negotiated transfer prices affect profit for the managers involved and can also impact company profit when quantity, as well as price, is an element of the negotiation. Thus, it is important for both companies and managers to understand the variables affecting negotiation outcomes. Prior research in negotiation (see Bazerman et al., 2000) has investigated how negotiators' perceptions of the negotiation situation impacted outcomes. Further, these perceptions seem to influence outcomes and enhance negotiator profit over and above the effect of other important variables in negotiation, like risk preference and competitive behavior (Thompson, 1998). Other recent research has shown that making the optimal payoff salient to negotiators increases negotiator effectiveness beyond that obtained through risk preference alone (Ghosh and Boldt, 2004).

Prior accounting research (e.g., Lipe, 1993; Luft, 1994) has also found that the framing of problems affects managers' judgments and preferences in other tasks and domains (e.g., variance investigation and contract choice). These studies have consistently shown that the presentation of monetarily equivalent options in semantically different ways (i.e., gains and losses, bonuses and penalties) affects how managers frame problems and make judgments. However, some research suggests the framing effect is not consistent and research findings may be limited by contextual and procedural variations (Levin et al., 1998). While Lipe (1993) proposes that future framing studies examine the role of motivation in general, Ghosh and Boldt (2004) list compensation structure as a specific motivation variable that could potentially limit the framing effect in negotiation.

To the extent that a manager is evaluated and compensated based on divisional profit, he or she would like to enhance divisional profit. Not surprisingly, prior research suggests that compensation structure is an important variable associated with transfer pricing (Grabski, 1985; Ghosh, 2000). Specifically, negotiators achieve higher profits when profit is a larger percentage of total compensation (Ghosh, 2000). These findings imply that negotiators see the making of profit from a transfer transaction as a more important goal when profit is a larger percentage of compensation. Still, how the profit goal is framed may affect the manager's likelihood of performing the actions necessary to achieve the goal.

Our research uses an experiment to examine the effect of positive and negative goal framing on sellers' share of profit available from a negotiated transfer for two different compensation structures. Participants were given the role of a seller facing a negotiation for a potentially profitable transfer with another division in the same company. The positive frame condition asked participants to think about the profit to be made from the transaction while the negative frame condition asked participants to think about the profit they would forego to the other division. The amount of management compensation dependent upon divisional profit also varied. The low compensation condition told participants that their bonus compensation was only 3% of divisional profit while the high compensation condition told participants that their bonus was 30% of divisional profit.

The remainder of this article is organized as follows. The next section develops the research hypotheses. The following section discusses the research method. Then, the results of the data analyses are discussed. The last section summarizes the results and provides some conclusions.

THEORY AND HYPOTHESES

Framing

Research evidence indicates the framing effect has an impact on choices and behaviors of negotiators (Bazerman et al., 1985: Bottom and Studt, 1993). Negotiators compare, code and evaluate negotiation outcomes relative to a reference point (Neale and Bazerman, 1991). Evidence from the decision-making literature suggests the adopted reference point impacts how the outcome situation is framed. Further, decisionmaker choices and behaviors depend on the reference point used in evaluating outcomes (Tversky and Kahneman, 1981; Kuhberger, 1998).

Recent accounting research has found similar effects in contract choice. Luft (1994) found that employees prefer bonus contracts to penalty contracts. Ghosh and Boldt (2004) found that making the potential profit outcome salient enhanced negotiator effectiveness. These findings provide additional evidence that the frame affects negotiation outcomes.

In the context of the current study, managers of selling divisions enter negotiations for the transfer sale of a good with the goal of increasing their divisional profits. They essentially face a situation of obtaining more profit or gain (i.e., a positive frame) for their division from the transfer or forego some of the profit or gain (i.e., a negative frame) from the transfer to the other division. Therefore, positive or negative framing of the profit goal from transfer pricing is expected to culminate in sellers claiming different shares of the profit available from the transaction. Thus, the first hypothesis is:

H1: Seller's share of the profit will be higher when the profit goal is expressed in terms of profit foregone (i.e., a negative frame) compared to when the goal is expressed in terms of profit made (i.e., a positive frame).

Compensation Structure

Managing the transfer pricing problem can be difficult because the transfer price affects divisional profit which, in turn, is typically the basis for evaluating and compensating the manager (Eccles, 1985). Also, a firm's compensation plan significantly influences the motivation of organizational members (Schwab, 1973) and stimulates behavior between negotiating divisions by influencing the bargainers' aspiration level (Pruitt and Lewis, 1975). Research in transfer pricing indicates that compensation structure (e.g., basis of the compensation) is a pervasive issue in transfer pricing (Eccles, 1985; Grabski, 1985; Vancil, 1978) and has a significant impact on outcomes of negotiated transfer pricing (Chalos and Haka, 1990; Ghosh, 2000).

In the current study, sellers with a compensation structure that is more dependent upon divisional profit may perceive the earning of profit from the transfer as a more important goal than sellers whose compensation structure was less dependent upon divisional profit. Based on the above, sellers' shares of the profit available from the transfer are expected to be larger when the bonus percentage based on divisional profit is larger. The second hypothesis is stated as:

H2: Seller's share of the profit will be higher when bonus compensation based on divisional profit is a larger percentage (i.e., high compensation) compared to when bonus compensation based on divisional profit is a smaller percentage (i.e., low compensation).

Flexibility

Conflict, in general, is inevitable in organizations with divergence of preference among its members (Eccles, 1985). Not surprisingly, negotiation research shows that conflict is a natural phenomenon when both the trading divisions are trying to enhance their division performance (Eccles, 1985; Grabski, 1985; Ghosh, 2000).

Negative goal framing is expected to intensify the conflict problem. Some flexibility on the issue being negotiated reduces the level of conflict inherent in negotiation (Lax and Sebenius, 1986; Thompson, 1998). Flexibility via concession on the price (i.e., lower price for the seller and higher price for the buyer) would mean adversely affecting divisional profits. However, when the goal is framed negatively (i.e., profit foregone), flexibility will be perceived as giving up even more profit. Thus, negative framing is expected to manifest itself in reduced flexibility for sellers. Thus, the third hypothesis is:

H3: Sellers will be less flexible via concession on price when the profit goal is expressed in terms of profit foregone (i.e., a negative frame) compared to when the goal is expressed in terms of profit made (i.e., a positive frame).

Similarly, compensation structure is also expected to have an effect on flexibility. As stated above, the seller may perceive the goal of earning divisional profit as a more important goal when divisional profit is a larger percentage of total compensation than when divisional profit is a smaller percentage of total compensation. Thus, it is expected that sellers will be less likely to give up a portion of their divisional profits via concession on price.

H4: Sellers will be less flexible via concession on price when bonus compensation based on divisional profit is a larger percentage (i.e., high compensation) compared to when bonus compensation based on divisional profit is a smaller percentage (i.e., low compensation).

METHOD

Design and Participants

Participants were 48 managers of a Fortune 500 company. Inter-unit transfers are quite common in this organization and the prices of these transfers are nearly always negotiated between managers of the trading units. The participants had, on average, 14.5 years of experience. All of the participants have had direct and frequent involvement with determining transfer prices: 29 (61%) within the past year, 17 (35%) within the past 2-4 years and two (4%) more than five years ago.