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

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Accounting, Organizations and Society 33 (2008) 704–717 www.elsevier.com/locate/aos

The effect of framing and negotiation partner’s objective on 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 have different expectations regarding what constitutes a ‘fair’ transfer price, leading to a less efficient negotiation process. In this 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 or low concern-for-others). We propose that these two factors affect managers’ perceptions of the negotiation context, and thus the way they interpret the economic and social consequences of accounting information. Our results show that a loss frame (compared to a gain frame) exacerbates managers’ self-serving biases and increases the ‘transfer price expectation 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) when they are negotiating with a partner with high concern-for-others than with a partner with low concern-for-others. We discuss the broader implications of these results for the design of management accounting systems. Crown Copyright Ó 2008 Published by Elsevier Ltd. All rights reserved.

Introduction Negotiation is a common method used by firms to set transfer prices (Ghosh, 2000). Even where an external market exists, transfer price negotiation is

*

Corresponding author. Tel.: +61 2 9385 5831; fax: +61 2 9662 4491. E-mail address: [email protected] (K.T. Trotman).

a potentially useful control mechanism, allowing a balance between economic considerations and broader social concerns by interdependent divisions (Kachelmeier & Towry, 2002). These transfer price negotiations are important to managers as they influence both their own and other divisional profits. Previous research has shown that these transfer prices are affected by both economic factors (market prices) and behavioural factors including fairness (Luft & Libby, 1997).

0361-3682/$ - see front matter Crown Copyright Ó 2008 Published by Elsevier Ltd. All rights reserved. doi:10.1016/j.aos.2008.01.002

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

In the current study, we examine whether the impact of accounting information on managers’ transfer price expectations are moderated by the way accounting information is framed (either as potential gains or potential losses) and the manager’s perception of the other negotiation party’s objective (whether their partner’s objective involves high or low concern-for-others). These expectations are important as they directly affect the costs and outcomes of negotiations (Ghosh, 2000; Luft & Libby, 1997; Trotman, Wright, & Wright, 2005). Previous negotiation literature has shown the importance of ‘fairness’ during negotiation and that participants’ estimates of a fair price display a ‘self-serving bias’ (or egocentrism). The self-serving bias refers to the cognitive bias arising from an individual’s tendency to view an outcome more favourable to them as being fairer when resolving conflicts1 (Thompson & Loewenstein, 1992). Specifically, where an active external market exists, and the market price is greater than a price that would lead to both divisions receiving an equal profit, a seller will generally consider the market price to be a fairer transfer price as it results in a higher profit for the selling division. The buyer, however, would view the transfer price that allows profit to be equally shared between the two divisions as a fairer price (Luft & Libby, 1997). Both Luft and Libby (1997) and Kachelmeier and Towry (2002) found that where market price differed from the equal-profit price, managers based their transfer price judgments on both the market price and the equal-profit price. Furthermore, both studies found that sellers and buyers placed different weights on these two reference points when formulating judgments. Specifically, due to selfserving biases, sellers’ transfer price expectations were closer to the market price than that of the buyers, while buyers’ expectations were closer to the equal-profit price. One likely effect of a ‘transfer price expectation gap’ between buyers and sellers 1

This is in contrast with ‘self-interest’, which refers to a negotiator’s motivation to advance their own outcomes. Individuals with a high level of self-interest do not necessarily have a biased view of what constitutes a fair outcome; rather, they are motivated to achieve a favourable outcome for themselves.

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is a prolonged and inefficient negotiation process. While this may be avoided by the intervention of top management to mediate any inter-divisional dispute, such an approach would undermine the autonomy of decentralised divisional managers. Instead, if we have a better understanding of those factors that influence managers’ transfer price judgments, we may be able to overcome managers’ biases by re-designing the negotiation process. Prior research in psychology suggests that the key to understanding how managers make negotiation judgments is to examine the way in which managers define their negotiation context, and their perception of variables that are critical and endogenous to the negotiation process (Bazerman, Curhan, Moore, & Valley, 2000; Ghosh & Boldt, 2004; Kristensen & Garling, 1997; Neale & Bazerman, 1992). Neale and Bazerman (1992) in particular have argued that: ‘‘Rather than focus only on external factors [to the negotiation process], it may be most useful to view situations from an interpretive perspective. It may not be the objective, external aspects of the situation that directly affect negotiator judgment; instead, it may be the way that the negotiator perceives these features and uses those perceptions to interpret and screen information.” (Neale & Bazerman, 1992, p. 161, emphasis added). Two factors that are of particular interest in the current study are the goal frame adopted by managers, which affects the way managers perceive the negotiation outcome, and the negotiation partner’s objective (also called ‘social concern’) which affects the way managers perceive the negotiation partner. Both of these variables are found to be important in the psychology and economics literature (e.g. Kahneman & Tversky, 1979; Lewicki, Saunders, & Barry, 2005; Neale & Bazerman, 1992; Roth, 1995), but are generally controlled for rather than manipulated in prior accounting studies. For example, both Luft and Libby (1997) and Kachelmeier and Towry (2002) adopted a consistent positive goal frame in all their treatments, and controlled for negotiation partners’ objectives by telling their participants that a positive relationship existed between negotiators.

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We extend these earlier studies by examining the impact of these variables on managers’ selfserving biases in a transfer pricing setting. There are benefits in studying these two variables simultaneously. We suggest that the reason the loss frame affects negotiation judgments is because it causes managers to become more concerned about their own outcome (not to incur any further losses), exacerbating their self-serving bias. Their negotiation partner’s objective also is expected to influence the level of concern managers have for their own outcome. For example, a perception that the negotiation partner has high concern-for-others causes managers to be more willing to give up some of their divisional profit and accept a less favourable transfer price. By using both cognitive and social lenses together, we attempt to obtain a more unified understanding of how the negotiation process works and eventually, how to overcome barriers to effective negotiation. The study of these variables is important because of their implications both for transfer pricing and for their impact more generally on systems and processes in decentralised organisations that use management accounting information. Transfer price negotiations, in particular, allow business unit managers to utilise and share their local knowledge (Dikoli & Vaysman, 2006) and maintain inter-divisional coordination while preserving autonomy (van Helden, van der Meer-Kooistra, & Scapens, 2001). The cost of negotiation, however, is not negligible, and the negotiation approach to transfer price determination is only recommended when the 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 bias is one factor that can reduce the accuracy of manag2 In addition, while the perception of a ‘fairer’ outcome can result in a more positive feeling at the end of the negotiation process (Lewicki et al., 2005), this perception may have negative consequences for firms as divisions use ‘profit equality’ as an argument for ‘fairer’ outcomes. As the gap between equal-profit price and market price grows bigger, the pursuit of profit equality may give rise to an ‘internal socialism’ problem where firms inefficiently try to equalise divisional performance (Bolton & Scharfsein, 1998). The resultant impact is the distortion of profits as a result of managers’ pursuit of profit equality.

ers’ transfer price judgments and thus potentially increase the time and costs of negotiation. An understanding of framing and negotiation partner’s objective also has wider implications for the management accounting literature and these implications are included in our ‘Discussion’ section. In summary, our study makes a number of significant 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 transfer price judgments. We specifically address the role of framing and the negotiation partner’s objective. The first factor is directly controllable by management accountants. For example, management accountants can produce reports based on alternative negotiating reference points to support a seller–manager involved in a transfer price negotiation. When the market price is used as a reference point, the management accounting reports are likely to highlight the potential loss in profit as the negotiated transfer price falls below the market price (Perera, McKinnon, & Harrison, 2003). This will lead to the negotiating manager adopting a loss frame. Alternatively, the reports can use product costs as a reference point, focusing on the gains in profit as the negotiated transfer price moves above the product costs (Colbert & Spicer, 1995). This is likely to cause the negotiating manager to adopt a gain frame. Second, the importance of social considerations was highlighted by both Luft and Libby (1997) and Kachelmeier and Towry (2002) when they found evidence of the effect of fairness concerns on transfer price judgments. Building on this research, we demonstrate, in a situation where market prices are above equal-profit prices, that managers expect the final transfer price to be lower when they are dealing with a partner with high concern-for-others than when negotiating with a partner with low concern-for-others.3 This is because managers tend to

3 In this study, we use an example where market price is above the equal-profit price and therefore concern-for-others results in transfer prices below market prices. We note that direction of the difference between market price and transfer price would reverse if the market price given in an experiment was lower than the equal-profit price.

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reciprocate the perceived social concerns of their negotiation partner. The lower price, however, is also further from the market price which has implications for production divisions that depend on the transfer price and may have longer term implications if managers are put under increased pressure to reach profit targets. Deviations from the market price also have potential negative implications on intra-organisational resource allocation (Bolton & Scharfsein, 1998). As noted by Sprinkle (2003), it is important to study the extent to what social motives, and other aspects of a firm’s information systems, interact with the more formal accounting systems to affect managerial behaviour. Our results imply that these two factors significantly influence the way managers make use of accounting information when making transfer price judgments. Third, our study extends the existing literature by examining the impact of the above variables on two dimensions of transfer pricing judgments: a reservation price and a price premium (i.e. the difference between the reservation price and the estimated transfer price). Our results show that a loss frame increases the sellers’ reservation price, and thus eventually their final transfer price judgment. In contrast, negotiation partner’s objective did not affect reservation price judgment, but rather, we found that sellers who perceived their partner to have a high level of concern-for-others were more willing to accept a lower price premium. Finally, inter-divisional negotiation (such as transfer price negotiations) is an important control mechanism that balances divisional autonomy with inter-divisional coordination (van Helden et al., 2001). Our study extends the growing literature on improving negotiation outcomes in accounting/auditing situations (Bame-Aldred & Kida, 2007; Gibbins, McCracken, & Salterio, 2005; Gibbins, Salterio, & Webb, 2001; Ng & Tan, 2003; Trotman et al., 2005) to the management accounting arena, and in doing so, contributes to our understanding of the challenges faced by decentralised organisations. Literature review and hypotheses development Conventional economic arguments suggest that transfer price judgments should be based on ‘eco-

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nomically rational’ concerns such as the market price, transaction costs and the division’s cost structure (e.g. Colbert & Spicer, 1995). However, prior literature in psychology has demonstrated that negotiators do not always act ‘rationally’. Rather, they suffer from a number of judgmental biases, such as anchoring their decisions on irrelevant information, and the escalation of commitment (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 negotiation, sellers’ estimates of negotiated transfer prices tend to be significantly higher than those of buyers, particularly when the market price is higher than the equal-profit price. Luft and Libby (1997) argue that their finding demonstrates the existence of a ‘self-serving bias’, which causes managers to overweigh the negotiation outcome that is most beneficial to them (Luft & Libby, 1997; Thompson & Loewenstein, 1992). Thus, where more than one definition of a ‘fair’ transfer price exists (e.g. in the Luft & Libby, 1997 study, where market price was higher than the equal-profit price),4 negotiating managers will interpret fairness in ways that favour their position, such that the transfer price estimates by sellers are significantly higher than the transfer price estimates by buyers. Before developing our hypotheses we first replicate the baseline condition established in Luft and Libby (1997) on the difference in transfer price judgments between sellers and buyers resulting from the self-serving bias. H1: Sellers’ estimated final transfer prices are higher than buyers’ estimated final transfer prices. ‘Frames’ are subjective cognitive systems through which individuals evaluate and make sense 4

The prevailing market price is often perceived as a fair transfer price because it is the result of ‘impartial’ market forces of supply and demand. On the other hand, a fair price can also be defined as one that provides equal profit to both negotiating divisions (i.e. the equal-profit price). The concept of equalprofit price is likely to be particularly salient in the internal transfer price negotiation process, where the negotiating managers belong to the same company, and inter-divisional equity becomes an important concern.

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of situations they are in. Different frames adopted can lead individuals to pursue or avoid subsequent actions (Lewicki et al., 2005). Traditionally, negotiation literature has focused on the effect of ‘risk preference framing’ (Bottom & Studt, 1993; Kahneman & Tversky, 1979; Neale & Bazerman, 1985; Thaler, 1992) – a framing effect characterised by a choice between outcome certainty and a more risky alternative. The underlying decision valence is then manipulated, such that a loss frame is represented by uncertainties surrounding a negative consequence, and a gain frame is represented by uncertainty surrounding a positive consequence.5 For example, Neale and Bazerman (1985) investigated the risk frame in a management/union negotiation by either telling the participants that any concessions made by the company will result in significant financial losses (loss frame), or any concessions from the union will result in significant financial gains (gain frame). All impasses were to be referred to an arbitrator, and as the arbitrator’s final decision was unknown, this presented the participants with a risk element. Inter alia, they found that compared to negotiators with gain frames, negotiators with loss frames were more likely to have their agreements determined by the arbitrator (i.e. they chose the riskier option). They also found that compared to gain framed negotiators, loss framed negotiators were less likely to make concessions. In this study, we examine the framing role of accounting information, and how this affects managers’ transfer price judgments. Our focus is on using accounting information to frame the negotiation goal. We propose that because managers are more concerned with avoiding losses than increasing gains both buyers and sellers are more likely to focus on maximising their divisional profit when given a loss frame compared to a gain frame. This

5 While the major emphasis in the framing literature has centred on the standard risky choice framing affect introduced by Kahneman and Tversky (1979) and Tversky and Kahneman (1981), Levin et al. (1998) developed a typology to distinguish between risky choice framing, attribute framing and goal framing. Levin, Schneider, and Gaeth (1998) suggest that the different operational definitions of framing have effects that rely on different psychological processes.

greater concern for achieving their own outcome is likely to further increase the transfer price judgement gaps between buyers and sellers. Prior literature on motivated reasoning suggests that a higher level of motivation to achieve an outcome can lead people to overestimate the probability that a favourable outcome will eventuate (Brownstein, 2003). Further, motivated reasoning also distorts people’s perception of others, such that they tend to expect others to behave in a way that results in favourable outcomes (Kunda, 1990). In the context of a negotiation, we predict that the loss framed managers’ greater concern for maximising their divisional profit will cause them to overestimate the likelihood that their partner will take their view of what constitutes a fair price, and thus agree on a transfer price more favourable to them. Specifically, sellers (buyers) with a loss frame are more likely to believe that their partner will agree on a higher (lower) price being a fair transfer price, compared to sellers with a gain frame. As such, we predict that a loss frame will increase negotiators’ self-serving biases. In addition, as loss framed managers become more motivated to achieve a better outcome, they may be more willing to incur greater bargaining costs compared to gain framed managers. In the absence of any information about their partner’s negotiation frame (and thus the level of their partner’s motivation), the loss framed managers are also likely to expect their willingness to incur greater bargaining costs will lead to a more favourable outcome. As such, we predict that the transfer price judgement gap between buyers and sellers is greater under the loss frame than the gain frame condition.6

6

As we do not manipulate or provide information about the negotiation partner’s frame, buyers and sellers may not be making the same transfer price predictions. For example, the seller in the loss frame is predicting the price that a loss framed seller and a buyer with unknown or neutral frame will negotiate, whereas the buyer in the loss frame is predicting the price that a loss framed buyer and a seller with an unknown or neutral frame will negotiate. Even if both buyers and sellers assume the same (e.g. neutral) frame for their negotiation partner, the differences in transfer price predictions by sellers and buyers are still not necessarily all self-serving bias and may, in fact, be partially due to the lack of information about their negotiation partner’s frame.

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H2: The difference in estimated final transfer price between buyers and sellers is smaller when information provided to negotiating managers is framed as gains rather than losses. A number of prior studies have suggested that social concerns influence transfer price negotiation judgments (e.g. Kachelmeier & Towry, 2002; Luft & Libby, 1997). Both Luft and Libby (1997) and Kachelmeier and Towry (2002) found that while economic rationality would dictate that negotiators should expect market-based transfer prices, negotiators have an aversion to unequal profits. While they attributed this aversion to negotiators’ concerns about profit sharing and ensuring both divisions receive satisfactory profits, the impact of social concern was not directly tested. In this study, we seek to directly examine the effects social concerns have on transfer price judgements. We propose that managers’ concerns about unequal profits and therefore their transfer price judgments may be affected by the perception they have of their negotiation partner (i.e. the other party to the negotiation process). In particular, during negotiation, managers would try to gauge their partner’s objective, and then combine this information with their own negotiation objective when formulating their transfer price judgments (e.g. Carroll, Bazerman, & Maury, 1988; Lewicki et al., 2005). An established framework used to explain a negotiator’s objective is the ‘dual concern model’ (e.g. Lewicki et al., 2005; Pruitt, 1983; Sorenson, Morse, & Savage, 1999). This framework postulates that a negotiator’s objective is influenced by two independent types of concerns: concern for their own outcomes (‘concern-for-self’) and concern for the other party’s outcomes (‘concernfor-others’). Our focus in the current study is on a manager’s perception of their partner’s degree of concern-for-others. Our manipulation of this variable is consistent with large variations of concern-for-others in transfer pricing situations; for example, the level of concern for the profits of other divisions is likely to vary in organisations that are quasi-markets compared to quasi-families (Eccles, 1985, pp. 273–278).

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Following the suggestion in previous research (Kachelmeier & Towry, 2002; Luft & Libby, 1997), in situations where the market price is higher than the equal-profit prices, that this concern-for-others results in transfer prices below market prices, we predict that when the level of concern-for-others is stronger, both buyer and seller will expect the price to be lower. We note that this prediction only holds for situations where the market price is higher than the equal-profit price, which is the case in our experiment. The above prediction particularly applies when the level of concern is similar for both negotiators in the pair. While we only manipulate the level of concern-for-others for the negotiation partner, we suggest this is likely to result in a similar level of concern for the negotiating manager for two reasons. First, the psychology literature refers to the ‘reciprocity’ principle as a social norm by which an individual who acts in a certain way will expect a similar return action (e.g. Maxwell, Nye, & Maxwell, 2003).7 The norm of reciprocity therefore establishes expectations about how one is to behave in social interactions (Maxwell et al., 2003). Prior research has consistently found that negotiators have a tendency to reciprocate negotiation motives of their negotiation partners (Maxwell et al., 2003). Therefore, negotiating managers who perceive that their negotiating partner has high concern-for-others will reciprocate with a similar objective, showing high concern for profit sharing, In contrast, negotiating managers who perceive that their partner has low concern-for-others are expected to reciprocate by showing low concern for profit sharing. Second, organisations differ in the types of employee behaviours that are considered acceptable. For example, our low concern-for-others manipulation would be acceptable in some organisations but clearly unacceptable in other organisations. By informing a participant about the negotiation partner’s concerns-for-others we also tell participants something about the culture of the organisation. Specifically, our manipulation 7

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

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of concern-for-others involves providing participants with a memo from their negotiation partner. In the low concern-for-others treatment, the memo includes references to ‘maximising profit of my division’ which also communicates to the other party that this is accepted practice in this organisation. In contrast, in the high concern-for-others treatment, the culture encourages both divisions to receive satisfactory profits and therefore both parties would expect a lower price. H3: Managers’ estimated transfer prices are lower when they are negotiating with a partner with high concern-for-others than when they are negotiating with a partner with low concern-for-others.

Research methods Research design A controlled laboratory experiment was conducted to test the proposed hypotheses, using a 2  2  2 between-subjects design. The three independent variables were the negotiating manager’s role (participants acting as either a buyer or a seller), goal frame (gain frame or loss frame) and the negotiation partner’s objective (high or low concern-for-others).

then sold to an external customer. As the two divisions are autonomous, both divisional managers are free to negotiate a mutually acceptable transfer price or to trade externally at the prevailing market price (which was set at $70 per unit).9 The cost structures of the two divisions were designed such that the equal-profit price was $50.10 Included in the task was a profit schedule illustrating the profit implications of a range of transfer prices for both parties (between $20 where the profit for sellers was zero, and $80 per unit, where the profit for buyers was zero). Both buyers and sellers were then asked to predict the final negotiated transfer price and the sellers’ reservation price. Independent variables The negotiation role was manipulated by randomly assigning participants either to the role of ‘Parts Manager’ (i.e. seller) or ‘Assembly Manager’ (i.e. buyer). The goal frame was operationalised by ‘framing’ the instructions provided in the instrument either as a gain frame or a loss frame. Specifically, instructions provided to Assembly managers (the buyers) assigned a gain frame were as follows: ‘‘As you can see from the table, for every $5 decrease in transfer price you stand to gain $5000 profit. For example, by negotiating a transfer price of $55, your profit is $25,000. But if you negotiate a lower transfer price, say, $50, your profit is $30,000, which means that you have gained $5000 profit. In other words, as you settle for a lower transfer price, you stand to gain profit for your division in $5000 increments.”

Experimental task The experimental task was modified8 from Luft and Libby’s (1997) instrument, where participants assumed the role of a manager who is responsible for negotiating a transfer price of component ‘Parts’. ‘Parts’ are components sold by the Parts Division to the Assembly Division, which can then be processed further by the Assembly Division and 9

8

Two main modifications were made to the Luft and Libby (1997) instrument to accommodate two of our variables of interest (discussed in more detail later). A pilot test was then conducted (with 21 undergraduate accounting students) to ensure that our modifications were understood by our participants and that the independent manipulated variables had the intended effects. As a result of the pilot test, and discussions with pilot test participants post-experiment, further minor modifications were made.

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 Assembly department was ($80 less negotiated transfer price); while the profit for the Parts Division was (transfer price less $20). Thus, at a transfer price of $50 per unit, both divisions would obtain a profit of $30 per unit.

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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

ASSEMBLY profit ($000)

0

5

5

0

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

ASSEMBLY profit ($000)

60 55 50 45 40 35 30 25 20 15 10

5

10 15 20 25 30 35 40 45 50 55 60 5

0

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

For participants assigned a loss frame, the description explained how every $5 change in the transfer price would result in the division losing $5000. Further, participants were also provided with a schedule of profit framed either as profit increases or profit decreases as the transfer price changed (refer to Fig. 1). To manipulate the negotiation partner’s objective, participants were provided with a fictitious memo indicating their negotiation partner’s level of concern-for-others. Participants assigned to the ‘high concern-for-others’ conditions were given a memo stressing their partner’s desire for mutual concession and maximising profit for both divisions. In contrast, participants in the ‘low concern-for-others’ conditions were given a memo emphasising their partner’s desire to maximise profit for their own division only and their unwillingness to make concessions. For example, the memo from a partner with low concern-for-others highlighted their intention to ‘‘. . . achieve the best profit for my division . . . if you are unwilling to make concessions, I am prepared to trade externally.”

(i.e. seller’s reservation price).11 Consistent with Luft and Libby (1997), to minimise the time required for data collection we did not ask participants to estimate buyers’ reservation price.

Dependent variables We measured the dependent variable, managers’ estimated negotiation prices, by asking participants to predict the final transfer price of the negotiation process. In addition, participants were also asked to indicate the expected lowest price that sellers would likely to be willing to accept

11 Luft and Libby (1997) pointed out that negotiated transfer price is a more sensitive measure of potential conflict, while reservation price is more sensitive to managers’ mistaken judgments about their negotiation partner. As we are primarily interested in the former (i.e. the effect of managers’ perception on their expectations of how the ‘negotiation conflict’ would be resolved), our primary analysis will focus on estimated final transfer prices.

Participants One hundred and twenty-eight participants volunteered to participate in this experiment. All participants were enrolled in a Master of Commerce degree or Master of Business Technology at one Australian university, and each had at least two years of full time work experience. However, 32 participants failed one or more post-experiment manipulation tests and were later excluded from the analysis, resulting in 96 usable responses. The cell sizes for each of the eight treatment group varied between 11 and 15 (see Table 1). Manipulation check and post-test measures After participants completed the negotiation task, they were given three manipulation checks. The first asked participants to indicate what role they played in the negotiation (i.e. whether they

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Table 1 Means (standard deviation) of estimated final transfer price ($) Partner’s objective

Frame total

High concern-for-others

Sellers

Buyers

Column total

Total

Low concern-for-others

Gain frame

Loss frame

Total

Gain frame

Loss frame

Total

Gain frame

Loss frame

58.64 (7.10) n = 11 57.69 (8.32) n = 13 58.13 (7.63) n = 24

61.92 (8.04) n = 13 52.73 (10.57) n = 11 57.71 (10.21) n = 24

60.42 (7.65) n = 24 55.42 (9.55) n = 24 57.92 (8.92) n = 48

62.50 (9.50) n = 10 60.30 (7.51) n = 10 61.40 (8.41) n = 20

65.50 (6.96) n = 15 56.92 (10.52) n = 13 61.52 (9.56) n = 28

64.30 (7.89) n = 25 58.39 (9.29) n = 23 61.47 (9.01) n = 48

60.48 (8.35) n = 21 58.83 (7.91) n = 23 59.61 (8.01) n = 44

63.84 (7.44) n = 28 55.00 (10.53) n = 24 59.76 (9.95) n = 52

were acting as a Parts manager or an Assembly manager). The second asked participants to indicate whether their negotiation partners were interested in maximising both divisions’ profits, or only their own division’s profit. The third asked participants to indicate whether the case material stated that ‘‘for every $5 increase in transfer price you stand to lose $5000 profit”, or ‘‘for every $5 decrease in transfer price you stand to gain $5000 profit”.12 Results Hypothesis testing The descriptive statistics for estimated transfer price are summarised in Table 1, and a 2  2  2 ANOVA model, with estimated transfer price as the dependent variable, is presented in Table 2. As can be seen from Table 1, and consistent with H1, the average estimated transfer price was higher for sellers (62.40) than for buyers (56.87). This difference (the main effect of role) is statistically significant (F = 8.71, p = 0.00), thus H1 is supported. H2 predicted that the difference in estimated transfer prices between buyers and sellers would be smaller when potential negotiation outcomes are framed as gains rather than losses. The descrip12 56% of the manipulation test errors related to the framing effect. All statistical tests were re-run after including participants who failed the manipulation tests, and all results remained statistically the same.

62.40 (7.93) n = 49 56.87 (9.44) n = 47 59.69 (9.09) n = 96

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

Negotiator’s role Partner’s objective Frame Role * objective Role * Frame Objective * frame Role * objective * frame Error

DF

MS

F

p

1 1 1 1 1 1 1 88

644.11 298.70 6.22 0.60 315.05 2.49 5.16 73.93

8.71 4.04 0.08 0.01 4.26 0.03 0.07

0.00a 0.02 0.39 0.46 0.02b 0.43 0.40

Negotiator role – participants acting as either a buyer or a seller. 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.

tive statistics in Table 1 further indicate that the difference in estimated transfer prices between sellers and buyers under the gain frame condition (60.48 58.83 = 1.65) was lower than that under the loss frame condition (63.84 55.00 = 8.84). This difference is shown in Table 2 as a significant interaction effect between role and goal frame (F = 4.26, p = 0.02), thus H2 is supported. H3 examined the effect of the negotiation partner’s objective on managers’ transfer price judgments. In H3, we expected the negotiation partner’s objective to have a main effect, where both buyers’ and sellers’ transfer price expectations would be lower if they were negotiating with

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a partner with high concern-for-others than if with a partner who had low concern-for-others. The overall ANOVA model as shown in Table 2 confirmed our expectation (significant main effect for negotiation partner’s objective, F = 4.04, p = 0.02) thus, H3 is supported. Additional analysis We also conducted additional analyses to delineate the effect of goal framing and the negotiation partner’s objective on two elements of managers’ transfer price judgments: the reservation price and the difference between the reservation price and the estimated transfer price (which we refer to as ‘price premium’). The reservation price (also known as the resistance point) represents the minimal price sellers are willing to accept from the transaction (e.g. for sellers, this means the minimal acceptable price – Lewicki et al., 2005). In contrast, the price premium reflects the extent to which negotiators expect to achieve their desired outcome. That is, the price premium incorporates negotiators’ anticipation of the concession they will make during the offer–counteroffer process in negotiation. The descriptive statistics of these two variables are shown in Tables 3 and 4.

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Table 3 Panel A indicates that on average sellers’ reservation price was $54.04, which was higher than the equal-profit price of $50.00 (significant with one-sample t-test, t = 2.464, p = 0.01). This is consistent with our expectation that sellers in general would not consider the equal-profit price as a fair outcome of negotiation. Instead, their minimum acceptable price was significantly higher. Table 3 (Panel A) also shows that compared to their gain frame counterparts, sellers in the loss frame condition reported a higher reservation price ($56.54 vs. $50.71). The main effect for goal frame in the ANOVA reported in Table 3 Panel B shows that this difference is statistically significant (F = 6.33, p = 0.02). Consistent with our earlier argument, this finding suggests that a loss frame focuses individuals on a goal of avoiding negative consequences, thus increasing their ‘resistance point’ to an unfavourable transfer price, which results in a higher expected reservation price. Neither negotiation partner’s objective (F = 0.01, p = 0.94) or the interaction with framing (F = 1.06, p = 0.31) are significant for reservation price. Table 4 reports the descriptive statistics and ANOVA results for the sellers’ price premium. A

Table 3 Additional 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

Partner exhibits low concern-for-others

Total

49.00 (16.13) n = 10 56.87 (12.51) n = 15 53.72 (14.29) n = 25

50.71 (12.07) n = 21 56.54 (10.55) n = 28 54.04 (11.48) n = 49

MS

Panel B: ANOVA model a (dependent variable = sellers’ reservation price) Partner’s objective 1 0.56 Frame 1 641.74 Partner’s objective * frame 1 107.86 Error 43 101.40

F

p

0.01 6.33 1.06

0.94 0.02 0.31

a Two outliers were excluded from this analysis. One outlier was excluded because the subject reported a reservation price that was higher than the expected transfer price. A second outlier was excluded because the reported reservation price was greater than 3 standard deviations away from the mean.

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Table 4 Additional analysis – sellers’ price premium Partner exhibits high concern-for-others Panel A: Descriptive statistics – sellers’ transfer price premium Gain frame 6.36 (6.36) n = 11 Loss frame 5.77 (6.41) n = 13 Total 6.04 (6.25) n = 24 DF Panel B: ANOVA model a (dependent variable = price premium) Partner’s objective 1 Frame 1 Partner’s objective * frame 1 Error 43 a

Total

13.50 (10.55) n = 10 8.63 (8.09) n = 15 10.58 (9.27) n = 25

9.76 (9.15) n = 21 7.30 (7.37) n = 28 8.36 (8.18) n = 49

MS

F

p

166.08 107.29 129.70 51.21

3.24 2.10 2.53

0.08 0.16 0.12

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

marginally significant main effect of the negotiation partner’s objective (F = 3.24, p = 0.08) suggests that sellers who were negotiating with a high concern-for-others partner expected to give up a greater share of divisional profit during the negotiation process and thus predicted a lower price premium compared to those who were negotiating with a partner with low concern-for-others. Neither framing (F = 2.10, p = 0.16) or the interaction (F = 2.53, p = 0.12) are significant.13 Together, these results show that the goal frame and the negotiation partner’s objective have different effects on different aspects of managers’ transfer price judgments. Specifically, as individuals are more resistant to avoiding losses than increasing gains, a loss frame increases the sellers’ reservation price and eventually, their final estimated transfer price. On the other hand, the negotiation partner’s concern-for-others provides the sellers with an indication of the potential offers/counteroffers during transfer price negotiation, thus influencing the price premium the sellers expect on top of their reservation price.

13

Partner exhibits low concern-for-others

Due to the relatively small sample size, however, the statistical inferences of our additional analysis should be interpreted with care.

Summary and discussion In this study, we examined whether managers’ perceptions of potential negotiation outcomes (framed either as potential gains or potential losses) and of their negotiation partner (exhibiting high or low concern-for-others) affected self-serving biases and consequently their transfer price judgments. We found that compared to a gain frame, a loss frame exacerbates managers’ selfserving biases and increases the transfer price expectation gap between buyers and sellers. Further, we found that the negotiation partner’s objective had a significant impact on sellers’ transfer price judgments. Consistent with the ‘norm of reciprocity’, our results show that, in situations where market prices are higher than equalprofit prices, managers reciprocated their partner’s concerns and expected lower transfer prices when their negotiation partner exhibited high concernfor-others, and expected higher transfer prices when their negotiation partner exhibited low concern-for-others. This finding is particularly interesting as sellers in our experiment had relatively strong bargaining power but these sellers did not exploit their bargaining power by demanding high transfer prices regardless of their partner’s level of concern-for-others. Instead, we found that sellers

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were sensitive to their partner’s objective, and were more willing to accept a less advantageous outcome if their partner showed high concern-forothers. The additional analysis suggests that goal framing and the negotiation partner’s objective have different impacts on managers’ negotiation judgments. When we decompose the transfer price judgments into two subcomponents: the reservation price and a price premium, we found that the loss frame resulted in managers reporting a higher reservation price. On the other hand, managers’ perception of their partner’s objective had significant impact on their price premiums. Our study has important implications for both researchers and practitioners. Prior research has shown that negotiating managers suffer from selfserving biases, which result in a significant difference in expected transfer prices between buyers and sellers. We extended this line of research by examining how these differences in transfer price expectations are affected by managers’ perceptions of the negotiation context. Understanding managers’ transfer price expectations is important, as differences in expectations between buyers and sellers can lead to prolonged disputes and thus a costly negotiation process (Luft & Libby, 1997). Our findings that the provision of loss framed information increases the buyer–seller expectation gap can also have a significant impact on organisations. We note that systems and processes using management accounting can either inadvertently or by design cause managers to adopt different frames. For example, practitioner literature often advocates the use of customer profitability information to support customer negotiation (Kaplan & Cooper, 1998) and negotiators may be given a ‘‘price menu” listing a range of service levels and their associated costs (Kaplan & Anderson, 2007). In such circumstances, management accounting information can be presented in a way that induces either a gain frame or a loss frame. Specifically, management accounting reports can either describe the incremental cost increases with each service level (e.g. incremental cost of $500 every time a customer requests an additional sales visit), or the incremental cost savings (e.g. incremental costs savings of $500 per

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sales visit reduced). The former is likely to induce a loss frame and the latter a gain frame.14 The practitioner’s ‘self-help’ literature on negotiation often discusses the importance of building rapport and affiliation at the negotiation table (Fisher & Shapiro, 2005). Our study provides empirical support for the importance of communicating a positive objective. Our results show that managers expect a lower transfer price (closer to the equal-profit price) when they perceive that their negotiation partners have high concern-forothers. Our results imply that showing high concern-for-others (as opposed to showing low concern-for-others) can be effective in persuading negotiation opponents (especially sellers) to consider their perceptions. Our additional analysis suggests that managers’ perceptions of the negotiation outcomes and of their negotiation partners affect different aspects of the negotiation process. This finding enhances our understanding of how to ‘de-bias’ managers’ self-biased transfer price judgments. By framing the profit information differently we can encourage sellers to set a lower reservation price, and at the same time, organisations can also attempt to promote greater ‘concern-for-others’ among sellers so that they are more likely to accept a lower ‘premium’ on top of their reservation price. For example, incentive schemes that focus too much on the ‘stick’ rather than the ‘carrot’ may increase distrust (Fehr & Ga¨chter, 2000), potentially heighten managers’ concern-for-self relative to their concern-for-others, and thus reduce managers’ willingness to reciprocate positively during negotiation. Similar to earlier studies on transfer price negotiation (Luft & Libby, 1997; Kachelmeier & Towry, 2002), our results demonstrate a strong desire by participants to take fairness into account when making transfer price judgments, such that regardless of their role or the treatment, the resultant transfer price judgment is different from the external market price. On the other hand, Bolton and Scharfsein (1998) argue that the pursuit of 14

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

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‘internal socialism’ can be costly, as decentralised firms sometimes try to equalise divisional profit at the expense of resource allocation efficiencies. Our results show that internal socialism is also likely to arise from inter-divisional negotiations, potentially adding to the costs of internal transactions. An understanding of framing and negotiation partner’s objective has wider implications than just transfer pricing given that other inter-divisional negotiation is common in decentralised organisations. For example, a production manager may need to negotiate inventory management and delivery policies with the marketing division; and a research and development (R&D) manager in one division may need to negotiate with the R& D manager in another division over resource allocation issues in collaborative projects (Coletti, Sedatole, & Towry, 2005). The impact of these variables on negotiations also has implications for organisation design. For example, larger self-serving biases result in bigger errors in judging the outcome a bargaining partner will accept in the end. These higher selfserving biases have been shown to have a negative impact on reaching an agreement and create more impasses (Babcock & Loewenstein, 1997; Gelfand et al., 2002). Consequently, as decentralised organisations rely more on negotiation between peers, if the setting is one where large self-serving biases are likely to be present, these decentralised organisations will not work as effectively. They will require greater interventions from headquarters and more hierarchical decision making, thus making decentralisation more costly and less effective. Acknowledgment We gratefully acknowledge a research grant from the Australian Research Council and the helpful comments from Joan Luft, Sue Haka, Kim Langfield-Smith, Anne Lillis, Steve Salterio, Jane Baxter, Brian Burfitt and Habib Mahama, as well as seminar participants at University of Cincinnati, University of Melbourne, 2006 AFAANZ Conference and 2005 EAA Conference.

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