The Economics of Advance Pricing Agreements

Advance pricing agreements (APAs) determine transfer prices for intra-firm
transactions in advance. This paper interprets these contracts as a means to
overcome a hold-up problem that occurs because governments cannot commit
to non-excessive future tax rates. In addition, with private information, just as
in practice, our APAs will be complex and require lengthy negotiations. Never-
theless, implemented APAs lead to a Pareto improvement even when all agents
are risk neutral. However, not all efficient APAs are concluded in equilibrium.
International agreements to avoid double taxation will likely reduce the number
of realized APAs.