Delegation and Transfer Pricing in a Principal-Agent model, International Economic Review
This paper studies transfer prices and compensation mechanisms in a principal-agent model with moral hazard and private information by the agent. Production requires unobservable effort by the agent and a purchased input. In general it is optimal for the principal to create an internal market for the input and charge the agent a tax or subsidy which differs from the market price. Conditions are found under which the optimal compensation function is given by the difference between a nonlinear "revenue" function depending only on output and a nonlinear transfer pricing function which depends only on the amount of the purchased input.
Besanko, David. 1991. Delegation and Transfer Pricing in a Principal-Agent model. International Economic Review. 32(1): 55-68.