(Page 2 of 15) - Hard Bargains: Examining Transfer Pricing Disputes through the Lens of the Political Bargaining Model authored by Eden, Lorraine.

HARD BARGAINS:

TRANSFER PRICING DISPUTES AND THE POLITICAL BARGAINING MODEL

INTRODUCTION

The best-known model of relations between multinational enterprises and host country

governments is the obsolescing bargain model (OBM), first developed by Raymond Vernon in
Sovereignty at Bay (1971). OBM explains the changing nature of bargaining relations between a
multinational enterprise (MNE) and host country government (HC) as a function of goals,
resources and constraints on both parties (Vernon, 1971, 1977; Kobrin, 1987; Brewer, 1992;
Grosse & Behrman, 1992; Grosse, 1996). In OBM, the initial bargain favors the MNE, but
relative bargaining power shifts to the host country government over time as MNE assets are
transformed into hostages. Once bargaining power shifts from the MNE to the host country, the
government imposes more conditions on the MNE, ranging from higher taxes to complete
expropriation of MNE assets. Thus, the original bargain obsolesces, giving OBM its name.
Originally applied as an explanation for widespread expropriation and nationalization in the
1970s of MNE natural-resource subsidiaries located in developing countries (Vernon, 1977),
OBM was later tested in other situations such as manufacturing MNEs and developed HCs, with
much weaker results (Kobrin, 1987).

The widely held view among international business scholars is that the obsolescing

bargain model has outlived its usefulness. The many case studies testing the model suggest that
MNEs were able to retain relative bargaining power and prevent opportunistic behavior by HC
governments so the bargains, in practice, seldom obsolesced. In addition, today, few
governments restrict inward FDI, either in the form of screening or performance requirements, so
that little formal bargaining over entry occurs between MNEs and host governments. To the
extent entry bargaining does occur, it is mostly at the local level as cities compete in so-called
‘locational tournaments’ to attract new investments. Thus, host governments have shifted from
‘red tape’ to ‘red carpet’ treatment of foreign MNEs. MNE-government relations are now seen as
cooperative, not conflictual (Dunning, 1993a; Stopford, 1994; Luo, 2001). As a result, there
appear to be few areas where OBM applies.

A recent paper by Eden, Lenway and Schuler (2005) refutes this view. They argue that

OBM has long term usefulness as a theoretical model of MNE-state relations once the twin
emphases on ‘entry’ and ‘obsolescing’ are removed. They propose that IB scholars revitalize
OBM by reconceptualizing OBM as a political bargaining model (PBM). In their political
bargaining model, MNE-state relations are modeled as iterative political bargains negotiated
between MNEs and governments over a wide variety of government policies at the industry
level. Their model updates the obsolescing bargain model by incorporating recent insights from
the liability of foreignness, transaction cost economics and the resource based view literatures.
They argue that ‘obsolescing bargain’ can be reconceptualized as ‘political bargaining’ if, first,
scholars broaden the issue area from a focus on ownership shares and recognize that firms and
governments engage in iterative bargaining over a wide variety of government policies at the
industry level. MNE entrants want to not only maintain the original bargain but also search for