"Environmental Awareness" Training Mega Manufacturing's corporate headquarters requires periodic classes in the green policies that it embraces. The Human Resource Department conducts the relevant classes and is run as a profit center with each plant
manager paying a transfer price per employee taking the classes. Recently, some of the plant managers have been hiring outside firms to conduct these classes. HR has complained to corporate that they will have to lay off staff if this continues but the plant managers reply that the outside firms are much cheaper. Why might corporate headquarters want to ban classes run by external firms anyway?
The transfer price could be too high. The plant managers are choosing the outside option because the transfer price, which should be equal to HR's marginal cost, in fact exceeds the market price. However, the internal and external training may not be comparable. If the plant manager is indifferent to these green policies, he has an incentive to seek out external firms that will do a perfunctory job. That way he both reduces the direct costs of the classes and he does not keep his employees away from their jobs for as long but circumvents the intent of the corporate mandate.
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