The objective of this paper is to study how transfer-pricing schemes interact with subcontractors' opportunistic behaviors to affect supply chain coordination. We model the supply chain by incorporating asymmetric information among all the parties, contractors' innovation activities, subcontractors' misappropriation, and transfer-pricing schemes. We examine the impact of various transfer-pricing schemes on supply chain efficiency. Specifically, we conduct a performance comparison between the variable-cost transfer-pricing scheme and the full-cost transfer-pricing scheme. We find that the subcontractor's choice of transfer-pricing scheme affects the contractor's sourcing decisions and supply chain performance. For a selected set of parameters we show that the variable-cost transfer-pricing scheme achieves better supply chain coordination.
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