At the Movies: The Economics of Exhibition Contracts

Darren Filson, David Switzer, and Portia Besocke June 17, 2004

Contact info: Darren Filson (Corresponding Author), Associate Professor of Economics, Department of Economics, Claremont Graduate University, 160 E. Tenth St., Claremont, CA 91711; ph: (909) 621-8782; fax: (909) 621-8460; email: Darren.Filson@cgu.edu. David Switzer is a Ph.D. Candidate at Washington University in St. Louis. Portia Besocke is a Ph.D. Candidate at Claremont Graduate University. We thank Fernando Fabre, Alfredo Nava, and Paola Rodriguez for background research that contributed to this paper. We thank Darlene Chisholm and Doug Whitford for comments. Filson thanks the Fletcher Jones Foundation, the John M. Olin Foundation, and the National Association of Scholars for nancial support.

At the Movies: The Economics of Exhibition Contracts

Abstract: We describe a real-world prot sharing contract - the movie exhibition contract and consider alternative explanations for its use. Two explanations based on diculties with forecasting t the facts better than asymmetric information models. The rst emphasizes two-sided risk aversion; the second emphasizes measurement costs. Transaction costs and long-term relationships also aect contractual practices. We use an original data set of all exhibition contracts involving thirteen theaters owned by a prominent St. Louis exhibitor over a two-year period to inform our theories and test hypotheses. JEL Codes: L14: Transactional Relationships and Contracts; D45: Licensing; L82: Industry Studies: Entertainment Keywords: risk sharing, relational contract, principal agent, motion picture, lm

1. Introduction
The literature on prot sharing stresses asymmetric information. Prot sharing occurs when a party has private information that cannot be credibly revealed or when a partys actions cannot be observed. Economists avoid taste-based explanations such as risk sharing (Stigler and Becker 1977) and other factors that may lead to sharing, such as measurement costs. We describe a real-world sharing contract that is widely used - the movie exhibition contract - and argue that asymmetric information is not the main cause of sharing. Two explanations based on diculties with forecasting revenue t the facts better. The rst is that movie distributors (studios or independent distributors) and exhibitors (theater owners) are both risk averse and exhibition contracts are designed to share risk. The second is that the sharing rules accompanied by ex post adjustments economize on measurement costs. Transaction costs and long-term relationships also aect contractual practices. We use an original data set of 2,769 exhibition contracts to inform our models and test hypotheses. The data includes all contracts involving thirteen theaters owned by Wehrenberg Theatres, a prominent St. Louis exhibitor, over roughly two years. Our models explain the sharing

that occurs and the conditions that lead to adjustments, and our ndings may be relevant for other contracting environments. Our explanations for the features of exhibition contracts complement those of De Vany and Eckert (1991) and De Vany and Walls (1996), who emphasize that diculties with forecasting demand necessitate the use of short-term contingency-rich contracts. Some other work on non-exhibition aspects of the movie business also compares asymmetric information models to alternatives. Ravid (1999) tests and rejects a model of asymmetric information at the project selection stage. Ravid and Basuroy (2004) consider risk aversion at the project selection stage. Chisholm (1993, 1997) and Weinstein (1998) compare principal agent models to alternatives in studies of contracts between studios and talent. In the next subsection we describe the basic features of modern exhibition contracts.1 In the subsection after that we describe how the sharing rules evolved over time and argue that asymmetric information does not explain the sharing rules. Section 2 contains our models, Section 3 contains our empirical work, and Section 4 concludes. 1.1. The Modern Movie Exhibition Contract The unit of analysis for the contracts we describe is a single movie in a single theater (a theater is a building which may contain multiple auditoriums). While there is typically a boilerplate contract between each distributor and exhibitor that species general conditions that apply to all individual contracts, terms such as sharing rules and run lengths vary by movie and theater. A typical run ends after four to eight weeks, but the run may be adjusted after early revenues are observed, and holdover clauses may be used to extend the run as long as revenue is suciently high. De Vany and Eckert (1991) and De Vany and Walls (1996) attribute adjustable runs to imprecise forecasts.
Modern exhibition contracts have been described by De Vany and Eckert (1991), De Vany and Walls (1996), and Borcherding and Filson (2001). We also beneted from several conversations with industry participants, particularly D. Barry Reardon, past-president of Warner Bros. Distributing Corporation and a former executive of both Paramount Pictures and General Cinema Corporation; Doug Whitford, the executive at Wehrenberg Theatres in charge of negotiating lm rental contracts; and Mike Doban of TransLux Cinema Consulting. We also beneted from several articles in The Movie Business Book, edited by Jason E. Squire. The authors of the articles were, at the time of writing, prominent industry participants, and include among others D. Barry Reardon; Stanley H. Durwood, chairman and chief executive ocer of AMC Entertainment Inc.; A. Alan Friedberg, chairman of Loews Theatres, a subsidiary of Sony Pictures Entertainment; and A. D. Murphy, nancial editor and reporter for Daily Variety and Variety.
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We focus on explaining the peculiar revenue sharing rule that is common in modern contracts. While some contracts are aggregate deals, in which each sides percentage share remains xed throughout the run, most are sliding scale deals. In a sliding scale deal, each week, the distributor gets the maximum of two possible payments: 1) 90% of the movies weekly ticket revenue over the house nut, which is a at payment to the exhibitor; 2) a oor payment, some percentage of the weekly ticket revenue that typically declines according to a sliding scale as the weeks go by - perhaps 70% in the rst week, 60% by the third week, and as low as 30% at the end of the run. If the parties anticipate that revenue might peak in the second or later weeks (which can occur when the movie opens before a holiday weekend, for example) the contract includes a best weeks clause that ensures that the high oor payments are associated with the high demand weeks. Most of the time the oor is relevant; the 90/10 provision applies only for hits early in their runs. The exhibitors payo function for one week associated with such a contract is graphed in Figure 1. Interestingly, concession revenue is not shared - the exhibitor gets it all. This is not a trivial oversight as concessions typically account for approximately half of an exhibitors prot. Most deals are rm term, which indicates that both parties expect to be compensated according to oors or aggregate shares that are specied at the beginning of the run. In contrast, exible deals have boilerplate terms that are rarely enforced, and the exhibitor determines the appropriate shares as revenue is observed. In either case, terms may be adjusted during the run or after it ends; for exible deals this is common and for rm deals it is rare. We ignore the rm-exible distinction in most of our analysis and focus on explaining oors with sliding scales, best weeks clauses, the 90/10 provision, and the nature of adjustments. Other factors aect our modeling assumptions. Most contracts result from negotiations (Friedberg 1992; Reardon 1992). The courts favored competitive bidding at the time of the Paramount decrees of the 1940s and 50s, but even when bids are used they are points of departure for negotiations. Given this, our models emphasize bargaining rather than auctions. Friedberg (1992) notes that distributors cannot simply choose the highest bid because multiple factors matter, including local demographics, the location, and the decor. Exhibitor bids typically include 1) a schedule of ticket prices; 2) the number of shows for 4

weekdays and weekends; and 3) the screen number and the number of seats in the auditorium in which the picture will play. Practitioners tell us these are guidelines only; 2) and 3) are dicult for distributors to monitor and none of the three terms are enforced. However, ticket prices are typically constant across movies and time at the theater level (except for daily matinee prices).2 Given this, ticket prices are exogenous in most of our analysis. Our models consider a theater with only one auditorium. Given this, we do not endogenize the allocation of movies to time slots and auditoriums.3 However, in our empirical analysis we consider the impacts of such allocation decisions. 1.2. The Evolution of Revenue Sharing Our conversations with practitioners (see fn.1) and historical analyses such as Hanssen (2000, 2002) allow us to describe how sharing rules evolved and explain why sliding scale rules are used today. Originally movies were short, silent, low-cost, relatively non-dierentiated products that were sold to exhibitors outright. As feature lms were introduced, production budgets rose and consumers became more selective. Avoiding downside risk became important. Murphy (1992) notes that percentage rentals were introduced to justify the investment risk. With the arrival of sound in the late 1920s, production budgets rose more and the variance of movie revenue (and prot) increased (Sedgwick and Pokorny 1998; Hanssen 2002). Revenue sharing became increasingly common.4 The distributors share of ticket revenue rose as budgets rose, from roughly 20% early on, to 25% in the 1920s, 33% in the 1960s, and 45% in the 1990s. Shares varied by movie and theater.
Practitioners provide several explanations for inexible ticket prices. Exhibitors want to avoid menu costs and eliminate consumer uncertainty about what the movie will cost. Exhibitors do not increase prices of hits because they are engaged in repeat business with local consumers, and the potential loss of goodwill from increased prices outweighs the potential gain. Charging dierent prices for dierent movies at multiplexes necessitates employing monitors to ensure that consumers see the movies they pay for. Even oering midweek discounts may lead to more time shifting than new demand. Not all analysts or practitioners agree that inexible prices are optimal (see Orbach and Einav 2001), although it seems unlikely that such an easyto-exploit prot opportunity would persist. Some practioners have experimented with non-uniform prices in the U.S. in the recent past but inexible prices remain the norm. 3 Filson (2004) provides a dynamic model that includes allocation decisions within a multiplex. 4 Hanssen (2002) describes how exhibitor inputs were less important for big-budget movies, particularly after sound. As a result there was less need to make the exhibitor the residual claimant. However, this leaves open the question of why the distributor was not made the full residual claimant. Hanssen (2002) argues that exhibitors needed incentives to provide local inputs. We evaluate this argument below - it may have been relevant in the 1920s but does not appear to explain revenue sharing today.
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The modications to the earliest sharing rules reect attempts to minimize downside risk. As noted in the previous subsection, in most modern contracts the distributor gets 90% over the house nut during high-revenue weeks. The nut is a xed dollar amount that the distributor pays to the exhibitor. It was originally included in contracts with the pretext of covering the exhibitors costs, which eectively limits the exhibitors downside. Murphy (1992) describes how oor payments originated in the late 1960s as a countermove by distributors who questioned the validity of house nuts and who no longer could aord to absorb most of the losses incurred by a failed lm. A oor payment limits the distributors downside - it ensures that the distributor obtains some minimum percentage of the movies revenue. In practice, the oor is the relevant payment the vast majority of the time. In sum, practitioners claim that downside risk motivates revenue sharing. This is not surprising; several authors argue that risk is important in the movie industry (De Vany and Eckert 1991; De Vany and Walls 1996; Weinstein 1998; Borcherding and Filson 2001). Production involves high upfront sunk costs, and demand is dicult to predict.5 Historically, distributors and exhibitors relied heavily on internal nancing, and neither party could aord to bear the full impact of a big-budget op (Murphy 1992). As budgets rose and uncertainty increased, contracts became more sophisticated. In contrast, asymmetric information about movie quality does not appear to be important. As De Vany and Eckert (1991) and De Vany and Walls (1996, 1999) note, the main information problem is that it is dicult to forecast demand prior to release because every movie is dierent. This does not give one side an informational advantage. The movie must be shown in the theater, and then demand is discovered. De Vany and Eckert (1991) suggest that the information provided by pre-release screenings is quite limited - exhibitors often do not attend screenings. Further, evidence suggests that screenings do not aect sharing rules. Regulations vary by U.S. state: blind bidding ( contracting before screening) is allowed by some but not others. Where blind bidding is prohibited, distributors must allow exhibitors to see the movie before contracting (although exhibitors may choose not to go). The sharing
On average, movies made by Motion Picture Association of America members in 2003 had production, distribution, advertising, overhead and interest costs of $102.9 million. The average movie does not earn a positive return on investment - high prots on scarce hits make up for losses on the rest (Vogel 1998).
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rules are similar whether blind bidding is used or not.6 When comparing contracts in states with blind bidding to those in states without Blumenthal (1988) focuses on the guarantee because it is the most variable element of the bid vector. Is incentive provision important? Bhattacharyya and Lafontaine (1995) show that simple sharing rules can be optimal when double-sided moral hazard exists, and their model could be applied to movie exhibition. Distributors must advertise and promote the movie, while exhibitors must hire employees and do some local advertising. Neither partys activities are easy to monitor. Kenney and Klein (1983) and Hanssen (2002) point out that sharing contracts provide incentives for exhibitors to keep theaters clean and take other actions which are hard to monitor but that may increase ticket revenue. Are these eects the reason for revenue sharing? We argue that long-run relationships between exhibitors, customers, and distributors reduce the need for incentive contracts - reputational concerns provide incentives. For example, an unclean theater loses repeat business with local consumers. Even if distributors paid at payments to the exhibitor, a new contract would be negotiated each time a new movie was released. Thus, payments to the exhibitor could quickly fall if the theater lost customers. Therefore, the exhibitor would have the incentive to keep the theater clean in the absence of a sharing rule. Given this, the distributor could simply rent the auditorium at a at rental rate using a four walls contract. Such contracts have been used, but only rarely - sharing is the norm. In our conversations with practitioners, we found absolutely no support for the notion that revenue sharing encourages theater cleanliness or any other standard good business practices.7 Our models of risk sharing and measurement costs are consistent with what rms claim
Exhibitor objections contributed to regulations prohibiting blind bidding, but De Vany and Eckert (1991 fn. 77) explain that the main objections were to bidding itself (exhibitors preferred negotiations) and the accompanying guarantees, which were nonrefundable upfront payments from the exhibitor to the distributor. Like many contract terms, guarantees were originally introduced to protect one party against downside risk. In this case, the risk was that the exhibitor would go bankrupt, taking the revenues and the print (the copy of the movie). Guarantees are almost never used today and even refundable advances (which ensure that the exhibitor does not lose money on a movie that does not earn its advance) are rare. Information technology facilitates paying the distributor early in the run from revenues, so advances are unnecessary. 7 Of course, building a reputation may not be costless, and it may take time before a new exhibitor develops a reputation for cleanliness and other good business practices. Our point is that the exhibitor has the incentive to bear these costs regardless of whether the exhibition contract uses a sharing rule or a at payment; the exhibitors main concern is to build and maintain customer goodwill.
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they are doing and explanations based on asymmetric information appear inadequate. However, our explanations raise a question. Given that movie-specic risk is primarily idiosyncratic, and given that standard nance theory suggests that rms should ignore idiosyncratic risk, why do distributors and exhibitors care about movie-specic risk? We note that in contrast to standard nance theory, most rms care about idiosyncratic risk. For example, risk-neutral rms would not buy insurance because insurance premiums are not actuarially neutral, and yet corporations spend more money on insurance premiums than they pay out in dividends (Mayers and Smith 1982; Martin 1988). It is beyond the scope of this paper to explain why rms alleviate idiosyncratic risk, but most analyses emphasize stakeholder risk aversion (see Smith and Stulz 1985, De Alessi 1987, DeMarzo and Due 1995, and Tufano 1996). For example, insurance shifts the risk of bankruptcy away from employees who cannot diversify toward shareholders who can, and by doing so it encourages employees to make rm-specic investments. Alleviating idiosyncratic risk also encourages some shareholders to become large undiversied shareholders, who then perform monitoring that aids all investors. In the movie industry, revenue sharing contracts play this role.8

2. Models
2.1. The Risk Sharing Model Here we present a simple risk sharing model that explains the basic features of the sharing rule. The sharing rule evolved when single-auditorium theaters were the norm, and our model has one distributor with one movie and one exhibitor with one auditorium. We ignore costs and focus on revenues; this is reasonable because when the movie is placed in the theater most of the distributors costs are sunk and most of the exhibitors costs are xed. For now, suppose the distributor designs a contract for a single week, and assume that both players take the ticket price p as given (this is reasonable; see Subsection 1.1). Given p and
Note that movie-specic risk may be very hard to insure using third-party insurance. Distributors and exhibitors have industry know-how that third parties lack, and as a result they may be best-suited to bear movie-specic risk. Dekom (1992) summarizes the industry attitude: In the case of major studios, avoiding risks (by taking serious downside protection) is simply not a business plan.... If the management has insucient condence in its own abilities to choose and distribute motion pictures, perhaps they should nd solace in another industry.
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the theaters weekly capacity N, attendance during the week, nt , is determined according to a probability density function Pr(nt |p, N, t). The game proceeds as follows: The distributor proposes a contract wt (pnt ). If the exhibitor accepts the contract then it shows the movie and gets paid accordingly. If it does not accept the contract it receives its reservation utility
Ue . In reality Ue would be determined by competiting distributors movies (opportunity costs), but for simplicity assume that Ue is exogenous. For now, ignore concession revenue;

we discuss it below in Subsection 2.3. The distributor chooses wt (pnt ) to maximize its expected utility subject to the exhibitors participation constraint:
N X

{wt (pnt )}n

maxN
t =0

E (Ud ) =

nt =0

Ud (pnt wt (pnt )) Pr(nt |p, N, t)

(2.1)

s.t. E (Ue ) =

nt =0

N X

Ue(wt (pnt )) Pr(nt |p, N, t) Ue

(2.2)

where Ud (.) and Ue (.) are the distributors and exhibitors utility functions and E (.) is the expectation operator. The rst-order condition implies that at each value of nt ,
0 0

Ud (pnt wt (pnt )) = t Ue (wt (pnt )),

(2.3)

where t is the Lagrange multiplier.9 Dierentiating both sides with respect to nt yields the slope of the revenue-sharing rule: Ud (pnt wt (pnt )) = 00 00 Ud (pnt wt (pnt )) + t Ue (wt (pnt ))
00

0 wt (pnt )

(2.4)

Risk aversion implies that the second derivatives of both utility functions are negative,
Expression (2.3) is similar to the rst-order condition in several classic papers on risk sharing. Borch (1962) was the rst to characterize the rst-order condition for optimal risk sharing. Stiglitz (1974) and Leland (1978) consider constant relative risk aversion, which we discuss presently. A rst-order condition similar to (2.3) can be derived from a Nash bargaining model where both players have exogenous outside 1 [E (Ud )Ud ] [E (Ue )Ue ] , where Ud is the distributors options. Nash bargaining solves: max{wt (pnt )}N nt =0 reservation utility and measures relative bargaining power. At the solution the marginal utilities are proportional to each other as in (2.3). Thus, the shape of the optimal contract does not depend critically on relative bargaining power. When = 1, the distributor has all of the bargaining power and the problem is identical to solving (2.1) subject to (2.2).
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which implies that the slope of the sharing rule is positive. However, the change in the slope of the sharing rule as nt changes depends on the third derivatives of the utility functions. Thus, we require additional assumptions to replicate the pattern in Figure 1. Suppose both parties have constant relative risk aversion (CRRA): Ud (x) = xd and Ue (x) = xe , where x is money and d and e are the coecients that measure relative risk aversion. These functions have several plausible properties: the marginal utility is positive and diminishing as long as i < 1; relative risk aversion,
xU 00 (x) , U 0 (x) U 00 (x) , U 0 (x)

is constant; and absolute risk aversion,

is

decreasing in the money payo as long as i < 1. We follow the standard principal-agent model (Mas-Colell et al. 1995) and assume that the contract proposer (the distributor) is less risk averse than the other party (the exhibitor). However, we assume that both parties are risk averse.10 Assumption 1: Both parties have CRRA utility and 0 < e < d < 1. Assumption 1 must hold for the results in the remainder of this subsection. We do not have a strong justication for the assumption that e < d , but it seems reasonable. We argue in the conclusion that distributors have a higher ratio of variable to xed costs and are in a better position to absorb uctuations in revenue. Further, distributors often reduce their exposure on particular movies through co-production arrangements and revenue sharing contracts with talent; exhibitors lack similar options. Note that the principal-agent model also lacks a strong justication for the assumption that the principal is less risk averse than the agent in many settings where it is used. However, this does not imply that the models are not useful, and even when we cannot verify assumptions we can evaluate models based on how well they predict. Our simple model predicts many of the features of modern exhibition contracts. Given Assumption 1, (2.4) can be expressed as 1 1+
h
t e d

0 (pnt ) = wt

0 Expression (2.5) shows that wt (pnt ) is increasing in pnt and that wt (pnt ) diminishes as

1 d 1

e 1 w (pnt ) d 1 t

e d d 1

(2.5)

If both players are risk neutral then neither cares about who bears the risk and an innite variety of contracts are optimal. If one player is risk neutral and the other is risk averse then it is optimal for the risk neutral player to bear all of the risk and pay the other a at payment.

10

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wt (pnt ) rises. Thus, the optimal sharing rule has a diminishing slope as in Figure 1.11 We cannot solve for wt (pnt ) analytically, but we can compute it numerically using realistic parameters for urban theaters (provided by the sources in fn. 1). Assume the capacity per showing is 250 and there are four showings per day: N = 7000. The ticket price p = 7. Given N and p, the maximum weekly ticket revenue is $49,000. Friedberg (1992) and Murphy (1992) suggest this is a reasonable upper bound. We choose the remaining parameters, d , e , and t , in a rough attempt to minimize the distance between the payments the model generates and the real-world payments graphed in Figure 1. We set d = .75, e = .5, and t = 21. The optimal contract is graphed in Figure 2. Result 1: The optimal sharing rule has a diminishing slope, as in the real-world contract. If we consider multiple weeks, the model explains oors with sliding scales and best-weeks clauses. Suppose that at the beginning of the movies run, the distributor solves (2.1) for each week based on a forecast of Pr(nt |p, N, t). The solution is an optimal wt (pnt ) for each
must rise in order for the exhibitor to obtain utility Ue each week. Formally, this results

week. Typically, pnt is expected to fall over time.12 Given this, the exhibitors share of pnt

from an increase in t , since the risk aversion parameters, prices, and other variables do not change over the life of the movie.13 When t rises the entire sharing rule becomes steeper, whereas in reality only the oors do and the 90/10 split remains a possibility. However, the oor is virtually always the relevant payment in later weeks so it is reasonable that the real-world parties reduce transaction costs by not revising the 90/10 provision. Result 2: If attendance is expected to fall over time, the exhibitors share of revenue must
each week (which is required in rise over time in order for the exhibitor to obtain utility Ue

order for the exhibitor to continue to show the movie). Thus, the optimal sharing rule has a oor with a sliding scale, as in the real-world contract. Result 3: If attendance is expected to peak in the second or later weeks, the exhibitors
share of revenue initially falls and then rises in order for the exhibitor to obtain utility Ue

Note that if d = e , the exhibitor receives a constant share of ticket revenue. De Vany and Eckert (1991), De Vany and Walls (1996, 1999), Sawhney and Eliashberg (1996), and Eliashberg et al. (2000) examine time series of ticket revenue. Typically, revenue per screen falls over time. 13 The multiplier t measures the distributors expected marginal utility from a change in Ue . During low-revenue weeks the distributor gets less revenue at each level of nt (because the exhibitor must continue ). Given that Ud (.) is strictly concave, this implies that t is higher during such weeks. to receive Ue
12

11

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each week. Thus, the optimal sharing rule explains the best weeks clause that occasionally appears in real-world contracts. Note that even with perfect forecasting, the exhibitors payment would adjust over time
in order for it to obtain Ue . Thus, conditional on sharing, adjustments to the oor may

be explained by exhibitor opportunity costs that are roughly constant. However, with perfect forecasting there would be no need for revenue sharing; at payments would suce. Even with unpredictability, if one party is not risk averse, a at payment could be used to compensate the risk averse party, as long as the appropriate payment could be calculated. In sum, our model explains concave sharing rules, oor payments with sliding scales, and best weeks clauses. However, the real-world contract is simpler than the model so far suggests because it typically species a single oor percentage for each week rather than a mapping from revenues to the oor percentage.14 Thus, transaction costs and the possibility of ex post adjustments matter. As in many other contractual environments, parties use simple fractions (see Young and Burke 2001). Most contracts include the 90/10 provision, and oors adjust by ve or ten percentage points, not the one or two that marginal analysis would suggest.15 Suppose that both parties agree on an interval that is likely to contain the weekly revenues and choose the oor using (2.5) adjusted to the nearest whole 5%. Both parties agree that if, once they observe revenue, they learn that their forecast was grossly in error, they will re-evaluate the shares using (2.5). This contract economizes on transaction costs if negotiating appropriate payments for unlikely contingencies ex ante is costly relative to the expected cost associated with ex post adjustments (which takes into account both how unlikely the contingency is and the ex post transaction costs). In this case, the model yields two predictions: Result 4: Ex post adjustments occur only when the movie performs much better or much worse than expected. Result 5: Adjustments favor the distributor when the movie performs better than expected
Occasionally more complex contingent shares are used and they have the features our model suggests: the exhibitors share is higher when revenue is lower. Also, exible deals allow the percentage shares to depend on revenues. 15 Diculties with forecasting partly account for coarse percentages. However, even exible deals involve coarse percentages. Thus, minimizing transaction costs associated with quibbling also plays a role.
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and favor the exhibitor when the movie performs worse than expected. This approach also explains the 90/10 provision. Ex post transaction costs would be higher when there is more prot to ght over - when prot is low not much can be gained by quibbling. In order to avoid high ex post transaction costs in the event of a surprise blockbuster hit, industry participants have adopted the standard practice (and therefore the low-transaction-cost practice) of including the 90/10 provision in most contracts. Can a principal-agent model generate our results? Yes, but the required assumptions are not realistic. We argued in Subsection 1.2 that exhibitors do not require contractual incentives to incur eort. However, even if we assume incentives are required, in a principal agent model the slope of the optimal sharing rule is steeper when it is more important for the exhibitor to incur eort. Thus, Result 1 requires that exhibitor eort is more important at low revenue levels. Results 2 and 3 require that exhibitor eort is more important in low revenue weeks than in high revenue weeks, whereas the opposite is true in reality. Further, typical piecewise linear sharing rules in principal agent models include at payments from one party to the other - shares provide incentives and the at payment adjusts to ensure that the agent receives its reservation utility. Other than the house nut in the 90/10 provision, at payments are not a feature of modern exhibition contracts. 2.2. The Measurement Costs Model Here we show that a simple cooperative model that emphasizes ex ante and ex post measurement diculties can also generate Results 1-5. Again we consider one distributor with one movie and one exhibitor with one auditorium, and we begin by considering a single week. To ease the notational burden we suppress the time subscripts. Suppose both parties agree the movie is expected to earn = d + e , where d is the distributors contribution and e is the exhibitors contribution; d is due to the movie per se, whereas e is due to theater-specic attributes, such as location, size, decor, and so on. Suppose there are two shocks that aect revenue. The rst is a movie-specic shock d that does not depend on any theater-specic attributes; it reects diculties with forecasting how the movie will be received by audiences in general. The second shock accounts for all other sources of randomness that aect movie attendance. The movies weekly revenue pn is given by 13

pn = d + e + d +

(2.6)

Now suppose the parties agree that the distributor should receive d if it is positive and compensate the exhibitor if it is negative. This is reasonable because d depends on moviespecic attributes provided by the distributor. However, ex post the parties cannot be sure whether any gain or loss relative to is due to d or . As neither party is responsible for , suppose that both parties agree that shares of revenue should be based on the posterior estimate of d + d and e . To compute these, assume that both shocks are normally
2 distributed with zero means and variances 2 d and . The posterior estimate of d is

2 d (pn d e ) 2 2 d+ Given this, the exhibitors share of revenue (the posterior estimate of
2 ( 2 d + )e 2 (d + e ) + 2 d pn e ) d +d +e

(2.7) is

(2.8)

Clearly (2.8) is decreasing in pn. Thus, the exhibitors share of revenue falls as revenue rises, as in the real-world contract. If revenue is exactly d + e , the exhibitor gets the share
e . d +e

Other things equal, the exhibitors share is increasing in e and 2 and decreasing in d and
2 2 d . If as the weeks go by, d falls (as we argued in the previous subsection) and d falls (the

movies quality gets revealed), the exhibitors share of revenue rises. On the other hand, if d is anticipated to rise, then the model predicts a best-weeks clause would be used. Thus, this model generates Results 1-3 discussed above. As we argued in the previous subsection, transaction costs, preferences for simple fractions, and the possibility of ex post adjustments aect contract terms. Suppose that both parties initially agree to share revenue each week according to their ex ante estimates of relative contributions as given by d and e . That is, the contract species that the exhibitor receives the share
e . d +e

Both parties agree that if, once they observe revenues, they learn

that their forecast was grossly in error, they will re-evaluate the shares using (2.8). In this case, the model yields Results 4 and 5.

14

2.3. Concession Revenue, Pricing, and Long-term Relationships Why is concession revenue not shared? In the aggregate, concession revenue is close to being a deterministic function of attendance. Given this, a sharing rule based on attendance (or ticket revenue, given that p is xed) approximates one that includes concession revenue. Further, concession revenue is dicult for distributors to monitor, particularly in a multiplex where it is dicult to attribute concession revenue to the various movies showing at once. When the monitoring cost is weighed against the small gain from sharing concession revenue, the parties prefer contracts based solely on ticket revenue.16 Interestingly, leaving concession revenue out of the contract creates a problem: the exhibitor may wish to reduce p after signing the contract. Given the sharing rule, the exhibitor bears only its percentage of lost ticket revenue but obtains the entire gain from increased concession revenue that results from higher attendance. On the other hand, the distributor wants to maximize ticket revenue and does not care about concession revenue, so it prefers a higher p. The parties cannot set p in the contract because courts frown on vertical price restraints.17 The parties could divorce the distributors payment from p by basing it on attendance rather than ticket revenue, but such per capita clauses are rare (De Vany and Eckert 1991; Friedberg 1992). The main solution relies on long-term relationships. The exhibitor gains from adjusting p only if the adjustment occurs after the contract is signed. If the exhibitor adjusts p before the contract is signed then the distributor will simply argue to change the sharing rule to ensure that the exhibitor still gets its reservation utility. Given that exhibitors include their proposed p in their initial bid, a subsequent adjustment would violate an implicit contract. Such behavior could cause the distributor (and perhaps others as well) to punish the exhibitor in the future. This encourages exhibitors to keep p up.
Including concession revenue and monitoring costs in the above models is straightforward. Consider the risk sharing model. Denote concession revenue by c, the exhibitors share by wc (c), and assume that c is a (possibly random) function of attendance n. Suppose that including concession revenue in the contract requires a monitoring cost of m. In this case, the distributor compares its expected utility from maximizing (2.1) subject to (2.2) to the modied problem where its utility is based on pn + c w(pn) wc (c) m, the exhibitors is based on w(pn) + wc (c), and the expected utility calculations consider any randomness in the determination of c. Clearly if c is a deterministic function of n, there is no gain to including c in the contract. Even if this is not the case, if m is suciently high the distributor prefers leaving c out of the contract. 17 Many economists believe that vertical restraints should be permitted, partly because they can help resolve agency problems (for a discussion see Carlton and Perlo 1994).
16

15

3. Wehrenberg Theatres Contracts

Our data is provided by Wehrenberg Theatres of St. Louis, Missouri. To avoid revealing proprietary information, all of the dollar values have been rescaled. Relative comparisons across theaters, contracts, time, and so on are entirely valid, but the levels are deliberately misstated. Further, we do not reveal distributor identities. Wehrenberg Theatres was founded in 1906 and currently operates thirteen theaters of various sizes in the St. Louis area, primarily in the suburbs. Wehrenberg has two main competitors that are concentrated in the city center: AMC operates four theaters and St. Louis Cinema operates two. In 2001-2002, Wehrenberg accounted for approximately 68% of the ticket revenues collected by the 19 theaters, which is in proportion to its capacity. We have data on all movies playing in a Wehrenberg theater as of 8/31/01 and all movies that opened on or before 5/8/03. There are 308 movies and 2,769 contracts (each theater has a separate contract for each movie). Table 1 lists by theater the number of screens, the seating capacity, the number of contracts (which equals the number of movies shown), the average revenue per contract, and the exhibitors average percentage share. Table 1 also provides a breakdown of the contracts into the four possible types. Clearly, the vast majority of contracts employ sliding scales, and most are rm term. The sharing rules vary substantially by movie and theater. For example, in sliding scale deals the exhibitors share ranges from 23-70% in week 1, 30-70% in week 4, and 40-70% in week 8. Run lengths depend on performance and vary from 1 to 28 weeks in our data; the average run length is 5 weeks. During the period, 21 distributors supply movies to Wehrenbergs theaters. The group includes all of the large distributors (Buena Vista, Fox, Miramax, Paramount, Sony, Universal, Warner Brothers) and several smaller ones. Table 2 lists by distributor the number of movies placed in Wehrenbergs theaters during the period and the total number of contracts. The distributors are ranked according to the number of movies provided, from largest to smallest. The fth column shows that average ticket revenue per contract varies substantially across distributors. This is to be expected; every movie is dierent, theater demographics dier, seasons dier, competition from other movies diers, and so on. The seventh column shows that distributors tend to receive slightly higher average shares when average ticket revenue

16

is higher. This is consistent with our models; distributors receive most of the gains when ticket revenue is high. On average, the distributor obtains 54% of cumulative ticket revenue. Table 2 also provides a breakdown of what types of contracts each distributor uses. Most use sliding scale deals exclusively and display a preference for either rm or exible deals. 3.1. Concave Sharing Rules The 90/10 provision is included in 86% of the contracts. Thus, most contracts exhibit the curvature suggested by Result 1 and depicted in Figures 1 and 2. However, 90/10 rarely applies. The distributor was compensated according to 90/10 for at least one week during the movies run in only 3% of the contracts. The provision applies for only the biggest hits in the biggest theaters, and even then for only one or two weeks of the run. The set of contracts that lack the 90/10 provision includes virtually all of the aggregate deals and a small percentage of the sliding scale deals. In our models, the 90/10 provision is a transaction-cost minimizing device that anticipates the adjustment that would occur if it were not in place. Given this, our models suggest parties would leave the provision out only if they anticipate low revenues. The data on sliding scale deals supports this view. For example, the average total revenue per contract for sliding scale rm-term deals with the 90/10 provision is $22,455; for those without, $13,233. This dierence is statistically signicant at the 1% level (t stat 4.87; 1% critical value 2.58). For brevity we do not report additional comparisons, but results are similar for the sliding scale exible deals and for comparisons at the theater level. We discuss aggregate deals below in Subsection 3.4. 3.2. Revenue Sharing and Run Lengths Our models suggest that revenue sharing is used to share risks and economize on measurement costs. Of course, many sharing rules could accomplish these goals; Result 2 suggests that sliding scale rules are prevalent because they provide the exhibitor with the incentive to keep the movie longer. In this subsection, we evaluate this claim. We must be careful when applying the models to data, because the models assume the exhibitor has a constant
reservation utility, whereas in a modern multiplex, Ue (or e ) changes systematically over

the life of the contract. When a movie rst opens, it competes for the best auditoriums 17

 and time slots; Ue is quite high. Later in the run, the movie is relegated to the smaller

auditoriums where the opportunity cost is much lower.18 However, our arguments here do
not depend on Ue being constant over a movies run.

We show that if run lengths are unaected by the form of the sharing rule, the parties could achieve essentially the same stream of revenues using a much simpler rule that eliminates transaction costs. Table 3 reports results from OLS regressions of the exhibitors portion of cumulative revenue for each movie (after any adjustment) on a constant and the movies total revenue, by theater. By construction in OLS, the estimated residuals sum to zero. Thus, each theater (and the distributors at each theater, as a group) would have received exactly the same cumulative money payos during the sample period if compensated using the regression line instead of the real-world contracts. The regression line suggests a simple linear rule that would be constant across movies and time for each theater: a at fee (given by the constant term) plus a share of the movies revenue (given by the slope coecient). For example, for every movie placed in the Arnold theater, Wehrenberg could require a at payment of $876 and 42% of the movies revenues. There would be no need to negotiate terms for each movie or adjust terms ex post. If run lengths are unaected, why not use this linear rule? Perhaps distributors would not want a one-size-ts-all rule. We re-ran the regressions in Table 3 while including dummy variables to allow the at payments and shares to vary by distributor for the largest ten distributors. Wald tests of the null hypothesis that all of these eects were zero were accepted in all but one of the theaters. This suggests that each distributors cumulative revenues would not be aected much by a switch to the linear rule, holding run lengths constant. Another possibility is that while cumulative revenues would be unaected, the ow of revenues would be drastically altered. This is not the case. The R-squared is at least .95 in every case in Table 3; the unexplained variance is small. As an example, Figure 3 compares Wehrenbergs weekly revenue from the Arnold theater to what it would have been under our linear rule with the at fee paid in four weekly installments. It is dicult to distinguish
The change in the opportunity cost is sometimes reected in the house nut. The house nut declines over the run in about 6% of the contracts. The decline in the nut also reects the decline in the number of prints (copies of the movie) required as the movie is shown less often.
18

18

the two cash ow series. Given the wide uctuations in theater revenue, it is unlikely that the relatively small deviations associated with switching to the linear rule would deter the exhibitor from adopting it. Figure 4 shows that the same is true for Distributor 1 at the Arnold theater. These gures are representative - moving from the relatively complex movieby-movie rules to our simple linear rule has little eect on any theaters or distributors cash ows, and the eects remain small when aggregated to the rm level. Finally, note that our rule could only improve resource allocation, because it ensures that the exhibitor optimizes by maximizing total revenue. Under the current sharing rules, it is possible that more favorable terms on a worse movie might encourage the exhibitor to allocate movies to screens and run times in an inecient (non total-revenue maximizing) way. In conclusion, it seems likely that the main reason why our simple linear rule is not used is that such a rule would encourage the exhibitor to shorten the run length. 3.3. Best Weeks Clauses Result 3 suggests that best weeks clauses are used when it is possible that movie performance might improve over time. Best weeks clauses are relatively rare; they are used in only 8% of the contracts in our data, and only ve distributors use them during the period we examine. Evidence supports Result 3. In contracts without best weeks clauses, weekly revenue peaks after the opening week in only 6% of the cases. In contracts with best weeks clauses, weekly revenue peaks after the opening week in 23% of the cases. This dierence is statistically signicant at the 1% level (t stat 9.08, 1% critical value 2.58). Thus, there is a strong positive correlation between the use of a best weeks clause and the likelihood that a movie reaches its peak performance after the opening week. 3.4. Aggregate Deals As we noted above, aggregate deals are used in a small percentage of cases. Table 2 shows that three large, one medium size, and three small distributors occasionally use aggregate deals; no distributor relies on them exclusively and most never use them. Practitioners tell us that some distributors use aggregate deals when the evolution of revenue is particularly dicult to predict, and our data supports this view. In such a case it may be dicult to 19

determine an appropriate schedule of oor payments in advance, and the distributor may not want to leave the choice up to the exhibitor, as in a exible sliding scale deal.19 For the distributors who sometimes use aggregate deals, we computed the ratio of week2 to week1 total revenues and week3 to week1 total revenues for every contract. Then we grouped the contracts into sliding scale deals vs. aggregate deals. While the mean ratios are virtually identical (.63 vs. .64 for week2 to week1; .39 vs. .40 for week3 to week1) the variances are substantially higher for aggregate deals (.040 vs. .053 for week2 to week1; .042 vs. .090 for week3-week1). F tests of the null hypothesis that the variances are equal are rejected at the 1% level in both cases (F statistics: 1.32, 2.14; 1% critical value <1.30). Our models suggest three implications of aggregate deals. First, an aggregate deal forces the exhibitor to bear a greater share of downside risk; in our models the exhibitor would have to be compensated with a greater share of the upside. This explains the absence of the 90/10 provision in virtually all aggregate deals. Second, our risk sharing model suggests that an exhibitor will accept non-optimal risk sharing only if it is compensated with higher expected revenue. The data provides some support for this view. On average, the exhibitor received lower revenue in sliding scale deals ($9,803 vs. $13,238 for aggregate deals) and the same percentage share in both types of deals (46%). However, this nding is not conclusive because movies with aggregate deals earned higher revenues and the exhibitor may have had higher opportunity costs (see Subsection 3.2).20 Third, aggregate deals are similar to our proposed linear deals; Result 2 suggests that they should lead to shorter runs. Unfortunately, we cannot assess this because we cannot isolate the eect of deal type on run length. In our data, average run lengths are slightly longer for movies with aggregate deals. However, this occurs because movies with aggregate deals were on average better than others, not because of the sharing rules.
A very small percentage of deals are aggregate exible, but these may be based on an exceptionally good long-term relationship between the distributor and the exhibitor. The next subsection shows that the overwhelming majority of such deals are adjusted after the run is over. 20 Also, the nding does not mean that aggregate deals are used when expectations are high. For distributors who use aggregate deals there is no clear association between higher-than-average revenues and the use of an aggregate deal.
19

20

3.5. Ex Post Adjustments All types of deals may be adjusted, and adjustments may favor either party. Here we count any departure from the initial schedule of oors or aggregate shares as an adjustment.21 This diers from actual adjustments only in that we count cases where 90/10 applies as adjustments favoring the distributor. This is sensible given our models; the 90/10 provision is a transaction-cost minimizing device that anticipates the adjustment that would occur if it were not in place. Flexible deals are more likely to be adjusted. Given our denition, 11% of sliding scale rm-term deals get adjusted, along with 41% of sliding scale exible deals, 13% of aggregate rm-term deals, and 82% of aggregate exible deals. In our models, adjustments occur when a movie does much better or worse than expected. Expectations vary by movie and theater and we cannot measure them directly. However, we can assess Results 4 and 5 by comparing revenue outcomes. We divide contracts into three categories: no adjustment, an adjustment favoring the distributor, and an adjustment favoring the exhibitor. If the probability of an adjustment is independent of the initial expectation, then the average expected revenue in each category should be the same in a large sample. Given this, we can compare the average actual revenue in each category to measure the departures from expectations. More realistically, departures from expectations may be i.i.d. zero-mean shocks with heteroscedastic variances, where the variance tends to be higher when expected revenue is higher. In this case, contracts with higher expected revenues are more likely to be adjusted. However, even in this case we can assume that the average expected revenue is the same in the two cases where adjustments occur. The exhibitors average revenue per contract from sliding scale rm-term deals with no adjustment is $8,933; with an adjustment favoring the distributor, $26,641; with an adjustment favoring the exhibitor, $7,723. The last two averages are signicantly dierent at the 1% level (t stat 6.86; 1% critical value 2.58). The facts are consistent with Results 4 and 5: adjustments favor the distributor when the movie does much better than average
Measuring adjustments for exible deals requires some subtlety. As we noted in Subsection 1.1, in a exible deal neither party expects to be compensated using the formal boilerplate terms. Instead, the exhibitor determines the payments as revenue is observed, and we use this schedule as our measure of the initial schedule rather than the boilerplate terms. Final settlements occur 21-30 days after the run is over, and adjustments may occur at that point.
21

21

and favor the exhibitor when the movie does worse than average. Note that the average revenue when adjustments favor the exhibitor is only slightly below the average revenue when no adjustments occur. This is consistent with our argument in the previous paragraph that adjustments are more likely when expectations are high. For brevity we do not report additional comparisons, but results are similar for the other types of deals, comparisons at the theater level, and comparisons where we exclude cases where 90/10 applies.

4. Conclusion
Our results suggest that exhibition contracts evolved to help distributors and exhibitors share risks and overcome measurement problems and not to overcome asymmetric information problems. Our models explain several contractual features including concave revenue sharing rules, oors with sliding scales, best weeks clauses, and ex post adjustments. Other features of the environment also aect contracts: concession revenue is not shared because it is dicult for distributors to monitor, and long-run relationships that exhibitors have with distributors and consumers explain several practices. Why were modern sharing rules not used when the industry began? Initially movies were low-cost non-dierentiated products; demand was fairly predictable and the cash ow consequences of a op were not serious. Given this, the transaction costs associated with complex sharing rules were not worth bearing. Revenue sharing requires that distributors monitor exhibitors, and monitoring is worthwhile only if the expected benet is suciently high. Even after sound, cheap B movies and movies shown in third, fourth, and fth run theaters were not leased using sharing rules (Hanssen 2002). Over time movies became more dierentiated, budgets grew, and risks increased. This trend continued through the 1950s when studios stopped making B movies in response to the emergence of television, and it became more worthwhile to adopt increasingly complex sharing rules. Although our models are designed to explain exhibition contracts in the movie business, many of the insights obtained apply to other goods with large upfront costs and uncertain demand such as new books and music. Other contracting environments also involve unpredictability, two-sided risk aversion, and measurement costs. Future research should in-

22

vestigate the eects of two-sided risk aversion and measurement problems on contract terms in greater depth and explain how levels of risk aversion dier across rms. An explanation may require considering rm-level cash ows in a dynamic environment. Firms avoid downside risks, and the stability of their cash ows determines how important it is to avoid downside risks. In the movie exhibition market, exhibitors have less control over their cash outows than distributors. Operating a theater involves mainly xed costs that cannot be avoided without exiting. On the other hand, distributors can avoid costs by delaying new movie projects, adjusting production and promotion budgets, sharing costs with outside investors, or compensating talent using sharing rules. These dierences may make exhibitors more reluctant to bear downside revenue risk than distributors.22

References
[1] Ackerberg, D.A. and M. Botticini. Endogenous Matching and the Empirical Determinants of Contract Form Journal of Political Economy 110 no.3 (June 2002): 564-91. [2] Bhattacharyya, S., and F. Lafontaine. Double-Sided Moral Hazard and the Nature of Share Contracts RAND Journal of Economics 26 no.4 (Winter 1995): 761-781. [3] Blumenthal, M.A. Auctions with Constrained Information: Blind Bidding for Motion Pictures The Review of Economics and Statistics (1988): 191-198. [4] Borch, K. Equilibrium in a Reinsurance Market Econometrica 30 (1962): 424-44. [5] Borcherding, T.E., and D. Filson. Conicts of Interest in the Hollywood Film Industry: Coming to America - Tales from the Casting Couch, Gross and Net, in a Risky Business in Davis, M., and A. Stark, eds. Conict of Interest in the Professions (New York: Oxford University Press, 2001). [6] Carlton, D.W., and J.M. Perlo. Modern Industrial Organization (2nd. ed. New York: Harper Collins, 1994).
It is also possible that stakeholder risk aversion diers between rms. Future research could explore the relation between stakeholder risk aversion, rm characteristics, and contracts. Ackerberg and Botticini (2002) provide insight into how this might be done when risk aversion cannot be observed directly. Hartog et al. (2002) describe how surveys can reveal levels of risk aversion.
22

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[7] Chisholm, D. Asset Specicity and Long-term Contracts: The Case of the Motion Pictures Industry Eastern Economic Journal 19 no.2 (Spring 1993): 143-55. [8] Chisholm, D. Prot-Sharing Versus Fixed-Payment Contracts: Evidence from the Motion Pictures Industry Journal of Law, Economics, & Organization 13 no.1 (1997): 169-201. [9] De Alessi, L. Why Corporations Insure Economic Inquiry 25 no.3 (July 1987): 429-38. [10] Dekom, P.J. Movies, Money and Madness in Squire, Jason E., ed. The Movie Business Book, 2nd ed. (New York: Fireside, 1992). [11] DeMarzo, P.M., and D. Due. Corporate Incentives for Hedging and Hedge Accounting Review of Financial Studies 8:3 (Fall 1995): 743-71. [12] De Vany, A.S., and R.D. Eckert. Motion Picture Antitrust: The Paramount Cases Revisited Research in Law and Economics 14 (1991): 51-112. [13] De Vany, A.S., and D.W. Walls. Bose-Einstein Dynamics and Adaptive Contracting in the Motion Picture Industry The Economic Journal (1996): 1493-1514. [14] De Vany, A.S., and D.W. Walls Uncertainty in the Movies: Does Star Power Reduce the Terror of the Box Oce? Journal of Cultural Economics (Nov. 1999): 285-318. [15] Eliashberg, J., J. Jonker, M.S. Sawhney, and B. Wierenga. MOVIEMOD: An Implementable Decision-Support System for Prerelease Market Evaluation of Motion Pictures Marketing Science 19 no.3 (Summer 2000): 226-43. [16] Filson, D. Dynamic Common Agency, Vertical Integration, and Investment: The Economics of Movie Distribution Claremont Graduate University working paper, 2004. [17] Friedberg, A.A. The Theatrical Exhibitor in Squire, Jason E., ed. The Movie Business Book, 2nd ed. (New York: Fireside, 1992). [18] Hanssen, F.A. The Block-Booking of Films Reexamined Journal of Law and Economics (October 2000): 395-426. 24

[19] Hanssen, F.A. Revenue-Sharing in Movie Exhibition and the Arrival of Sound Economic Inquiry 40 no.3 (July 2002): 380-402. [20] Hartog, J., A. Ferrer-i-Carbonell, and N. Jonker. Linking Measured Risk Aversion to Individual Characteristics Kyklos 55 no.1 (2002): 3-26. [21] Kenny, R.W., and B. Klein. The Economics of Block Booking Journal of Law and Economics (October 1983): 497-540. [22] Leland, H.E. Optimal Risk Sharing and the Leasing of Natural Resources with Application to Oil and Gas Leasing on the OCS Quarterly Journal of Economics (August 1978): 413-437. [23] Martin, R.E. Franchising and Risk Management American Economic Review 78 no.5 (December 1988): 954-68. [24] Mas-Colell, A., M.D. Whinston, and J.R. Green. Microeconomic Theory (New York: Oxford University Press, 1995). [25] Mayers, D. and C.W. Smith, Jr. On the Corporate Demand for Insurance Journal of Business 55 (April 1982): 281-96. [26] Murphy, A.D. Distribution and Exhibition: An Overview in Squire, Jason E., ed. The Movie Business Book, 2nd ed. (New York: Fireside, 1992). [27] Orbach, B.Y. and L. Einav. Uniform Prices for Dierentiated Goods: The Case of the Movie-Theater Industry Harvard Olin Discussion Paper 337, 2001. [28] Ravid, S.A. Information, Blockbusters, and Stars: A Study of the Film Industry Journal of Business 72 no. 4 (October 1999): 463-492. [29] Ravid, S.A, and S. Basuroy. Managerial Objectives, the R-Rating Puzzle, and the Production of Violent Films forthcoming, Journal of Business (2004). [30] Reardon, D.B. The Studio Distributor in Squire, Jason E., ed. The Movie Business Book, 2nd ed. (New York: Fireside, 1992). 25

[31] Sawhney, M.S., and J. Eliashberg. A Parsimonious Model for Forecasting Gross BoxOce Revenues of Motion Pictures Marketing Science 15 (1996): 113-131. [32] Sedgwick, J. and M. Pokorny. The Risk Environment of Film-Making: Warner Brothers in the Inter-War Years Explorations in Economic History 35 (1998): 196-220. [33] Smith, C., and R.M. Stulz. The Determinants of Firms Hedging Policies Journal of Financial and Quantitative Analysis 20:4 (December 1985): 391-405. [34] Stigler, G.J. and G. Becker. De Gustibus Non Est Disputandum American Economic Review 67 no.1 (March 1977): 76-90. [35] Stiglitz, J.E. Incentives and Risk Sharing in Sharecropping Review of Economic Studies 41 no.2 (April 1974): 219-55. [36] Tufano, P.F. Who Manages Risk? An Empirical Exploration of Risk Management Practices in the Gold Mining Industry Journal of Finance 51:4 (September 1996): 1097-137. [37] Weinstein, M. Prot Sharing Contracts in Hollywood: Evolution and Analysis Journal of Legal Studies (Jan. 1998): 67-112. [38] Young, H.P. and M.A. Burke Competition and Custom in Economic Contracts: A Case Study of Illinois Agriculture American Economic Review 91 no.3 (June 2001): 559-73.

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Figure 3. Wehrenberg Weekly Revenue Comparison for Arnold Theater

Arnold Theater - Weekly Revenue Comparison
Actual $40,000 Linear Rule

$35,000

$30,000

$25,000

$20,000

$15,000

$10,000

$5,000

10/31/01

11/30/01

12/31/01

10/31/02

11/30/02

12/31/02

8/31/01

9/30/01

1/31/02

2/28/02

3/31/02

4/30/02

5/31/02

6/30/02

7/31/02

8/31/02

9/30/02

1/31/03

2/28/03

3/31/03 3/31/03 4/30/03

Figure 4. Distributor 1 Weekly Revenue Comparison for Arnold Theater

Distributor 1 - Weekly Revenue Comparison
Actual $25,000 Linear Rule

$20,000

$15,000

$10,000

$5,000

$0

10/31/01

11/30/01

12/31/01

10/31/02

11/30/02

12/31/02

8/31/01

9/30/01

1/31/02

2/28/02

3/31/02

4/30/02

5/31/02

6/30/02

7/31/02

8/31/02

9/30/02

1/31/03

28

2/28/03

4/30/03

Table 1. Theater Characteristics

Theater Screens Total Contracts Average Exhibitor Seating Percent of Contracts that are: Sliding Scale
Flexible

Aggregate
Firm Flexible

Revenue % Share Firm per per contract* contract Arnold Clarkson DesPeres Eureka HallsFerry Jamestown Kenrick MidRivers Northwest OFallon Ronnies St. Charles St. Clair Wehrenberg 14 6 14 6 13 14 8 14 9 15 20 18 10 161 2,164 1,357 2,447 1,039 2,526 2,254 1,899 2,505 2,254 2,583 3,625 3,720 2,197 30,570 243 154 256 179 127 265 136 250 223 200 294 284 158 2,769

7,982 6,136 11,354 2,021 2,063 11,534 6,482 12,775 3,035 16,618 20,986 12,865 8,020 10,342

47 46 46 49 50 46 48 46 48 45 45 45 48 46

59 59 61 61 65 58 54 59 58 57 59 59 56 59

30 31 29 28 29 31 35 30 30 32 31 31 32 31

9 8 9 10 6 9 10 9 11 11 9 9 10 9

1 2 1 1 1 1 1 2 1 2 1 1 2 1

* Revenues have been rescaled to preserve proprietary information. All percentages and rankings remain intact.

29

Table 2. Distributor Contract Characteristics

Distributors Average Percent of Contracts that are: Total Distributor Contracts Revenue Revenue Rental Sliding Scale Aggregate per Rate per per (%) Firm Flexible Firm Flexible Movies Contracts movie contract* contract* 44 39 34 34 31 27 27 19 14 13 7 5 3 2 2 2 1 1 1 1 1 308 441 396 325 336 202 275 229 166 131 130 47 41 8 14 10 3 2 1 4 3 5 2,769 10 10 10 10 7 10 8 9 9 10 7 8 3 7 5 2 2 1 4 3 5 9 21,184 21,772 30,567 24,789 15,627 16,727 24,191 34,717 13,586 31,683 4,830 8,401 16,049 46,714 3,767 16,566 6,128 5,505 1,180 2,592 12,715 22,651 11,643 12,243 16,685 14,063 7,773 8,414 13,175 18,522 7,199 17,866 2,145 3,998 7,351 21,881 1,729 7,514 2,778 2,697 526 1,192 5,295 12,309 55 56 55 57 50 50 54 53 53 56 44 48 46 47 46 45 45 49 45 46 42 54 98 71 12 99 12 25 96 25 8 100 40 20 88 0 100 33 0 0 100 0 0 59 2 1 88 1 77 75 0 0 92 0 43 56 13 57 0 67 100 100 0 100 100 31 0 29 0 0 0 0 4 75 0 0 17 0 0 0 0 0 0 0 0 0 0 9 0 0 0 0 10 0 0 0 0 0 0 24 0 43 0 0 0 0 0 0 0 1 Total

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 All Distributors

* Revenues have been rescaled to preserve proprietary information. All percentages and rankings remain intact.

30

Table 3. Linear Regressions

Dependent Variable: Exhibitors Cumulative Revenue per Movie by Theater Table entry: Estimated Coefficient (White Std. Errors in parentheses) Total Revenue per Movie by Theater
0.42*** (0.0092) 0.44*** (0.015) 0.43*** (0.012) 0.46*** (0.012) 0.48*** (0.015) 0.43*** (0.011) 0.46*** (0.0095) 0.41*** (0.0079) 0.47*** (0.012) 0.39*** (0.013) 0.40*** (0.012) 0.41*** (0.015) 0.44*** (0.018) 0.98 0.98 0.97 0.97 0.97 0.97 0.97 0.98 0.97 0.95 0.98 0.97

Theater Arnold 243 Obs Clarkson 154 Obs DesPeres 256 Obs Eureka 179 Obs HallsFerry 127 Obs Jamestown 265 Obs Kenrick 136 Obs MidRivers 250 Obs Northwest 223 Obs OFallon 200 Obs Ronnies 294 Obs St. Charles 284 Obs St. Clair 158 Obs
* Significant at the 10% level

Constant
876*** (115) 274** (126) 812*** (204) 109*** (31) 86* (45) 853*** (197) 339*** (93) 1,329*** (163) 101** (49) 1,909*** (368) 2,075*** (405) 1,158*** (303) 636*** (227)

R2
0.98

**Significant at the 5% level

***Significant at the 1% level

31