Risky Business: The Impact of Property Rights on Investment and Revenue in the Film Industry
Executive Summary — Films are a risky business because much more is known about the quality and revenue potential of a film post-production than pre-production. Using rich data on the US film industry, this paper explores variation in property right allocations, investment choices, and film revenues to find empirical support for three predictions based on property rights theory. (1) Studios underinvest in the marketing of independent films relative to studio-financed films. (2) Because of underinvestment, independent films have lower revenues than comparable studio-financed films. (3) If production cost and marketing investment are complementary, underinvestment in marketing harms large-budget films more than small-budget films, making it more likely that large-budget films will be studio-financed. Kuppuswamy and Baldwin's paper may be the first to provide evidence that vertical integration affects the revenue of specific products through its impact on marketing investments in those products. Key concepts include:
- Studio-financed films receive superior marketing investments compared to independent films.
- The US film industry has two distinct property rights regimes: studio-financed films are produced and distributed by studios which take in the lion's share of revenue. In contrast, independent films are distributed by studios under revenue sharing agreements, which give studios 30-40% of the revenue stream.
- Under either regime, the allocation of scarce marketing resources is determined by and paid for by the studio. Studio-financed films offer higher marginal returns to marketing investments than independent films.
- Independent film distribution to theaters may be an institutional mechanism that allows studios to adapt to post-production information about the value of their own films vs. outside opportunities. This in turn justifies ex ante investment in the production of independent films (especially those with small budgets) despite their dampened revenue expectations.
Our paper tests a key prediction of property rights theory: that agents respond to marginal incentives embedded in property rights, when making non-contractible, revenue-enhancing investments (Grossman and Hart, 1986; Hart and Moore, 1990). Using rich project-level data from the US film industry, we exploit variation in property right allocations, investment choices, and film revenues to test the distinctive aspects of property rights theory. Empirical tests of these key theoretical predictions have been relatively sparse due to the lack of appropriate data. The US film industry displays two distinct allocations of property rights, which differentially affect marginal returns on a particular class of investments. Studio-financed films are produced and distributed by studios which take in the lion's share of revenue. In contrast, independent films are distributed by studios under revenue sharing agreements, which give studios 30-40% of the revenue stream. Under either regime, the allocation of scarce marketing resources is determined by and paid for by the studio. After accounting for the endogenous nature of property-right allocations, we find that studio-financed films receive superior marketing investments compared to independent films and that these investments fully mediate the positive effect of vertical integration on film revenues. As a result, this study contributes to the empirical literature on property rights by showing that both predicted linkages (from marginal returns to investment and from investment to revenue) exist in a single empirical setting.