At the movies: the economics of exhibition contracts.

I. INTRODUCTION The literature on profit sharing stresses asymmetric information. Profit sharing occurs when a party has private information that cannot be credibly revealed or when a party's 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 difficulties with forecasting revenue fit the facts better. The first 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 affect 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 13 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 findings 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 difficulties with forecasting demand necessitate the use of short-term, contingency-rich contracts. Some other work on nonexhibition 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. After that we describe how the sharing rules evolved over time and argue that asymmetric information does not explain the sharing rules. Section II contains our models, section III contains our empirical work, and section IV concludes. The Modern Movie Exhibition Contract The unit of analysis is a single movie in a single theater (a theater is a building that may contain multiple auditoriums). Although there is typically a boilerplate contract between each distributor and exhibitor that specifies 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 sufficiently high. De Vany and Eckert (1991) and De Vany and Walls (1996) attribute adjustable runs to imprecise forecasts. We focus on explaining the peculiar revenue sharing rule that is common in modern contracts. Some contracts are aggregate deals, in which each side's percentage share remains fixed throughout the run, but 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 movie's weekly ticket revenue over the "house nut," which is a flat payment to the exhibitor; (2) a "floor 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 first 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 floor payments are associated with the high-demand weeks. …