The global export of risk: finance and the film business

Abstract

This article examines the nature of risk and the limits of risk mitigation in the foreign financing of the US film business. The innovations and motivations through which foreign financial institutions have underwritten the most fundamental risk of the Hollywood model – the high costs of production – are discussed through several cases studies. These meetings of finance and the film business have produced monumental vestiges of corporate bankruptcy, market collapse and the inevitable redistribution of debt. Who paid? The public – and not only by their consumption of US film entertainment and merchandising. Foreign money has supported a portion of the substantial costs of failure created by the big-budget Hollywood production model. This global export of risk has often been placed upon the unknowing tax-payer or insurance-holder following the collapse of different financial institutions. Consequently, the ultimate importance behind the story of finance and the film business lies in its contribution to a broader evaluation about the sources of risk and the limits of risk mitigation in contemporary capitalism.

Keywords:

• Hollywood
• Film business
• Risk
• Corporate governance
• Financialization
• Casino capitalism

Notes

The dependency on the star system to drive studio marketing strategies is frequently reported in the industry press as the critical factor behind the increase in average production costs over the 1990s (cf. Cox, 1995). While the use of stars does not statistically guarantee blockbuster success (de Vany & Walls, 1999), it may decrease a film's volatility in the box office. Yet when balanced against the costs incurred, it is not clear that the star-driven blockbuster model actually achieves a net increase in revenues over time. Indeed some evidence suggests the reverse (Ravid 1999).

Until financial reporting changes in 2000, negative costs represent the official costs of both completed and abandoned production projects.

In 2001, independent US broadcaster, PBS, produced a Frontline documentary series entitled ‘The Monster That Ate Hollywood’ (transcript at http://www.pbs.org/frontline/shows/hollywood/). Peter Bart, current editor-in-chief of the industry trade magazine Variety and former executive of Paramount and MGM, described the changes in Hollywood as follows: Even when I arrived here, basically you had studios and networks undercapitalized, a bit undernourished, somewhat enfeebled. And they made movies or they made TV shows. It's only in relatively recent years that Hollywood became the playground of multinational corporations which regard movies and TV shows as a minor irritant to their overall activity. So it's become a corporate town, reduced to one sentence, ‘a very corporate town’. It was not a corporate town 10, 15 years ago.

While the US film industry is generally referred to as ‘Hollywood’, clearly this is somewhat of a misnomer. Nearly half of the film industry's official contribution to the US economy is reported to stem from outside California. The film industry officially contributed roughly US$72 billion to the Californian economy between 1995 and 1999. This represents roughly 54.5 percent of the US$132 billion that the film industry contributed to the US economy over the same period (Jones 2002).

HIH Casualty & General Insurance Limited & Others v. Chase Manhattan Bank & Others [2003] UK House of Lords 6, [2003] 2 Lloyd's Rep 61.

In one extreme example, US independent Corolco Pictures proved a loss-making venture for foreign investors Canal Plus, despite an otherwise impressive box office performance which averaged US$115 million in gross revenues over 23 films (Miller et al. 2001).

While 6 to 9 percent was normal, in some cases, insurance premiums would be as high as 12.5 percent of the slate's budget as in the case of Royal Sun Alliance's underwriting of Chase Manhattan's financing of Artisan Entertainment Inc. in October 1999 (Hive News 2001).

HIH Royal Commission testimony transcripts for 10 July 2002.

Flashpoint was not the sole producer of films but, rather, a financial intermediary which used insurance securitizations to supply financing for co-productions with other production companies such as Rojak Films, 7.23 Productions, Award Productions and Phoenix Pictures. Some of the films financed included The Mirror has Two Faces [1996] and The People vs Larry Flint [1996] with Phoneix Pictures (See HIH Casualty & General Insurance Ltd vs Chase Manhattan Bank [2003] UK House of Lords, 20 February) Many slates consisted of made-for-television movies such the six-film deal with 7.23 Productions or the ten film deal with Rojak Films (See HIH Casualty & General Insurance Ltd v New Hampshire Insurance Co [2001] Court of Appeal, England and Wales, 21 May).

HIH Casualty and General Insurance Ltd v New Hampshire Insurance Co and Others, Court of Appeal (Civil Division), [2001] EWCA Civ 735, [2001] 2 Lloyd's Rep 161, [2001] Lloyd's Rep IR 596, (21 May 2001).

HIH Royal Commission testimony transcripts for 27 July 2002.

In April 2002, CSFB was equally implicated in the Enron collapse through a class-action lawsuit filed in Houston by Milberg Weiss Bershad Hynes & Lerach LLP. The parallels between the structured finance deals underlying the Hollywood Funding Transactions, and those that enabled Enron to move debts off its balancesheet can be linked to a common broker Laurence Nath (Krim 2002; Robinson 2002).

Conversely, viable markets for risk transfer are those where firms outside of the contractual environment do not have the power to manipulate the payoff structure used within contractual transactions (Culp 2004). The point on market power will be returned to later in the discussion.

The Japanese have also been particularly important sources of investment into Hollywood, with Matsushta acquiring Universal and Sony acquiring Columbia Pictures.

Carolco Pictures is often regarded as one of the first production companies to raise the ceiling of big-budget productions and increase the level of star salaries. The risk brought about by this escalation in budget, would be borne in part, by foreign patrons such as Canal Plus as well as by Europe's largest bank, Crédit Lyonnais.

By July 2002, Germany's Federal Finance Minister was forced to step in and examine the possibilities for tighter regulations on how the media funds operate. Focussing more on empowering investors in fund decision-making than on regulating where such investments are made, the recent media rulings are still reported to leave German media funds open to financing US productions (Blaney 2003).

Indeed, comparable levels of German investment also appear to have flowed into Hollywood productions via loop-holes in German income tax laws. For example, an estimated US$3.4 billion of such private individual income reportedly flowed into the US film industry in 2001 (Frankel 2002).

Troubled Company Reporter, Friday, April 11, 2003, Vol. 4, No. 72.

This is largely because Wall Street learned from previous experience with the collapse of major independent production companies like the Cannon Group and Carolco Pictures. Both companies were tied to Crédit Lyonnais.

United States of America v Giancarlo Parretti, Florio Fiorini and Ramiro Colomina [1997] Central District of California. No. CR 98-200(A).

The transcript for this interview is available at http://www.lukeford.net.

Conducted in Mumbai during March 2003, several interviews with film financiers and producers reported this ‘tacit’ fact of Bollywood's history. The search for tax-relief in India stemmed from both regulatory conditions and the lack regulatory oversight in the film industry (as in real estate). High personal income tax, coupled with crippling entertainment taxes in some states, meant that finances from outside as well as inside the film industry would be reinvested in productions.

The magnitude of funds accessed in Germany stem from both the closure for other government tax shelters and from unique shelters for film production. Tax shelters for film allow investors an immediate write-off of their investment in any film for which the fund is granted ownership of the copyright – regardless of where the film is produced and by whom it is made. The magnitude of these write-offs is increased for funds which take equity stake in film productions (Moore 2001).

In 1995, BMW had secured exclusive branding rights in exchange for US$25 million in marketing support for the film Golden Eye, as well as on each of the following two Bond films. BMW pulled out of this deal by the third film when Ford upped their marketing contribution to US$35 million for the film Die Another Day.

MGM may have benefited from this in that, by 1993, its estimated market value had sunk to a low of US$500 million (Stowe 1996). Yet, the company's fortune had turned in 1995 when it achieved its first operating profit since 1986 riding upon the success of the BMW promoted Bond film, Golden Eye.

While some ‘independent’ production companies do contain substantial operational activities and staffing, these companies are generally the suppliers of the major distributors. The truly independent sector in the USA represents roughly 3,500 production companies that, with typically a median size of just two employees, produce feature films and videos without ever dealing directly with the major studios (Scott 2002).

Profit participation represents one of three basic ways in which producers can relate to distributors. For producers that can raise their own production financing and marketing budget, one option is to simply ‘rent a distributor’ and claim all exhibition revenues for themselves. This places the risk of not recouping costs firmly on the production company. Producers can also simply sell the rights to film outright if they can negotiate good price, or negotiate for a minimum guarantee with ‘net’ profit participation – both of which tend to translate into a one-off service fee for the majority of producers.

Profit participation became widespread practice following the breakdown of the old studio system in the 1940s. While evidence of their usage extends into the golden age of the US studio system (c. 1920–1940s) it has become an established practice in the USA since 1948 (Weinstein, 1998).

In 1992, Bettig (1996) estimated that 77 percent of all USA video revenues were claimed by six Hollywood studios or their subsidiaries: Disney (21.3%), Warner Home Video (18.1%), FoxVideo (14.1%), Columbia Tri-Star Home Video (9.7%), Paramount (7.3%), MCA/Universal Home Video (6.6%). Video revenues in other major European markets, such as the UK, were even more concentrated in studio hands.

Distributor releasing strategies – the capacity to decide when to take a film out of theatrical release (as indeed when to put it on release) – is another critical power. This market power is literally based on the fact that distributors act as a surrogate for the market though their interpretation of a film's marketability. The interpretation of a deviant attendance pattern can lead to a premature decision to write-off a film as a loss.

Lexington Insurance Co. v David Forrest and T. Beauclerc Rogers IV [2002] US District Court for the Eastern District of Pennsylvania, Civil Action No. 02-4435. Details of Lexington's arguments were outlined in a recent explanation and order issued on May 2003 (see http://www.paed.uscourts.gov/documents/opinions/03d0180p.pdf)