The Risk Environment of Film Making: Warner Bros in the Inter-War Years

EXPLORATIONS IN ECONOMIC HISTORY ARTICLE NO.

35, 196–220 (1998)

EH970691

The Risk Environment of Film Making: Warner Bros in the Inter-War Years* John Sedgwick and Michael Pokorny† University of North London, London, England This paper examines the financial strategies employed in the process of film production with particular emphasis on the performance of Warner Bros during the period from 1921 to 1940. The setting of film budgets is interpreted within a context of the financial risks involved, and in particular, a portfolio theory approach is found to provide a useful framework for describing and analyzing risk. The rapid growth of the film industry in the interwar years, together with the economic volatility of the period, produced a variety of risktaking strategies, and this paper attempts to assess the relative success of these strategies. r 1998 Academic Press

Film is a complex commodity. Each unit of output is unique, consisting of a set of characteristics which differentiates it from other film outputs, notably, genre, plot, screenplay, star billing, direction, cinematography, art direction, supporting actors, sets and settings, wardrobe and make-up, music, and length. Unlike live performance activities, each exhibition will be technically identical, although the size of screen and atmosphere associated with consumption will differ, and of course the technology associated with its diffusion allows an incomparably larger audience to enjoy its qualities. The monopoly of ‘‘uniqueness’’ is a property right and forms the basis for rent-seeking behavior. It also serves as a major problem for film production companies. Since box-office revenue will rest upon the reception of each film by consumers who are able to make choices between rival unique products, as well as having alternative uses for their time, production managers will be concerned about reducing the degree of potential uncertainty implicit in the property of uniqueness. They will seek to attenuate the risks * The authors thank seminar participants at the Universities of Cambridge, North London and East London, and delegates to the Ninth International Congress on Cultural Economics who made a number of very helpful observations on earlier drafts of this paper. In particular, the authors acknowledge the specific contributions of Stuart Archbold, Mark Casson, James Foreman-Peck, Bernard Hrusa Marlow, and two anonymous referees. † To whom correspondence should be addressed: Mr Michael Pokorny, The Business School, University of North London, 277-281 Holloway Road, London N7 8HN, England. Fax: 0171 753 5051; E-mail: [email protected]. 196 0014-4983/98 $25.00 Copyright r 1998 by Academic Press All rights of reproduction in any form reserved.

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associated with film consumption through incorporating a bundle of design features which arouse and satisfy a set of expectations among filmgoers. Historically, the most important of these devices have been stars, genre, director, sequels, and production company. Hence, publicity signaling that, say, James Cagney was to appear in a Warner Bros gangster movie or Gene Kelly in a MGM musical directed the potential consumer toward specific pleasure terrains. For consumers two opposing factors are important. First, while film producers are concerned with assuring potential audiences that their products will fulfill expectations, consumers know from experience that differences between ex ante and ex poste evaluations are common. This is quite unlike the normal pattern of consumer experience where rigorously standardized products meet precisely a set of ex ante expectations built upon repeated consumption. Second, as a general rule, consumers experience rapidly diminishing marginal utility with any single film product, suggesting that the expected utility derived from ‘‘new’’ film consumption tends to exceed that of repeat viewing. It would appear that on the one hand consumers seek assurance while on the other they demand novelty. Until 1948, when a federal court ruling compelled Hollywood’s major players to sell off their domestic cinema chains, the world market for films was dominated by five vertically integrated businesses. During the 1930s MGM, Paramount, Fox (20th Century Fox from 1935), RKO, and Warner Bros each produced an annual portfolio of over 40 films, distributed worldwide through their own distribution organizations.1 Each of these outputs was the subject of a severe amortization schedule of between 12 to 15 months.2 It was not until the 1940s that reissues became a more common practice. This portfolio would consist typically of three budget categories; super As, films intended for lengthy runs in prime location cinemas and exhibited as single features; A features which served as the main attraction on a double-bill program; and finally B features which were made to serve as second features on a double-bill program. Competition between the major players took the form of producing a relatively small number of potential ‘‘hit’’ films which might play on the screens of rival corporations. This practice occurred because the dominant body of assets owned by each of the vertically integrated players was not their production studios but the real estate value of their cinemas. Accordingly, at the margin for each of the vertically linked organizations, the choice of foregoing the revenues generated by a hit from a rival studio, at the expense of a less popular film from its own stable was irrational. B movies would not be expected to show on the screens of rival 1 Annual Hollywood production declined steadily from the peak of 678 films in 1927 to 489 by 1932. Production lifted to around the 520 mark for the three years of 1934, 1935, and 1936, but fell below 500 again toward the end of the 1930s. There were a number of forces at play in accounting for this decline including the transformation to sound during the late 1920s and substantially enlarged budgets per film toward the end of the 1930s. Undoubtedly, the severity of the depression in the early 1930s was an important factor in an account of the fall between 1930 and 1932 (Finler, 1988, Film Daily Yearbooks). 2 Greenwald (1950).

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cinemas, while the relative success of A films depended on it. Herein lies the source of strategic thinking for these combines. In needing to attract paying audiences the cinema chains required hit productions. Yet from Sedgwick’s (1997) work on the consumption of films and stars in Britain during the 1930s, only a small number of films could expect to become the season’s hits; between 1932 and 1937 only 8 to 15 films per season, from a stock of releases which increased from 648 to 803, earned more than five times the mean box-office take. The quest for hit production was elusive, yet necessary if the combine was not to become totally dependent on the products of rival studios, with the consequent probability of being subjected to opportunistic behavior, and explains the disproportionate budgets available for such gambles. As King (1986, p. 162) has written, ‘‘What the lucky producer (of a ‘hit’ production) has, therefore, is a monopoly (copy) right to a film which will give his company access to his competitor’s screen time for a price.’’ This paper sets out to chart Warners’ emergence during the 1920s, to become, by the end of the decade, one of the major Hollywood players. Based upon the recently discovered William Schaefer ledger of production costs and box-office returns of feature films released by Warners between 1922 and 1951,3 it traces the studio’s response to the rapid expansion in domestic and overseas demand during that decade followed by, in marked contrast, the Great Depression and subsequent slow and uncertain recovery up to 1941. From the ledger, it becomes clear that the size and organization of Warner’s filmmaking budget reflected strongly a changing set of box-office expectations on the part of its senior executives. In particular, by treating the annual film output as a portfolio of investments it can be shown that these expectations affected the risk stance of the business, which in turn manifested itself in the content and form of the films being made. THE EMERGENCE AND SURVIVAL OF WARNER BROS Warners transformed their position in the American film industry, during the 1920s, from a modest second level producer with a small number of first-run cinemas and distribution exchanges into one of the five major players. It did so through adopting a strategy of vertical integration, the finance for which was organized by the Wall Street investment house of Goldman, Sachs and Co. The major events in this transformation were the takeover, in 1925, of Vitagraph with its Brooklyn studio and important U.S. and overseas distribution exchanges; the agreements with Western Electric in 1925 and 1926 to first experiment with and then produce commercial films with soundtracks, resulting in the commercially successful exhibitions of Don Juan (1926) and The Jazz Singer (1927); the acquisition in 1929 of the Stanley cinema circuit of 300 east coast cinemas; and, between 1928 and 1929, the acquisition of First National’s substantial production,

3 The authors are grateful to Mark Glancy for allowing us access to the complete Schaefer ledger in contrast to the selected details published in Glancy (1995).

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RISK ENVIRONMENT OF FILM MAKING TABLE 1 Selected U.S. Statistics, 1922–1941, 1929 Prices

Year

Population (ms)

Unemployment (%)

CPI (1929 5 100)

Real personal disp. income ($bn)

1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941

110 112 114 116 117 119 121 122 123 124 125 126 126 127 128 129 130 131 132 133

6.7 2.4 5.0 3.2 1.8 3.3 4.2 3.2 8.7 15.9 23.6 24.9 21.7 20.1 16.9 14.3 19.0 17.2 14.6 9.9

97.9 99.6 99.8 102.3 103.3 101.4 100.0 100.0 97.5 88.9 79.7 75.6 78.2 80.1 80.9 83.8 82.3 81.1 81.9 86.0

61.6 70.0 71.5 71.3 74.9 76.4 77.5 83.3 76.4 72.0 61.1 60.2 67.0 73.0 82.0 84.9 79.6 86.7 92.5 107.8

Real recreational expenditure ($m)

2630 2770 3078 4331 4094 3715 3063 2911 3123 3283 3733 4034 3940 4257 4594 4931

Annual cinema admissions (m) 2080 2236 2392 2392 2600 2964 3380 4160 4680 3900 3120 3120 3640 4160 4576 4576 4420 4420 4160 4420

Real annual B–O ($m)

Average real admission price ($)

B–O/ recreational expenditure

337

0.15

0.13

359

0.15

0.13

519

0.18

0.17

720 751 809 661 637 663 694 774 806 806 813 898 941

0.17 0.16 0.21 0.21 0.20 0.18 0.17 0.17 0.18 0.18 0.18 0.22 0.21

0.17 0.18 0.22 0.22 0.22 0.21 0.21 0.21 0.20 0.20 0.19 0.20 0.19

Source: Historical Statistics of the U.S. (1975).

distribution, and exhibition assets. During this period Warners’ assets grew from $5 million in 1925 to $230 million by 1930.4 As pointed out above, this strategy of vertical integration adopted by Warners was common to the other four dominant firms in the industry. In order to finance this strategy all five had become incorporated during the 1920s and to a greater or lesser extent had incurred debt. The cost associated with reequipping the studios and cinemas for sound had been particularly onerous coming as it did at the tail end of the drive to acquire cinemas.5 The basis for this expansion rested ultimately with the popularity of film at home and abroad and expectations of continued growth in demand. Table 1 shows that during the 1920s cinema admissions in the U.S. doubled from a weekly figure of 40 million in 1922 to 80 million by 1929,6 while real personal disposable income increased by over a third. The major players all had extensive worldwide distribution operations by the end of the decade reflecting the international phenomenon of film popularity.7 The dramatic downturn in economic activity in the U.S. between 1929 and 1933 found these firms in a particularly vulnerable state. Cinema attendances and box-office receipts, in nominal terms, fell by a third during these years as unemployment 4 5 6 7

See Gomery (1992), Izod (1988), and Roddick (1983). Gomery (1992). Historical Statistics of the U.S. (1975), Series H.873. See Thompson (1985).

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soared, although given the fall in the Consumer Price Index from 100 in 1929 to 75.6 by 1933, the decline in real revenue (12%) was not as dramatic. During this time personal disposable income almost halved although, of course, this was mitigated by the fall in prices. One important observation derived from the statistics in Table 1 concerns the resistance of the industry to the decline in economic activity; between 1929 and 1931 box-office revenue actually increased in real terms. It was not until 1932 that the Depression began to make a significant impact on the film industry. Certainly, as a proportion of overall expenditure on recreational pursuits, cinema going became relatively more popular, increasing its share from 17% in 1929 to 22% by 1931 before stabilizing at 21% from 1934 as recovery slowly began to get under way. The importance of cinema going can be further emphasized by considering expenditure on just spectator amusements (cinema going, theatre, and spectator sports), and noting that cinema going accounted for 64% of such expenditures in 1923, increasing to 82% in 1930, a level which was maintained throughout the 1930s.8 Warners’ reported profits fell from $14,514,628 in 1929 to a loss of over $14 million in 1932.9 However, while Paramount, Fox, and RKO went into receivership and changed their management teams substantially, allowing financiers to take a much greater role at both the strategic and operational level, Warners, along with MGM (Loews), maintained the confidence of their shareholders and bankers and retained their management structures.10 Warners’ response to the recession was singular; overhead costs were driven down through selling cinemas while operating costs were rigorously managed. Warners had developed a reputation for tight control of filmmaking budgets during the 1920s.11 This served them in good stead during the height of the Depression. As Roddick (1983, p. 10) argues (b)udgets could not continue to spiral and since the actual physical cost of filming had increased, a proportional reduction had to be made in non-technical costs—that is to say, in sets, schedules, stars and story material. . . The new cost conscious budgeting and meticulous planning that would characterise the studio system through the 1930s had come to stay.

ANNUAL PRODUCTION PORTFOLIOS AND BOX OFFICE PERFORMANCE Table 2 charts the scale of the expansion of Warners’ production operations during the 1920s culminating in the acquisition of First National in 1929 and the leap in film production costs associated with full sound production during the 1929/1930 season which was immediately followed by the stark financial/ 8

Historical Statistics of the U.S. (1975), Series H 878–893. MGM was the only studio which continued to make reported accounting profits during the height of the Depression. Warners’ reported profits are listed in Finler (1988, p. 238) and can be found in detail in the Motion Picture News’ yearbooks of the period. 10 See Balio (1995). 11 Roddick (1993). 9

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TABLE 2 Annual Revenues, Costs and Profits of Warner Bros. Films Produced during the Period From 1921/1922 to 1940/1941, 1929 Prices ($’000)

Season 1921/1922 1922/1923 1923/1924 1924/1925 1925/1926 1926/1927 1927/1928 1928/1929 1929/1930 1930/1931 1931/1932 1932/1933 1933/1934 1934/1935 1935/1936 1936/1937 1937/1938 1938/1939 1939/1940 1940/1941

Films Domestic Foreign Total Production Film produced revenue revenue revenue costs profits a 3 6 13 23 45 29 38 36 82 60 52 56 54 54 58 58 56 53 47 48

1112 1977 4735 5059 8354 8172 11662 25892 36615 23381 22072 27533 26039 31095 29425 28334 32151 37545 32104 32690

85 197 468 792 1610 2937 3274 9133 15381 6004 6487 15932 12659 16385 15083 12633 14199 16057 13993 14634

1197 2173 5203 5851 9964 11109 14936 35025 51996 29385 28559 43465 38698 47479 44509 40967 46350 53602 46097 47324

268 803 2450 2337 5251 4814 3957 6657 25133 21260 16348 15431 16851 20136 19468 20649 28079 26244 25574 22658

485 566 828 1347 1026 2183 5453 15407 7627 22749 1644 11956 7522 9774 8568 5160 1118 7520 3465 7152

Rate of Average return production (%) b costs 68.2 35.2 18.9 29.9 11.5 24.5 57.5 78.5 17.2 28.6 6.1 38.0 24.1 25.9 23.8 14.4 2.5 16.3 8.1 17.8

89.2 133.9 188.4 101.6 116.7 166.0 104.1 184.9 306.5 354.3 314.4 275.6 312.1 372.9 335.7 356.0 501.4 495.2 544.1 472.0

Coefficient of variation of production costs 41.2 23.2 60.2 53.8 64.3 76.6 71.2 94.9 59.5 42.2 27.2 50.1 54.3 73.4 81.7 76.8 97.0 69.7 80.4 77.8

Source: William Schaefer Ledger. a Film profits are defined as total revenue minus the sum of production and distribution costs. Distribution costs are estimated as 37% of total revenue (see Note 23 for explanation). b The rate of return of the film budget is defined as the total profits (i.e., film profits in this table) generated by the budget as a proportion of the sum of total production and distribution costs.

commercial impact of the onset of the Depression in the 1930/1931 season. While the decline in Warners’ film output can be partly explained by the rationalization of production which followed the acquisition of First National,12 the decline in cinema attendances from 1930, charted in Table 1, led to a retrenchment across all Hollywood studios. Warners’ box-office receipts halved for those films released between the 1929/1930 and 1930/1931 seasons.13 Revenues continued to fall with the 1931/1932 batch of films and thereafter fluctuated widely around an upward trend. The 1937/1938 crisis in economic recovery is strongly reflected in the fall in domestic revenues for both 1939/1940 and 1940/1941 releases. Foreign sales contributed between a third and a half of receipts toward overall 12

Films continued to be presented under the First National trade name until 1941. It is important to note that there is a misalignment between Tables 1 and 2 dates. The latter represent the period of film release. Hence, given Warners’ use of a 14-month amortization schedule, the releases of one year would be expected to earn at least part of their box-office revenue during the following year. A further complicating factor in any time-series analysis is that the studio adopted a financial year which ended during the last week of August. 13

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box-office performance. Both revenue series have broadly similar characteristics, although foreign revenues were somewhat less volatile particularly those from Britain which was its largest overseas market. This is consistent with the greater severity of the Depression in the U.S. than elsewhere. The sharp increase in foreign revenues between 1931/1932 and 1932/1933 seems likely to have been more a function of exchange rate fluctuations during a period in which the U.S. dollar rose strongly against sterling. Likewise the slight reduction in the contribution of foreign revenues thereafter may be accounted for by the undervalued U.S. dollar exchange rate with sterling following the 1933 devaluation.14 Politically imposed barriers to entry in Germany and Italy may have played some part in this.15 Annual production budgets are the relevant costs when examining issues concerned with strategy formulation. They can be interpreted as reflecting ex ante decisions about the scale of annual film production. Distribution costs reflect, ex post, the success or otherwise of a film since distribution costs will be greater than planned where a film exceeds box-office expectations. Accordingly, they are directly related to the success of a film and therefore to film revenues. From Table 2 the manner in which the scale of film production responded to the developing recession is clear, with the season’s film portfolio budget cut back drastically between 1929/1930 and 1931/1932. However, note that even though film production continued to contract between 1931/1932 and 1932/1933, revenues began to recover, although, as commented upon above, this effect may be somewhat overstated owing to the exchange rate effect. The period from 1933/ 1934 to 1937/1938 saw a steady increase in annual production budgets, suggesting a demand-led explanation of expansion in the industry, with a particularly sharp increase from 1936/1937 to 1937/1938. The latter coincided with the 1937/1938 recession and resulted in a severe squeeze on profits. In the latter part of the period overall production costs were cut back somewhat as the studio sought to regain acceptable levels of profitability. Table 2 highlights the volatility of Warners’ profit performance16 during the period. The impact of the Depression is clearly reflected in the losses incurred on the 1930/1931 releases. There is a recovery with the 1931/1932 releases, and a sharp increase in profitability for those films released in 1932/1933, although again this is probably somewhat overstated by exchange rate fluctuations. The mid-1930s can be seen as a period of consolidation, recovery, and rising expectations. However, the joint impact of rapidly increasing annual production 14

See Dimsdale (1981). See De Grazie (1989). 16 These profit/loss figures are not, of course, the same as those which were published in the Warner Bros accounts for the period. They take no account of the company’s accumulated assets and liabilities, and the accounting conventions applied to these. Also, they do not represent performance within the strict limits of a trading year, since films released in one season generated revenue during the following season. Rather they are to be interpreted as reflecting Warner Bros’ annual performance with regard to its pure filmmaking activities. 15

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budgets and the recession of 1937/1938 led to a dramatic downturn in profitability for the releases of those years, and resulted in a cut-back in annual studio budgets between 1938/1939 and 1940/1941, even though profits showed some signs of recovery. Further insights are offered by considering average film production costs. Apart from the increase in film budgets brought about by the transition to sound, it is interesting to note that average production costs actually increased between 1929/1930 and 1930/1931, despite the large fall in total production budgets. Thus, as suggested earlier, the strategy employed was not so much a change in the nature of film production as such but rather a severe reduction in the number of films produced. In 1929/1930 82 films were produced, followed by a cut back to 60 films in 1930/1931. There was a further reduction to 52 films in 1931/1932, and thereafter annual film production stabilized at between 53 to 58 films, although only 47 and 48 films were produced in 1939/1940 and 1940/1941, respectively. Table 2 also highlights the much tighter cost controls which were exercised in the early 1930s and for the 1932/1933 releases in particular. Thus, apart from the exchange rate effect in 1933, the outstanding profit performance during this year can be explained in terms of the imposition of very tight cost controls, within an environment in which film revenues began to recover. It also highlights the apparent optimism which was felt in 1936, since both the studio budget and average film production costs for 1936/1937 and, in particular, the 1937/1938 releases, increased substantially. Finally, in Table 2 the coefficient of variation in annual film production costs serves to reinforce the observations made above. The upward trend in the coefficient during the 1920s reflects Warners’ increasing efforts to become a significant player by investing heavily in a small number of very expensive productions; from the 1927/1928 season these were generally associated with sound and the studio’s pioneering work in establishing the musical genre.17 The onset of the Depression reversed this trend. Thus not only did average production costs fall in response to the downturn but the variability in production costs also fell.18 The coefficient of variation also illustrates that budgetary strategy became increasingly more flexible over the period, perhaps encouraged by the success of the 1932/1933 portfolio and the overall recovery in profit performance. However, the poor performance in 1937/1938 did not lead to a marked reduction in average budgets but rather a smaller number of films in the next season’s portfolio. This ties in with the tendency on the part of the major Hollywood studios, to 17

See Barrios (1995). It is interesting to note that while average production costs were at their lowest in 1932/1933, production costs were more variable than was the case in the preceding year. However, this is the result of a statistical anomaly. The 1932/1933 portfolio contained six films, each costing just $28,000 to produce. These were then six of the seven most inexpensive films made over the entire 20-year period, the most inexpensive film made was at a cost of $23,000. Dropping these six films from the 1932/1933 portfolio reduces the coefficient of variation to 38.4. 18

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concentrate on A-type pictures and leaving B production to Columbia, Universal, and a set of ‘‘poverty row’’ studios.19 Within this context of prudent financial control came a set of artistic and genre innovations which further differentiated Warners’ product. Of the films themselves, Roddick (1983) has produced a careful and detailed assessment of the match between the system of production at Warners and the quality and characteristics of its output, maintaining that Warners produced a distinct, although changing, style of film during the 1930s. It became notable for producing films which were topical and hard hitting, with urban subjects and settings such as crime, gangsterism, bootlegging, federal agents, prisons, night clubs, prostitution, newspapers, and backstage intrigues that provide recurring contexts, particularly during the first half of the decade. Such films could be made relatively cheaply and quickly, almost exclusively on the studio’s stages, and often shot under night conditions requiring the minimum of detail to be shown, hence allowing backlot sets to be used time and again. A crop of new ‘stars’ emerged to carry these outputs with Joan Blondell, Bette Davis, Barbara Stanwyck, James Cagney, Edward G. Robinson, Paul Muni, Dick Powell, and Humphrey Bogart featuring prominently.20 From the data in Table 2 the strategy appears to have been brilliantly successful as the losses of 1931/1932 were transformed into profits during the following season and provided Warners with an artistic and commercial base from which to develop. The quest for big budget hits later in the decade led Warners to diversify into costume (historical) drama/adventure and biopics.21 The organization of human and physical capital was factory-like in form and intensity. Roddick maintains that more than any other studio, Warners’ films (w)ere strongly influenced by the economic and organisational system under which they were produced. The classic Hollywood style, with its insistence on the unproblematic, seamless narrative whose advancement is controlled by the destiny of one or more individual characters, was determined by the economics of the production system. (1983, p. 28)

Yet its strategy for survival, resulted in films of quality that audiences wanted to see. It was a factory geared to turning out product on a regular basis. But the product was in a sense artistic: if a work of art is defined not by the conditions of its production but by the circumstances of its consumption, then the product manufactured by Warners (and other studios) was undoubtedly art. (1983, p. 25)

19

Balio (1995, p. 29). Glancy (1995, pp. 61–62). 21 Captain Blood (1934/1935), Anthony Adverse (1935/1936), The Charge of the Light Brigade (1935/1936), the Adventures of Robin Hood (1937/1938), The Prince and the Pauper (1936/1937), The Private Lives of Elizabeth and Essex (1939/1940), The Sea Hawk (1939/1940), The Life of Emile Zola (1936/1937), and the Story of Louis Pasteur (1935/1936) are notable examples. 20

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FIG. 1.

Box-office revenue against production cost, 1921/1922 to 1940/1941 (1929 prices).

AN OVERVIEW OF THE RISK ENVIRONMENT In order to convey a flavor of the nature of the risk associated with film production Fig. 1 presents a scattergraph of the box-office revenue generated by each film against production cost for all 871 films produced by Warners during the period from 1921/1922 to 1940/1941. The revenue and cost data have been expressed in terms of 1929 prices. The obvious feature of Fig. 1 is the positive association between production costs and both the level and variability of box-office returns. Thus while higher budget films tended to generate higher box-office receipts, they did so with increasing uncertainty. However, the other feature of Fig. 1 is that very high revenues were generated from some modestly budgeted films.22 While box-office revenue might have been a reasonable reflection of film popularity, it was a poor proxy for film profitability. The more popular a film was the higher were the distribution costs incurred in exhibiting it, which in turn impacted on profits. This is illustrated in Fig. 2 which presents a scattergraph of film profits,23 but in this case against total costs (the sum of production and 22 An extreme example is The Singing Fool (1928/1929), the highest revenue generating film during the period, which generated receipts of $5,916,000, from a production budget of just $388,000. This compares with the average production cost during the period of $326,000. 23 In order to derive the net profit generated by a film, data are required on the distribution costs of the film in addition to its production costs. Unfortunately, a serious weakness of the information presented in the Schaefer ledger is the absence of data on distribution costs, and therefore such costs have had to be estimated. Sedgwick (1994) examined data from another film studio, RKO, for the period 1930–1941, from which distribution cost data could be derived directly. The sample of 155

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FIG. 2.

Film profits against total costs, 1921/1922 to 1940/1941 (1929 prices).

distribution costs). Thus Fig. 2 also reflects, indirectly, the rates of return earned by the films (the ratio of profits to total costs), and highlights more starkly the conundrum which studio heads faced. Thus, while low to medium cost films were more reliable in the sense that they were less likely to make losses, they tended to generate only half of Warners’ seasonal profits during the best box-office years. Even though some low cost films produced very high profits, these were relatively small in number and their overall contribution to annual profits was necessarily limited. Conversely, higher cost films were more likely to generate higher profits, but at an increasing risk of incurring losses. In the absence of any clear indication that profits were positively related to total costs, the decision to bet heavily on big budget productions would appear to be more inherently risky than the pursuit of a strategy based exclusively on low to medium cost production. Indeed, the information contained in Fig. 2 suggests that the premium to risk fell as total costs increased, not only does the variance of performance appear to increase with costs, but also the average rate of return appears to fall. A breakdown of the data into the period leading up to the Depression and the decade or so that followed, however, reveals distinctive patterns of performance. Fig. 3 shows profits against total costs for the 193 films produced up to RKO films, adopted by Jewell (1994), produced a very high correlation of 0.97 between film revenues and distribution costs, the more popular a film the greater the costs incurred in distributing it. On average, distribution costs represented 37% of film revenues. By applying this ratio to Warners’ revenue data a profit figure for each film can be derived as the difference between the total box-office revenue generated by the film and the sum of the production and estimated distribution costs. These are the profit figures shown in Fig. 2.

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FIG. 3.

Film profits against total costs, 1921/1922 to 1928/1929 (1929 prices).

1928/1929, while Fig. 4 shows profit performance for the 678 films produced from 1929/1930. For the 1920s it is apparent from Fig. 3 that a pronounced relationship existed between the variability of profit performance and the level of total costs; in general, more variable profit performance was associated with higher costs. In addition, there would appear to have been a positive association between profits and costs; while there might have been higher risks associated with high cost film production, the higher cost films tended to produce higher profits, on average. From Fig. 4 it can be seen that during the 1930s, while there was still a tendency for the variability of profit performance to increase with costs, this was not quite so pronounced as in the case of Fig. 3. However, and more significantly, Fig. 4 no longer appears to reflect a strong positive relationship between profits and costs; to the extent to which the production of higher cost films involved greater risks, Fig. 4 would imply that there were limited returns to such risk taking during the 1930s. Figure 4 also emphasizes the much higher incidence of lossmaking films during the 1930s. The relationship between film profits and total costs can be examined more formally by regressing profits on costs and testing for the significance of the slope

FIG. 4.

Film profits against total costs, 1929/1930 to 1940/1941 (1929 prices).

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coefficient. That is, we can test for the significance of b in the relationship Pi 5 a 1 bCi 1 ei,

(1)

where Pi is the profit generated by film i and Ci is the total cost of film i. In order to derive a valid significance test, account must be taken of the apparent heteroscedasticity in this relationship. The simplest assumption which could be made, and one that would appear consistent with Fig. 3 and 4, is that the variance of the eis are related to total costs. The specific relationship which produced the most satisfactory empirical results was Var(ei) 5 bC 2i ,

(2)

where b is some constant. Thus dividing Eq. (1) throughout by Ci produces an estimating equation with homoscedastic disturbances, and therefore the appropriate regression equation for testing for the significance of b is Pi Ci

5a

1 Ci

1 b 1 ui.

(3)

Estimating Eq. (3) for the films produced during the period from 1921/1922 to 1928/1929 produces the estimated equation (t-statistics in brackets)24 Pi Ci

5 235.638 (3.19) R 2 5 0.051

1 Ci

1 0.53 (4)

(9.18) n 5 192

Thus the estimate of b is positive and significant, implying that during the period from 1921/1922 to 1928/1929 an increase of $1000 in the total cost of a film generated, on average, an additional $534 in profit, albeit with increasing levels of risk. The corresponding estimated equation for the data in Fig. 4 is (Pi/Ci) 5 43.008 (1/Ci) 1 0.063 (6.05) (3.30) R 2 5 0.051

(5)

n 5 678

Thus the estimate of b is still positive and significant, but it is significantly lower than the value generated by Eq. (4) implying that during the 1930s, only $63 additional profit was generated per $1000 increase in costs; there were significantly lower returns to risk in the 1930s. However, it is apparent from Fig. 4 that higher profit levels still tended to be generated by the higher cost films, even if 24 There was one observation which proved problematical, and this was the lowest cost film produced over the period, which generated extraordinarily high profits. This was Lights of New York which was produced in 1927/1928 at a cost of just $23,000 but generated profits of $766,000. This observation was dropped for the purposes of estimating Eq. (3).

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this did not translate into higher rates of return. The difference between Figs. 3 and 4 is that the higher cost films in the 1930s also ran the risk of incurring substantial losses. However, annual estimates of Eq. (3) throughout the 1930s revealed considerable variation in the estimates of b, and years during which the value of b was insignificantly different from zero, namely, the low rate of return years of 1930/1931, 1931/1932, 1936/1937, 1937/1938, and 1939/1940. It would appear that the quest for hit production was not only more risky, the variance of profits increased with production budgets, but also that such productions generated lower average rates of return. A solution to this apparent paradox can be found in the joint product qualities of the studio’s portfolio of films. As argued above, the production and exhibition wing of Warners, along with the other major combines, were strategically bound by the need to meet cinema capacity utilization targets. Low budget B-movies were generally designed as support features, while big budget super As were intended not only to play at the organization’s principal cinemas as single features for extended runs, but also in the cinemas of their rivals. The degree of programmed support they received and the lengths of runs at these principal cinemas were a function of their popularity. Lower budget A films fulfilled both purposes, again depending on individual film popularity. For the greater part the combines were able to guarantee the exhibition of their lower budget films in support or supported roles in their in-house cinemas. (Columbia and Universal together with a host of ‘‘poverty row’’ producers, who did not own their own cinemas, also specialized in the production of support features.) With much lower budgets to amortize, such guaranteed billing was sufficient to earn such films healthy and fairly predictable returns. Although super A films would also play in the organization’s main cinemas, as principal attractions they were in effect competing for audiences with rival attractions in similarly priced cinemas within a locality. Audiences in general did not go to the cinema to watch low budget films. They were attracted by stars and production values. Accordingly, the studios, through their publicity departments, were very conscious of keeping their contract stars before the general public, primarily via fan magazines, newspapers, and radio outlets. However, given that capacity utilization was paramount, in-house super A films would only take up screen time on merit. It is for these reasons that the return to such productions was so variable, particularly in the context of a Depression which saw audiences fail to surpass their 1930 peak before the onset of America’s entry into the war. It is also for these reasons that the correct approach to analyzing studio performance is not one based simply on the relative performance of all films emanating from the studio, but rather their interrelationship as part of a portfolio of films designed to enhance the capacity utilization of the respective cinema chains, and of course through this the market share and the profitability of the organization. For each of the studios, accordingly, the quest for hit productions was intrinsically linked to the risk stance which was taken. In turn this was related to the willingness to bet heavily on potential film properties and stars as well as supporting these with high quality, idiosyncratic human and physical capital. At

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the margin this decision was a function of the extent to which an organization could increase its absolute profits from its portfolio of films by investing more heavily in features which might be expected to become hits, the corollary being dependence upon other super A producers, with all of the attendant problems associated with strategic vulnerability. A PORTFOLIO THEORY INTERPRETATION OF ANNUAL FILM PRODUCTION Given the overview presented above of the nature of risk and the role that it played in the vertically integrated industry of the 1920s and 1930s, it is appropriate to examine in more detail the stance that Warners adopted toward financial risk taking, and in particular, the manner in which this stance evolved and responded to changing circumstances. The approach adopted here is to interpret the process of annual film production as analogous to constructing an annual investment portfolio, where the films produced each year were considered as assets, each of which produced some rate of return, having incurred some level of risk. However, before such a portfolio could be constructed, the annual global budget dedicated to film production first had to be determined. The focus of the decision making process each year was the extent to which filmmaking activity was to be expanded or contracted. That is, the process was not so much one of setting the absolute level of the film production budget afresh each year, but rather one of determining the extent to which the film budget should be changed from year to year. Once this decision had been made, then the scale of annual film production was determined. Therefore, in terms of specifying a regression model, the appropriate dependent variable is the proportionate change in the annual production budget, which can be measured by the change in the logarithm of the production budget from year t-1 to t. This variable is here denoted by D ln Ct. Warners’ objective, presumably, was to maximize the rate of return on its annual film production budgets. Consequently film budgets would have been expanded if high rates of return were expected and contracted when low rates of return were expected. Assuming that a reasonable proxy for the expected rate of return in year t was the rate of return achieved on the previous year’s production budget, then this would imply that D ln Ct was positively related to Rt-1, where Rt is the rate of return on film production in year t. Thus using the rate of return data in column 8 of Table 2 as a measure of R, the following regression equation is produced: D ln Ct 5 20.240 1 0.018 Rt21 (2.27) (5.84) R 5 0.667 2

n 5 19

(6) d 5 2.11

Equation (6) can be seen to exhibit satisfactory statistical results. Further, solving Eq. (6) for DlnCt 5 0 provides an estimate of the rate of return (13.3%) which

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would have resulted in an unchanged annual budget and can be interpreted as the minimum rate of return required on film production; a lower rate of return would have resulted in reduced budgets, and hence a shift in resources away from film production.25 The robustness of the statistical results in Eq. (6) can be further illustrated by ‘‘undifferencing’’ the data on the left hand side of the equation, regressing ln Ct on Rt-1 and ln Ct21, and examining the stability of the resulting coefficients. The resulting regression is shown in Eq. (7). ln Ct 5 0.940 1 0.014 Rt21 1 0.881 ln Ct21 (1.55) (3.90) (14.58) R 5 0.939 2

n 5 19

(7)

d 5 2.54

Thus in moving from Eq. (6) to Eq. (7) we can note that the coefficients on Rt21 are stable in the sense that they differ insignificantly, and that the coefficient on ln Ct21 in Eq. (7) is insignificantly different from 1, consistent with the first difference transformation in Eq. (6). We can therefore conclude that Eq. (6) provides an efficient statistical summary of the manner in which the annual film production budget was set. Once the annual film production budget was determined, the next decision related to how the annual level of investment was then distributed across the set of projects earmarked by the studio executives. The approach taken here is to distinguish between three categories of film production, high, medium, and low budget productions. However, to define each of these categories in absolute terms would fail to recognize the changing nature of film production over time. Innovations such as sound and color, together with a general increase in the sophistication of film production meant that the nature of the film product was very much an evolving one. Thus the cost of a high budget film in the mid-1920s, say, would differ markedly from that of a high budget film in the late 1930s. In crude terms this can be seen from the general increase in average production costs in Table 2. Consequently the extent of high budget (and hence high risk) film production in any given year is measured here as the proportion of the total film budget which is absorbed by the top 20% most costly films produced during that year. Similarly, 25 A perhaps simpler hypothesis is to assume that annual production budgets were determined by cash flow. This could be examined by regressing D ln Ct on the proportionate change in cash flow in t-1. Cash flow could be measured either in terms of film revenues generated, or more realistically, in terms of film profits. However, both measures produced poor statistical results, and in the case of profits, insignificant results. Such a result is perhaps not surprising as a close association between production budgets and cash flow would imply that finance for film production was derived largely from internal sources, in addition to implying that it is only cash flow which is of relevance, in contrast to the rate of return which was generated by film production. Thus Warners certainly reallocated investment funds internally among its various divisions and subsidiaries over the sample period, in addition to raising finance from external sources. It is therefore more plausible to assume that the scale of film production was determined by rate-of-return performance, rather than the simple availability of internal finance.

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SEDGWICK AND POKORNY TABLE 3 Annual Rates of Return by Budget Category

Season

Top 20% of films

Middle 40% of films

Bottom 40% of films

Rate of return on film portfolio

1921/1925 1925/1926 1926/1927 1927/1928 1928/1929 1929/1930 1930/1931 1931/1932 1932/1933 1933/1934 1934/1935 1935/1936 1936/1937 1937/1938 1938/1939 1939/1940 1940/1941

23.1 3.8 26.3 54.3 79.6 12.5 220.8 26.0 43.1 23.6 17.0 14.4 8.1 29.6 19.6 2.8 19.9

37.1 6.2 10.1 52.4 78.3 18.9 25.7 8.6 30.6 27.1 33.3 27.0 13.8 10.8 12.6 9.2 15.5

56.5 28.2 42.8 69.2 76.3 22.3 1.6 10.6 44.5 20.4 30.2 42.1 34.2 22.7 17.3 21.3 18.0

28.8 11.5 24.5 57.5 78.5 17.2 28.6 6.1 38.0 24.1 25.9 23.8 14.4 2.5 16.3 8.1 17.8

Rate of return generated by

the extent of medium budget film production is measured by the proportion of the film budget absorbed by the next 40% of films in rank order. The extent of low budget film production is reflected in the proportion of the annual film budget allocated to the bottom 40% of films. Such an approach also has the advantage of standardizing for the number of films which were produced each year. While the choice of these partitions, the top 20% of films, the middle 40% and the bottom 40%, is essentially arbitrary, they serve to provide an adequate reflection of the budgetary decisions which were made with regard to the various categories of film production. Table 3 shows the annual rates of return which were generated by each of these budget categories. The final column of the table also shows the annual rates of return on the total film budget, from Table 2, for comparative purposes. The first data period in the table aggregates during the period from 1921/1922 to 1924/ 1925, in order to derive sufficient observations, given the very low level of film production in the early 1920s. Table 4 shows the annual allocations of the production budget and the proportionate contribution of each budget category to annual profits. The rates of return generated by the top 20% of films follows a clearly defined cyclical path, already noted in the discussion of Table 2, with peaks in 1928/1929, 1932/1933, 1933/1934, and 1940/1941, and troughs in 1930/1931, 1931/1932, and 1937/1938. Further, while the peaks are marginally greater than those of the

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RISK ENVIRONMENT OF FILM MAKING TABLE 4 Budget Allocations and Profit Contributions by Budget Category Top 20% of films

Season

Proportionate allocation of annual production budget

1921/1925 1925/1926 1926/1927 1927/1928 1928/1929 1929/1930 1930/1931 1931/1932 1932/1933 1933/1934 1934/1935 1935/1936 1936/1937 1937/1938 1938/1939 1939/1940 1940/1941

0.42 0.39 0.46 0.44 0.49 0.40 0.34 0.27 0.34 0.36 0.44 0.47 0.44 0.52 0.42 0.45 0.46

Middle 40% of films

Proportionate contribution to annual profits

Proportionate allocation of annual production budget

20.04 0.12 0.50 0.41 0.50 0.28 20.78 20.15 0.40 0.35 0.27 0.27 0.24 21.90 0.52 0.15 0.52

0.36 0.36 0.36 0.33 0.32 0.39 0.40 0.43 0.46 0.38 0.37 0.38 0.43 0.36 0.43 0.42 0.43

Bottom 40% of films

Proportionate contribution to annual profits

Proportionate allocation of annual production budget

Proportionate contribution to annual profits

0.50 0.19 0.13 0.29 0.32 0.44 20.27 0.62 0.35 0.44 0.51 0.44 0.41 1.65 0.33 0.48 0.37

0.22 0.25 0.18 0.23 0.19 0.21 0.26 0.30 0.20 0.26 0.18 0.14 0.13 0.12 0.15 0.13 0.11

0.54 0.69 0.36 0.31 0.18 0.28 0.05 0.53 0.25 0.21 0.22 0.29 0.35 1.25 0.16 0.37 0.11

other two budget categories, the troughs are considerably deeper. As argued above in relation to the discussion of Fig. 2, the volatility of this cycle when coupled with the comparative under performance of films in this category, characterize the risk environment faced by Warners’ executives. From Eq. (6) and Table 3 a set of expectations can be formed concerning the share of the annual budget taken up by the top 20% of films, based upon the rates of return of the previous period; where rates of return had been rising the expectation would be that the proportion of the budget would increase in the next period; where they had been in decline the opposite would occur. Table 4 shows this to have been broadly the case. The cyclical pattern is once again repeated so that in periods of downturn the proportion of funds going to big budget productions becomes very much more equal across the categories. Indeed in the 1931/1932 season the most expensive 20% of productions only absorbed 27% of the global budget, having fallen from 49% in 1928/1929. To this point the nature of risk in film production had been discussed in relatively broad terms, without having used a specific definition of risk or deriving an explicit measure of risk. Using a portfolio theory interpretation of the process of annual film production however suggests a natural measure. By interpreting the annual film budget as a three asset portfolio, the return on the portfolio will be a simple weighted average of the returns on each asset, where the weights are the proportions of the investment budget allocated to each asset. Thus the aggregate

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SEDGWICK AND POKORNY TABLE 5 Estimates of Risk on Film Assets and Film Portfolio

Season

Standard deviation of rates of return top 20% of films

Standard deviation of rates of return middle 40% of films

Standard deviation of rates of return bottom 40% of films

Estimate of risk experienced on portfolio

Estimate of risk taken on portfolio

1921/1925 1925/1926 1926/1927 1927/1928 1928/1929 1929/1930 1930/1931 1931/1932 1932/1933 1933/1934 1934/1935 1935/1936 1936/1937 1937/1938 1938/1939 1939/1940 1940/1941

16.9 20.1 15.3 36.8 36.8 38.0 20.4 18.6 31.7 20.8 18.0 26.0 20.8 24.8 20.5 16.6 18.3

18.0 16.7 13.6 27.3 26.0 27.2 28.9 24.6 26.6 28.6 25.6 20.8 23.5 28.8 22.9 21.6 21.5

22.7 17.8 18.9 32.3 23.8 18.7 19.1 15.2 31.9 18.6 16.3 11.9 9.9 18.6 13.8 17.9 20.9

17.5 17.2 14.4 30.7 29.3 28.2 22.2 19.1 27.7 21.9 19.3 20.7 19.6 24.3 19.5 17.9 18.9

20.6 24.7 26.8 26.0 33.0 19.6 13.3 10.4 19.9 22.1 27.3 28.3 29.6 31.2 25.3 26.9 27.0

rate of return on the annual film budgets in the last column of Table 3 is equivalent to such a weighted average.26 An overall measure of risk then can be derived from the risks associated with each asset. The commonly used measure of asset risk in the portfolio theory literature is the variability in the rate of return on an asset, and specifically, the standard deviation of the rate of return. In terms of the Warners’ data the risk associated with a given budget category, for any one year, can be measured by the standard deviation of the rates of return on the films falling into that category. These annual standard deviations are shown in columns 2, 3, and 4 of Table 5. Finally by combining these standard deviations it is possible to derive an overall measure of portfolio risk. The basic result of portfolio theory is that the risk on a portfolio is not just a simple weighted average of the individual asset risks. Rather the expression for overall portfolio risk will involve the covariances (or correlations) between the rates of return of the assets making up the portfolio, reflecting the risk reduction potential of a diversified portfolio. In particular, if rT denotes the rate of return on 26 There is a slight complication here as the rates of return in Tables 2 and 3 are net rates of return in the sense that they incorporate imputed distribution costs in addition to production costs. So strictly the weights which should be used are the proportions of total costs accounted for by each asset, rather than the proportions of production costs only. However, the use of weights derived from total costs result in only relatively small differences, and we prefer to focus on production costs as these are a more direct reflection of decision making and risk taking.

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the top 20% of films and rM and rB denote the rates of return on the middle 40% and the bottom 40% of films, respectively, then the overall rate of return on the portfolio, rP, is given by rP 5 xTrT 1 xMrM 1 xBrB,

(8)

where xT, xM, and xB are the proportions of the total production budget allocated to the top 20%, middle 40%, and bottom 40% of films, respectively. The risk associated with the portfolio, as reflected in the standard deviation of the rate of return on the portfolio, is derived from the variance of rP in Eq. (8), and specifically27 Var (rP) 5 x 2T Var (rT) 1 x 2M Var (rM) 1 x 2B Var (rB) 1 2xTxM Cov (rT, rM) 1 2xTxB Cov (rT, rB) 1 2xMxB Cov (rM, rB).

(9)

Alternatively, noting that Cov (rT, rM) 5 sTsMrTM, where sT is the standard deviation of the rate return on the top 20% of films, sM is the standard deviation of the rate of return on middle 40% of films, and rTM is the correlation coefficient between the rates of return on the top 20% of films and the middle 40% of films, we can write s2P 5 x 2Ts2T 1 x 2Ms2M 1 x 2Bs2B 1 2xTxMsTsMrTM (10) 1 2xTxBsTsBrTB 1 2xMxBsMsBrMB. The risk on the portfolio, then, is measured by the square root of this expression or sP. Annual estimates of sP can be derived by substituting into Eq. (10) the standard deviations of the rates of return in Table 5. The correlations between the rates of return can be estimated by the time-series correlations between the rates of return in Table 3.28 These estimates of sP are shown in the fifth column of Table 5. While the rate of return and risk data in Tables 3 and 5 provide a useful insight into the financial environment of film production during the 1920s and 1930s, the data strictly reflect the outcomes of film production decisions, rather than the explicit strategic decisions taken by Warner Bros during the period. Hence the risk estimates in column 5 of Table 5 reflect risk which was experienced or incurred, rather than the risks which were actually taken. That is, the portfolio risk measure used here reflects the influence of environmental/external factors, in addition to the explicit production decisions taken by Warners. However, it would be useful to examine the way in which Warners adjusted their own risktaking strategy over time in response to the return-to-risk performance of their film portfolios. A measure of the risk stance taken by Warners in any given year can be derived by considering the variability within their annual production budgets. Specifically, by interpreting the coefficient of variation of the production costs for a given 27

See Lumby (1991, p. 204). The correlation coefficient between the rates of return on the top 20% of films and the middle 40% from Table 3 is 0.84; the correlation between the top 20% and the bottom 40% is 0.76; and the correlation between the middle 40% and the bottom 40% is 0.87. 28

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FIG. 5.

Portfolio return against risk taken on portfolio, 1921/1925 to 1940/1941.

asset as a measure of the risk taken on the asset, Eq. (10) can be used to derive an estimate of the overall portfolio risk stance by substituting these coefficients of variation for the various s terms (and then taking the square root). These estimates are shown in the last column of Table 5. It is instructive to graph the portfolio rates of return against estimates of the risk taken in each year. This is shown in Fig. 5. In broad terms Fig. 5 provides evidence that there are returns to risk, a general tendency for returns to increase with the level of risk taken. In addition, higher levels of risk produced more variable rates of return performance, as would be expected. Figure 5 also implies a much stronger positive relationship between return and risk for the 1920s, than is the case for the 1930s. This is consistent with the much more volatile environment during the 1930s. The distinction between the risk environment of the 1920s and the 1930s can be seen more clearly in Figs. 6 and 7, which present separate graphs for each decade. What these measures highlight is the cyclical nature of the risk stance adopted by Warners in which increments in rate of return performance for any risk stance taken in period t-1 led to an increase in the risk taken in period t, up to the point at which the sequence is broken by an exogenous shock. The onset of the Great Depression caused the studio to dramatically revise downward its risk stance, so that it was a third of its pre-Depression level in the 1931/1932 season. Improving box-office performance thereafter results in a more positive risk position, only to be knocked back once again by the downturn in economic activity in 1938. These observations can be formalized by considering a regression equation which explains the change in Warners’ risk stance from year to year. The

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FIG. 6.

Portfolio return against risk taken, 1921/1925 to 1928/1929.

dependent variable would be the proportionate change in risk taken. Denoting the risk taken variable in Table 5 by RT, then the dependent variable is D ln RTt. Thus it can be argued that the change in the risk stance would have been influenced by the rate of return performance of the portfolio in the previous year relative to the risk taken during that year. Such a variable would reflect the returns to the risk which was actually taken, rather than the risk which in the event was experienced. As such it might have been expected to influence the structure of the following year’s film portfolio and in particular, the extent to which the risk taken on that portfolio should change. The following relationship can be hypothesized, where R denotes the rate of return on the film portfolio, as previously, D ln RTt 5 a 1 b

1RT2 R

1 et.

(11)

t21

In estimating Eq. (11) there were two observations which caused difficulties, and these were the observations for 1929/1930 and 1932/1933. The 1929/1930 season was the first season in which the First National production portfolio was included with the Warners’ portfolio, following Warners’ acquisition of First National during the previous year. This resulted in a 278% increase in the total production

FIG. 7.

Portfolio return against risk taken, 1929/1930 to 1940/1941.

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budget and a more than doubling of the number of films produced (see Table 2). While this jump in the scale of film production was rational from Warners’ perspective given the rapidly growing demand at the time and the success they were experiencing, they inherited a film portfolio which did not necessarily reflect their own risk stance. Indeed, the First National portfolio consisted of films with a lower average cost and lower variability than Warners’ portfolio in 1929/1930. Consequently it might be argued that the risk stance taken in 1929/1930 was somewhat more conservative than might have been the case had Warners’ had full control over the construction of the 1929/1930 First National portfolio. In addition, it might also be argued that such a large increase in the total production budget may have induced a degree of conservatism in Warners’ own risk taking. For these reasons a dummy variable for 1929/1930 was included in Eq. (11) (denoted by D30). The problem with the 1932/1933 observation is the issue which was commented upon in the discussion of the coefficient of variation data in Table 2 (see Note 18). That is, the coefficient of variation of the low budget films in 1932/1933 was swamped by the six very low cost Westerns made in this year, producing an overall coefficient of 50.9. By comparison the coefficient of variation of the low budget films in the previous year was 17.9 and for the following year it was 24.3. In turn this abnormally high coefficient dominates the RT measure for the portfolio, even though the low budget films accounted for only 20% of the film budget (the coefficient for the high budget and medium budget films for 1932/ 1933 were 13.4 and 13.9, respectively). Rather than drop these six observations from the sample the approach taken was to interpret these six films as effectively two films. Thus they were divided into two sets of three films and then costs, revenues, and profits were aggregated across these two sets. The films each cost the same to produce and each generated virtually identical profits. Such an approach can be justified by arguing that the six films were of the same genre (Westerns), used the same stars (all starred John Wayne), used a small core of technical staff, and effectively just repeated an identical formula in their production. The result was that the coefficient of variation for the low budget films in 1932/1933 was reduced to 25.79 (although low budget films now accounted for 25% of the 1932/1933 production budget). The RT measure produced was 15.0 (in contrast to 19.9 in Table 5).29 The resulting estimate of Eq. (11) is shown in Eq. (12). D ln RTt 5 20.094 1 0.172 (R/RT)t21 2 0.836 D30t (1.39) (2.91) (4.16) R 5 0.589 2

n 5 16

(12)

d 5 1.96

Therefore these regression results are consistent with the notion that portfolio risk stance adjusted positively to return on risk.30 It is certainly not being suggested

29 30

Dropping the six films from the sample produced an RT value of 14.4. Equation (7) can be further improved by adding a dummy variable for 1930/1931. Equation (7)

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that Eq. (12) provides a comprehensive explanation of the evolution of Warners’ risktaking strategies. The focus here has been purely on financial performance, and no consideration has been given to the much broader artistic context in which film production takes place. Thus while financial performance may have placed constraints on the scale of film production there is a wide range of nonfinancial strategies which can be adopted within these constraints, each of which will involve risks, the nature of which may not be directly quantifiable. CONCLUSION This paper makes a contribution to the growing field of research into film as a business. A notable recent contribution is that of De Vany and Walls (1996), which examined the nature of information dynamics and transmission mechanisms in the generation of box-office revenues, and in turn how such processes result in box-office ‘‘hits’’ and ‘‘flops.’’ However, their analysis derived from contemporary data and an environment which was (and is) dominated by independent production companies. By contrast, the analysis here focuses on the much more tightly controlled studio system of the interwar years, and an industry which was characterized by a high degree of vertical integration. It is clear from the evidence presented that Warners responded to changing economic and competitive circumstances in a strategic fashion: During the 1920s expectations of an expanding market, principally at home but also overseas, led to a series of heroic corporate decisions in the direction of vertical integration, while the onset of the Depression caused it to produce fewer films and alter the cost, genre, and star characteristics of its annual portfolio of films. Although it sold some cinemas during these lean years, the vertical structure of its business, like that of its main rivals, was left intact. In particular, three distinct stages can be distinguished during the 1930s: The period of survival following the onset of the Depression when average film costs were reduced dramatically; the slow return to confidence as both annual portfolio and average film budgets crept up; and finally, the move toward exclusive A film production schedules at the end of the period. In drawing attention to the variability and structure of production budgets through the application of portfolio theory it is clear that during Hollywood’s classical period Warners took a strategic approach to risk, both in terms of the global sum they were willing to invest for any single production season and the manner in which it was spread across the set of production projects. The results in predicts a relatively large increase in risk taking for 1930/1931, on the basis of satisfactory return to risk performance of the 1929/1930 portfolio. However, this increased risk taking does not in fact take place. The inclusion of the dummy variable for 1930/1931 might be justified by arguing that the 1930/1931 portfolio was constructed in the immediate aftermath of the 1929 Wall Street crash, and thus in an environment of considerable uncertainty and volatility. Thus irrespective of the satisfactory performance on the 1929/1930 portfolio, this major structural change inhibited risk taking severely. Thereafter the approach to risk taking returns to that implied by Eq. (6). Including a dummy variable for 1930/1931 increases R 2 to 0.813; the coefficient on the return to risk variable is virtually unchanged at 0.174, but now with a t-statistic of 4.17; d remains insignificant.

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Table 5, together with the estimated models set out in Eq. (6) and (12) suggest that Warners adopted a retrospective approach to risk, where the financial performance of films in period t-1 proved to be a critical factor. This led to a cyclical pattern in annual film production budgets and risks taken which closely mirrored the behavior of the U.S. economy. REFERENCES Balio, T. (1995) (Ed.), Grand Design: Hollywood as a Modern Business, 1930–39. New York. Barrios, R. (1995), A Song in the Dark: The Birth of the Musical Film. Oxford. Bordwell, D., Staiger, J., and Thompson, K. (1985), The Classical Hollywood Cinema: Film Style and Mode of Production to 1960. London. De Grazie, V. (1989), ‘‘Mass Culture and Sovereignty: The American Challenge to European Cinemas, 1920–1960.’’ Journal of Modern History 61, 53–87. De Vany, A., and Walls, W. D. (1996), ‘‘Bose-Einstein Dynamics and Adaptive Contracting in the Motion Picture Industry.’’ Economic Journal 106(439), 1493–1514. Dimsdale, N. H. (1981), ‘‘British Monetary Policy and the Exchange Rate 1920–38.’’ Oxford Economic Papers 33, 306–349. Fine, B., and Leopold, E. (1993), The World of Consumption. London. Finler, J. (1988), The Hollywood Story. London. Glancy, H. M. (1992), ‘‘MGM Film Grosses, 1924–1948: The Eddie Mannix Ledger.’’ Historical Journal of Film, Radio and Television 12, 127–144. Glancy, H. M. (1995), ‘‘Warner Bros. Film Grosses, 1921–1951: The William Schaefer Ledger.’’ Historical Journal of Film, Radio and Television 15, 55–74. Gomery, D. (1992), Shared Pleasures: A History of Movie Presentation in the United States. London. Greenwald, W. I. (1950), The Motion Picture Industry: An Economic Study of the History and Practices of a Business. Ph.D. dissertation, New York University. Izod, J. (1988), Hollywood and the Box Offıce, 1995–1986. Basingstoke. Jewell, R. B. (1994), ‘‘RKO Film Grosses, 1929–51: C. J. Trevlin Ledger.’’ Historical Journal of Film, Radio and Television 14(1), 35–50. King, B. (1986), ‘‘Stardom as Occupation.’’ In P. Kerr (Ed.), The Hollywood Film Industry. London. Lumby, S. (1991), Investment Appraisal and Financing Decisions. (4th ed.). London. Roddick, N. (1983), A New Deal In Entertainment: Warner Bros in the 1930s. London. Sedgwick, J. (1994), ‘‘Richard B. Jewell’s RKO Film Grosses, 1929–51: The C. J. Trevlin Ledger: A Comment.’’ Historical Journal of Film, Radio and Television 14(1), 51–59. Sedgwick, J. (1995), ‘‘The Warners’ Ledger 1921–22 to 1941–42: A Comment.’’ Historical Journal of Film, Radio and Television. 15(1), 75–82. Sedgwick, J. (1998), ‘‘Cinema-Going Preferences in Britain in the 1930s.’’ In J. Richards (Ed.), The Unknown 1930s: An Alternative History of the British Cinema, 1929–39. London. Thompson, K. (1985), Exporting Entertainment: America in the World Film Market 1907–1934. London. U.S. Department of Commerce, Bureau of the Census (1975), Historical Statistics of the US; Colonial Times to 1970.

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