Priceonomics

Star Wars: Return of the Jedi. 

Forrest Gump

Harry Potter and the Order of the Phoenix. 

What do these three films have in common? Each was a blockbuster, among the first or second highest grossing films of the year. All three were also unprofitable.  

Two years after the re-release of Return of the Jedi in 1997, for example, David Prowse, the actor who played Darth Vader, told Equity Magazine that he still received letters informing him that Lucasfilm had no profits to share with him:

“I get these occasional letters from Lucasfilm saying that we regret to inform you that as Return of the Jedi has never gone into profit, we’ve got nothing to send you. Now here we’re talking about one of the biggest releases of all time. I don’t want to look like I’m bitching about it, but on the other hand, if there’s a pot of gold somewhere that I ought to be having a share of, I would like to see it.”

These films are not a cautionary tale about how wasteful spending can turn a commercial success into a net failure. They had perfectly average production budgets and expenses for movies of their scale. Their lack of profitability, in fact, is typical. Over 80% of Hollywood movies fail to turn a profit. 

Reading this statistic, we agreed with Darth Vader that this seems implausible. Where is his pot of gold that lures businessmen and investors to Hollywood?

Buried in paperwork. Hollywood’s lack of profits exists only on paper, the result of creative accounting practices so institutionalized and infamous that a Wikipedia page on “Hollywood Accounting” includes the inside joke that Hollywood’s most creative minds are the accountants. Instead of cooking the books to hide losses and inflate profits, Hollywood accountants inflate costs to ensure that even smash hits stay in the red. 

A 2010 Planet Money podcast with “Hollywood economist” Edward Epstein explains how it’s done. For each new film, a movie “is set up as its own corporation, the entire point of which is to lose money” by paying fees to the studio producing the movie. So if Superhero Studios decides to film Spider-Man 10, they create a shell company, Spider-Man 10 Incorporated. Superhero Studios then overcharges Spider-Man 10 Inc for every aspect of making, marketing, and distributing the movie. By the time Superhero Studios finishes paying itself (through Spider-Man 10 Inc) to perform work that costs $100 million, Spider-Man 10 Inc will be on the hook for one billion dollars.

As suggested by the example of a cheated Darth Vader, the purpose of the charade seems to be hoarding profit shares promised to actors, writers, and other individuals or organizations. If anyone asks for a share of the profits of Spider-Man 10, the producers can point to Spider-Man 10 Inc. Since it is still paying off its debt to Superhero Studios, there are no profits to share. Paramount Pictures famously offered Winston Groom $350,000 and a 3% share of net profits for the rights to his novel Forrest Gump. Since Forrest Gump is still not profitable, he did not receive any share of the profits.

The survival of these accounting practices may be the most magical thing about Hollywood. These situations - a writer scammed out of a 3% share of Hollywood’s biggest hits - must look like truffles to lawyers.

A Guardian article on Hollywood accounting wrote that “participants have no right to complain if they don't see any profits because they sign a contract agreeing to abide by the studios' accounting rules.” Nevertheless, judges or jurors have ruled against the practice on multiple occasions. 

A 1990 court case described Paramount’s accounting practices as “unconscionable” and freed up the writer behind the film Coming to America to pursue his fair share of the film’s profits. In 2005, Stan Lee, the man behind Spider-Man and X-Men, won a similar lawsuit as did two individuals suing over their share of television show profits in 2010. People have predicted the demise of Hollywood accounting after each lawsuit, but the practice has endured.

One reason for Hollywood Accounting’s longevity may be the lack of financial transparency. Insiders describe the true costs behind any picture as practically unknowable and public production budgets a malleable fiction. Movies can also spend years in “development hell,” accumulating millions of dollars in costs as the studio rewrites the script and recasts the characters over and over. And profits really can take years to trickle in as only 20% of profits are made at the box office. 

Considering the costs of a lawsuit and the difficulty of knowing how much profit has been made, it is perhaps unsurprising that most individuals accept settlements - as the author of Forrest Gump and the writer behind Coming to America ultimately did. Or, much more commonly, console themselves with the tips or gifts that studios offer under the guise of “an advance on expected profits” when a movie does well at the box office.

This lack of transparency, however, is a boon to another group: Hollywood actors. As insiders, they understand Hollywood Accounting and can insist on a share of gross proceeds rather than net profits. But they may seek out a share of net profits to exaggerate the size of their contract.

If a Hollywood star - Epstein explains - cannot find a studio willing to pay them a rate as high as for their last gig, their agent may prefer a share of net profits. Accepting a lower salary would hurt the actor’s star power and make it harder to negotiate for a big payday in the future. But the ambiguity of future profits, “allows them to lie... so you can say your contract is worth $10 million when you’re only paid $800,000.” Thanks to the ambiguity of net profits, every actor and actress can make headlines with a record payday even when their career is in decline.

In an industry where salary is synonymous with star power, a contract that exaggerates your compensation is almost as valuable as one that actually pays richly. But writers and actors like the one who played Darth Vader would probably prefer to simply be paid transparently. 

This post was written by Alex Mayyasi. Follow him on Twitter here or Google Plus. To get occasional notifications when we write blog posts, sign up for our email list.



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