Reel Authority: Theory and Evidence on Relational Renegotiation in the Movie Industry

Abstract: Despite the importance of relational contracting, parties in ongoing relationships partially structure their dealings using formal contracts that are largely incomplete, leading to adaptation ex post and raising the question of how parties should formally contract with each other when a relational contract is in place. Here, we explore this question by developing both a model and an empirical test in a specific setting: the formal and informal contracts between movie distributors and exhibitors. These typically enter into formal contracts specifying how the box-office revenues for a given movie are to be shared, without requiring the exhibitor to actually show the movie creating a conflict of interest between them. Interestingly, the sharing rate is often renegotiated after the movie’s run is complete, with the exhibitor paying the distributor a lower sharing rate than formally specified. Since such transfers would not occur in one-shot transactions, our analysis considers a repeated game between both parties, where this ex post settling-up can be seen as “relational renegotiation.” We explore the implications of our theory using data from a major non-integrated Spanish movie exhibitor that includes contracted and renegotiated weekly sharing rates for all movies played between January 2001 and June 2002. First, we show that ex post renegotiation is the rule rather than the exception. Second, we hypothesize that both the probability of renegotiation and the size of the discount will be positively related to the opportunity cost of showing a given movie. Our initial findings are in line with our predictions.