Hollywood Creative Accounting, or, How to Hide a Hit and Still Profit From It
From Batsuits to Lawsuits, Hollywood Studios have a long history of hiding profits to claim that enormous hits were actually flops. How do they do this, and why?
Without adjusting for inflation, the Harry Potter series of movies is the highest grossing film franchise of all time. In fact, Harry Potter and the Deathly Hallows – Part 2 (2011) is the highest grossing Warner Bros. movie ever made.
So… what if I told you that the Harry Potter franchise was actually a financial flop?
Well you'd probably call me a liar or, at least, point out how ridiculously wrong I am because, let's face it, that claim is obviously ridiculous.
Let's take a look at the fifth film alone (so as not to skew our results with Warner Bros.'s hugest success). Harry Potter and the Order of the Phoenix (2007) reportedly cost $150 million to make and that investment proved to be sound because the film pulled in almost $940 million at the box office. That is obviously a hit by anyone's standards, but anyone with knowledge of the behind-the-scenes costs of films knows that Warner didn't simply laugh all the way to the bank with $790 million in profit. After all, you have advertising and publicity dollars, prints, dubbing into other languages, shipping of prints, subtitles, distribution fees and...
Wait just a cotton pickin' second here. "Distribution Fees"? But Warner Bros. distributed the film. Who the hell are they paying that to?
That was one question that arose when an official Warner Bros. receipt for the film was leaked online showing how the costs were allocated. According to independent analysts, the whopping $212 million that Warner Bros. spent on "Distribution Fees" was actually paid back to itself (or, at least, one of the divisions of the same company) in order to help tip the scales and make the movie "lose" money… at least on paper.
How is this possible? Another look at that ledger shows $130 million allocated for advertising and publicity. Wait, what? Did Warner Bros. spend almost the equivalent to the film's entire budget in order to market this surefire hit? Well, perhaps… but it's more likely that Warner Bros. paid itself, its properties or other divisions of Time Warner for this marketing (or a large portion thereof). And once these easy things are taken into account, there is no surprise that we can find things like $57 million in "Interest" (albeit completely undefined interest) and $315 million in "Negative Cost and/ or Advance" lurking around that spreadsheet like hungry money pits.
Thus the film that earned $940 million at the international box office was actually a financial loss for the company of a whopping $167 million.
Sound confusing? Or maybe the smug among you will smile and say that it's clear that I, the writer, don't understand this kind of accounting. Guess what! You're right. That's because such Hollywood Creative Accounting is designed to be confusing as well as impossible to figure out. This isn't something I, or you, are likely to "get".
So why would a movie studio (or any company, for that matter) do such a thing? Why "lose" money?
The answer is astoundingly simple. Companies like this "lose" money to make more profits for themselves. When contracts are written to share net profits with actors, writers, producers, directors or even other production companies, studios take a big hit. Therefore, to reduce (or in the case of "lost" moneys, eliminate) the amounts that a studio has to pay out, accountants will frequently massage the numbers to make that shared profit smaller and smaller and smaller until (quite often) it's gone.
Let's take a look at another major studio. 20th Century Fox had just made boffo box office with Star Wars (1977) when one of the best, scariest and most profitable films of all time was released by the same company. It was called Alien (1979), it cost between $9 and $11 million to make and by April of 1980 the film had already made over $100 million at the box office. So, at worst that's an $89 million profit for Fox, right? One would think. However, the Foxy accountants revealed that by this time the film had actually lost over $2 million for the studio since its 25 May 1979 release.
Wow, 11 months of release and no profit (in spite of huge box office numbers)? How much longer could Alien possibly perform? Well by August of 1980 after a number of industry accountants cried foul and demanded a recount, Fox changed its story and indicated that by that time the film had made $4 million in profit for the studio. Yeah. Nobody believed that, either.
Brandywine, the production company responsible for Alien thus sued Fox over the distribution of those profits, delaying the sequel that Brandywine was determined to make as quickly as possible. Fox, for its part, pointed back to its financial reports that indicated that Alien was, at best, a low earner and at worst, a money loser and thus, did not warrant a sequel.
That lawsuit wasn't settled until 1983 with Fox finally agreeing to fund an "Alien II" so that Brandywine could recoup some of the profits it knew belonged to it. In this case the bet worked out splendidly and that sequel, finally entitled Aliens (1986) made over $183 million against an $18 million budget and was also a huge critical success (matching the original) with awards nominations to back up that praise.
While not all of that settlement has been disclosed to the media, the suit itself does give us a bit of a look into why this creative accounting takes place.
Unlike as we have with Order of the Phoenix, we don't have any ledger explaining just how Fox (allegedly) buried the profits from Alien but the question of "Why?" is easily answered by looking at the partnership itself. In the case of Alien, Brandywine acted as the production company with input from Fox, which acted as something of a co-studio. The producers were all Brandywine personnel like Gordon Carroll, David Giler and Walter Hill, but the production funds themselves came from Fox, which actually doubled the budget when it saw director Ridley Scott's impressive story boards.
The producers, writers, director, cast and crew all were paid from this budget, but the companies involved relied on the profits of the film. In any partnership of this kind, profits are divided in the contractual phase of pre-production with the funding party naturally taking the larger slice of the pie and the larger company (usually the same) handling distribution and accounting.
For the sake of this argument, let's pretend Brandywine agreed to 30 percent of the net profits (the total revenue minus total expenses) of Alien, while Fox agreed to accept the remaining 70 percent. Keep in mind that the aforementioned expenses include revenue sharing with the actual exhibitors (movie theaters that own the actual box offices) as well as shipping costs (FedEx, Buena Vista Distribution, Film Tracking are just a few possibilities) and the cost of printing the actual films to put in those shipping cans, it's true that the costs can add up. That's where large box office revenues tend to cancel out the expenses. True, the more screens a film lights up, the more money it costs to make the prints to display on those screens, but in general the increasing number of tickets sold greatly exceeds that cost.
In today's market the cost to make a (non-digital) movie print is around $1,500. Alien opened on 91 screens and pulled in $3.5 million on its opening weekend. Assuming the cost of prints was comparable at $1,500 each (including shipping costs), that's around $136,500 in print costs, but each screen pulled in $38,767 in the opening weekend alone. That means that in one weekend, each print paid for itself over 25 times over and then continued exhibition for a year or more. Sure, printing and shipping movies does not constitute the only release cost of a film, but this example shows how quickly a film can pay for itself. Thus we are still looking at huge profits around 30 percent of which Brandywine was entitled to.
But what if 20th Century Fox employed a little creative accounting to keep that 30 percent from being too high? As we learned from the Warner Bros. example, Fox could both "spend" and "save" these dollars by utilizing companies under the same umbrella and ultimately while it is true that on paper the expenses were paid for and chipped away from the net profits of the film, much of the money never actually left the Fox family of companies.
In short, 30 percent of $100 million is $30 million, 30 percent of $4 million is $1.2 million and 30 percent of any negative number is still a negative number. If given the choice of what to fork over to someone else, which would you choose? Probably the same thing Fox chose. It's the Hollywood equivalent of saying "Sorry, bro, I can't give back that 20 bucks I owe you, I'm all tapped out!"
That is, of course, difficult to prove which is why such a lawsuit took so long to be settled (and still resulted in profits for Fox, thanks to the large successes of Aliens). Whether the books were ever opened or not (and they were not), it's true that Brandywine ultimately won the suit (albeit with little substantial hit to Fox) and went on to make six more Alien films in partnership with the bigger company.
This suit was finalized in the early '80s before News Corporation purchased 20th Century Fox, before there was a Fox Network, a Fox News Channel or a Fox Sports Net. Warner Bros.' story is quite different. By the time of Order of the Phoenix's 2007 release, Warner Bros. parent company owned half of the CW Network and all of HBO, Cartoon Network, CNN, TNT, TBS, HLN, Turner Classic Movies, Time Warner Cable, Warner Bros. Distributing Inc., Warner Home Video, DC Comics, Warner Interactive, Warner Bros. Music (and its subsidiaries), New Line Cinema and much more.
While we can't know exactly how the expenditures broke down (the ledger is both mathematically sound and extremely vague) it's easy to imagine Warner mandating that Phoenix trailers be placed at the beginning of any New Line or Warner Bros. features for months prior to that film's release. Yes, this happens. As a former projectionist I had distributor preview mandates for most every print. Any Warner Home Video releases of Warner or New Line films could (and did) also have Phoenix previews included on the discs. Further, "brother-in-law deals" can easily be made with company advertising outlets including billboards, commercials on the varied Time Warner owned networks as well as empty spots on Time Warner Cable's feed, full page ads in DC Comics and yes, HBO specials to help promote the film. Then there was also the obligatory soundtrack (thanks to Warner Bros. Records and Warner Sunset Records) and the video game (distributed by Warner Bros. Interactive Entertainment). All of this could easily be shoved into that undefined mass of "Advertising and Publicity" and "Negative Cost and/ or Advance".
How did the film actually get to the theaters? Warner Bros. Distributing Inc. Who published the DVDs? Warner Home Video.
Again, why go to these lengths? The answer is similar to the Alien deal. There are a lot of chefs surrounding the Harry Potter cauldron, all of whom have a stake in the film's success. There were no less than four Production companies involved with the creation of Harry Potter and the Order of the Phoenix, only one of which is Warner Bros. Cool Music, Heyday Films and a one-off company called "Harry Potter Publishing Rights" were all involved and are likely recipients of profit percentages. It's not unheard of for actors contracted to long running series to be compensated, in part, by small percentages of the profits and this saga lasted over a decade of these primarily youthful (and arguably irreplaceable) actors' lives.
That is not to mention author and creator J.K. Rowling herself, whose percentage comes from somewhere.
Thus, Warner Bros. stood to lose a lot of profit by making (or at least, reporting) a lot of money. The smaller the net percentage, the smaller the amount Warners had to share. In spite of the $790 million in profits, Warner Bros. claimed that amount was actually minus $167 million. Any percentage of a negative number is a negative number (even if Time Warner's own cut was not so negative).
This clearly illustrates how a company (particularly a conglomerate) can both spend more money than it takes in on a project and still make a profit (albeit clandestinely).
Warner Bros. and Fox are definitely not the only companies in Hollywood to employ this sort of creative accounting (nor is this merely a Hollywood phenomenon, if the word "Enron" means anything to you).
So creative accounting may be a common practice, but is it legal? After all we didn't hear many entertainment companies swept up in the accounting investigations of the early '00s. There is a grey area there, and the legality of this sort of profit sharing tends to be defined only when lawyers can prove damages. This usually requires the close inspection of a studio's books and accounting methods and you can imagine how they might resist such scrutiny, especially when their own profits might be erased in fact as well as on paper.
Let's take a look at Paramount Pictures for a moment. While Rowling's percentage deal with Warner Bros. is not known at the time of this writing, the doctoring of books has excluded authors from their contracted percentages to keep more money for the company. For example, Winston Groom was granted three percent of the profits of the enormously successful adaptation of his book Forrest Gump (which hit theatres in 1994), but in spite of making $678 million against a $55 million budget, distributor Paramount claims that distribution and exhibition fees caused the film to actually lose $62 million. Again… the distributor… blamed distribution fees. Curious, isn't it?
This wasn't the first time Paramount allegedly worked around paying a writer for his work. Way back in 1982 humorist Art Buchwald pitched a treatment to Paramount called "It's A Crude, Crude World", which was later renamed King for a Day. The story was about a member of African royalty (planned to be played by Eddie Murphy) coming to the United States and his misadventures while attempting to fit in, including a stint in poverty. The screenplay went through many iterations with many writers and director John Landis was approached to direct, but the film went into development hell so Warner Bros. optioned the treatment.
But in 1987 Warner Bros. backed out of production because Paramount announced its new project, Coming to America directed by John Landis. This film was about a member of African royalty, played by Eddie Murphy, coming to the United States and his misadventures attempting to fit in, including a stint in poverty. Since this sounded exactly like Buchwald's project, Warner Bros. dropped it like a hot tong fearing a twin film controversy. When the film was released in 1988 Murphy, not Buchwald, was given story credit. Buchwald was not paid. (One undeniable irony of this rip-off is that a subplot of the final film involves a copyright infringement investigation between a certain mega fast food chain and a burger joint called "McDowell's".)
Naturally Buchwald sued, as his contract with Paramount indicated he would be paid for creating the film's story. The California Superior Court heard Buchwald v. Paramount and reached a verdict in 1990, deciding in favor of Buchwald. The court stated that a preponderance of evidence proved that Coming to America was based on Buchwald's treatment especially because Landis and Murphy had full access to this treatment as well as the previous versions of the script. Because of the decision that the story was "based upon" Buchwald's work, Paramount's option agreement specified that he would be paid should a movie based on the treatment be made and Buchwald was, in fact, never paid Paramount was found in breach of the contract.
But this is a breach of contract lawsuit. Why discuss this in a film about fuzzy accounting in movie production? You should ask Paramount's lawyers that question, because they're the ones who brought it up. Coming to America was a huge success for Paramount, eventually earning $288 million against a $39 million budget. Yet during the second phase of the trial when the court was set to decide how much Buchwald was owed, Paramount argued that development and marketing costs had resulted in "no net profit" and backed this up with Buchwald's own contract. The court was so outraged by this Hollywood Creative Accounting that it ruled that Paramount had used "unconscionable" means of determining a writer's percentage and found that Buchwald could pursue a separate tort lawsuit against Paramount.
A tort suit against Paramount could have huge implications, not just for that studio, but for the entire system. If net profit formulas in studio contracts do not correspond to generally accepted accounting principles those same studios might face something as frightening as an audit from the Securities and Exchange Commission. And if that were to happen, the entire profit hiding scheme might become a thing of the past.
The court further found that such formulas effectively "double-count" many expenses of the studio and have been designed for the express purpose of making sure a net profit is mathematically impossible (and therefore no profits must be shared). This, coupled with the overwhelming evidence against Paramount that indicated a tort case would be lost (not to mention the fact that Paramount would have to open their books to fight this suit), the studio settled with the writer and his producer for $900,000 and had the previous decision vacated as part of the1990 settlement.
Naturally this threatened to shake the entire film industry as this sort of revisionist math was common practice in Hollywood. But did it, and would any real changes be seen?
In 1992 Michael Uslan and Benjamin Melniker filed Batfilm Productions v. Warner Bros. in Los Angeles Superior Court. Uslan and Melniker were the duo who purchased the film rights to the character Batman from DC Comics back in 1979 and despite popular culture still seeing the character as something campy and reminiscent of the 1966 TV show, it was Uslan's plan to make a serious and dark version of Batman, closer to the original. Along the way several studios rejected the project, including United Artists, Columbia and Universal and two other producers, Jon Peters and Peter Guber joined Uslan and Melniker in their quest. Eventually Warner Bros. (which, again, owns DC Comics) agreed to make the movie but by this time Uslan and Melniker believed their "indispensable creative" contributions had been minimized (especially since they were the dynamic duo who bought the rights to the Dynamic Duo in the first place). The lawsuit argued that they had been cheated out of proper credits and financial rewards and that "a sinister campaign of fraud and coercion" prevented their involvement in the production of Batman (1989) and its sequels (of which, at the time of the lawsuit, there were none).
So what exactly did that mean? Well, as everyone knows, Batman was an enormous success, pulling in over $253 million (at the time, the final count exceeds $411 million) against a budget of $48 million, yet when it came time for profit sharing, Warner Bros. claimed a net loss of $20 million. According to the suit itself, Warner Bros' Hollywood Accounting ensured that "'Batman' will never earn net profits for the two men who conceived the movie, acquired the rights and provided the creative blueprint for the film."
By way of comparison, Jack Nicholson was lured to the (then-believed risky) role of The Joker with top billing a $6 million paycheck and an unspecified percentage of the gross. By the time the suit was filed, Nicholson had reportedly been paid $50 million (with estimates today suggesting up to $90 million) and even received a financial interest in Batman Returns (1992), a film he had no involvement in. Guber and Peters were said to have made up to $20 million from the film. Warner Bros. agreed with those numbers and said that this was one reason that final accounting had not been made. Uslan and Melniker's deal was for net profits. Nicholson, at least, received a deal for "gross profits" (a percentage of the receipts before expenses were accounted for), meaning he would get a cut of the box office whether the film was successful or not. No amount of fuzzy accounting could bury a gross profit deal.
Logically, Uslan and Melniker hired Buchwald's attorney Pierce O'Donnell and he (along with much of the industry) considered Batfilm Productions v. Warner Bros. a logical extension of Buchwald v. Paramount. So how could they lose? If such a formula was "unconscionable" for Paramount surely it must be "unconscionable" for Warner Bros. Even the press felt that this was a foregone conclusion with the Los Angeles Times reporting "Even the Joker might laugh at this accounting."
Yet it was Warner Bros. that had the last laugh. A Superior Court judge threw out the lawsuit in 1994 (two years after Uslan and Melniker were credited as Executive Producers of Batman Returns) in spite of the fact that the pair claims to have received no money after the production of Batman because their “net profit participation has proved worthless". Warner Bros. eventually offered the producers a settlement, which their attorney (who did not specify the amount) described as the value of “two popcorns and two Cokes". They might need to buy a few more than two each, because while this verdict seemed to contradict the previous win against Paramount, all wasn't lost for Uslan and Melniker. Both men have been listed as Producers on every single Batman film since the 1989 movie, whether live action or animated, including the Christopher Nolan “Dark Knight Trilogy" that kicked off in 2005.
The Batman lawsuit is hardly unique and seemed to repeat itself a decade later. Spider-Man co-creator Stan Lee, who shaped much of what we know of the “Marvel Universe" claimed to have had a deal with Marvel for ten percent of any profits from film and television programs that utilize his characters. When 2002's Spider-Man motion picture (from Columbia Pictures) raked in over $800 million (against a $140 million budget), Lee stuck his hand out and found it slapped. According to the Marvel's lawyers the gargantuan success somehow managed not to net any profits whatsoever, so Stan (The Man) and his company, Stan Lee Media were out of luck. Thus, Lee sued but found little luck in the courts thanks to Hollywood Creative Accounting. Since then, Stan Lee Media has sued Marvel more than once to attempt to obtain ownership of the many characters he co-created.
Similarly, Peter Jackson and Wingnut Films sued Warner Bros' subsidiary New Line Cinema in 2005 claiming that they had been shut out of huge profits from the Lord of the Rings trilogy (specifically the first film, 2001's The Fellowship of the Ring) due to Hollywood Creative Accounting. As if it needed to be said, the Lord of the Rings trilogy (directed by Jackson) was an enormous critical, award and financial success which brought in close to $3 billion against a cumulative budget of $281 million. How could anyone hide profits like that?
Jackson asked that very question and demanded an audit. New Line chief Bob Shaye was furious and refused to allow Jackson to ever direct another film with the company. New Line was later fined $125,000 for failing to provide its accounting documents in relation to the suit.
By 2007, after a string of flops for New Line, Jackson was brought back to the studio to first executive produce, then to officially direct the new trilogy based on J.R.R. Tolkien's The Hobbit (all part of the same continuity as The Lord of the Rings). This reversal was partially because co-studio MGM shut down production without Jackson.
By 2008 the suit was overshadowed by a similar suit from The Tolkien Estate, claiming they were owed 7.5 percent of all profits from the films. The suit was settled for an undisclosed amount in 2009, though insiders reported that the payout was about $38 million. Their original suit was for $220 million.
It isn't merely huge studios with gigantic, effects-laden productions that have employed this practice, either. In spite of its name, My Big Fat Greek Wedding (2002) was actually a tiny little independent movie from Gold Circle Films; however, it soon became a Big Fat American Success at the box office, pulling in over $368 million with a budget of only $5 million. In short, this Canadian/ Greek/ American co-production (quickly labeled the “most Profitable Independent Film in History") would be considered a hit by any accounting practice in Canada, Greece or America.
Well, yes, except for that one part of America called “Hollywood". According to Gold Circle Films the “little movie that could" actually lost over $20 million. Thus the cast (with the exception of writer/ star Nia Vardalos) joined together to sue Gold Circle for their fair share of the pie. They weren't alone. Executive producers Jim Milio, Melissa Jo Peltier and Mark Hufnail (of MPH Entertainment, Inc.) sued Gold Circle and other companies involved with the production including Tom Hanks' Playtone Company and even Vardalos herself demanding three precent of the actual profits.
Undaunted, Hanks, wife Rita Wilson and Gary Goetzman (who also produced) joined with Vardalos and also sued Gold Circle (along with Big Wedding Productions, LLC and Vortex Pictures) separately. Vardalos was reportedly contracted to receive eight percent of the profits with Hanks, Goetzman and Wilson promised one third of the remaining funds after expenses. Even with Gold Circle revising the net from the negative to around $287 million, the various parties continued their suits until 2008 when the various parties requested a dismissal “without prejudice" (meaning the suits could be re-opened).
The man who would love for you to think of him as both “Mister Documentary" and “Mister Independent", Michael Moore, also filed suit over shady accounting practices. Having made $222 million against a $6 million budget, Moore's 2004 documentary Fahrenheit 9/11 was a big surprise debuting at #1 in the USA (a definite rarity for documentaries). Moore waited until 2011 to sue his buddies Bob and Harvey Weinstein (of the Weinstein Company) for a big, fat $2.7 million, claiming that the brothers had employed those similar creative formulas to cheat him out of his just income. A lawyer for the former Miramax executives responded that Moore had “been paid $20 million and he claims he should get $2 million more" and went on to call Moore's claims “Hogwash". While it might take a big screen investigation like a Michael Moore film to figure out where the real corruption here is, The Weinstein Company settled out of court with the big guy.
Even Hollywood's television interests are not immune. Studio Celador had to sue Disney over millions in claimed lost revenue over the TV series Who Wants to Be a Millionaire. Amazingly, the British firm won that suit against the House of Mouse. Don Johnson sued the Cox Media's Rysher Entertainment for lost income over Nash Bridges and he won that one, too.
Those are a whole lot of examples of the ramifications (and lack thereof) of Hollywood Creative Accounting. The prevalence of litigation both proves that this is a common practice and that such a practice isn't going anywhere. So… is it legal? The answer, in the case of Hollywood Creative Accounting and just about all other things, is: “It is unless you get caught."
Keep in mind, most of the time this practice is only known to the public when lawsuits are filed and the press gets interested. The practice is, in fact, so widespread that such contracts (unconscionable or not) are drafted every day with strange double-counting, self-paying, subsidiary sharing, sister company funding formulas that should be illegal, but technically are not (unless you get caught). On paper, at least when it comes to profit sharing numbers, virtually every movie loses money. After all, if it can happen to Harry Potter it can happen to anyone!
In an NPR interview, author Edward Jay Epstein argues that this double-edged sword can also be doubly beneficial in some cases. When an actor, director, producer or writer is given a profit sharing contract with a promised percentage of the net profits, on paper they are shown (and reported in the press) to be making incredibly huge amounts of money... even though that money will never be seen. When negotiating their next projects they can demand higher fees based on that very thing. This could be one reason that individuals rarely sue over this. Fellow production companies like Brandywine, Playtone and Celador not to mention rights holders like The Tolkien Estate and creator companies like Stan Lee Media are much more likely to sue as reports of high dollars for them mean a lot less than the actual dollars themselves.
If there is any lesson to be learned here, it's that Hollywood Creative Accounting will always be a standard practice as long as there are pieces of the financial pie to share. Studios cannot change agreed-upon percentages, so the smartest and most money-making strategy is to simply make the pie itself smaller and smaller and smaller (often along with their ethics).
Now imagine yourself finally walking into that studio meeting, finding your pitch accepted and right there on the desk in front of you is a gleaming contract that looks so golden to you that you can almost make out a rainbow arcing out of it into the heavens, obscured only by your name up in lights. Right there in black and white are the beautiful words illustrating that a full three percent of the film's profits are yours, yours and only yours.
My advice to you? The first words out of your mouth need to be “gross or net?"
See you in The Next Reel.