The Costs of Outside Equity Control: Evidence from Motion Picture Financing Decisions

Recent theoretical work suggests that outside equity monitoring and control come with costs as well as benefits, especially in small, entrepreneurial firms. These costs arise when outside investors undervalue any private benefits of control that may accrue to an entrepreneur. The resulting hold-up problems may reduce the entrepreneur's incentives to invest personal effort into the firm. This paper investigates the financing of individual motion pictures in light of a tradeoff between better monitoring and better creative effort. Filmmakers have the choice of using studio funds (and giving up control) or of obtaining independent financing (and retaining control.) Consistent with arguments in the literature on investor control, I find that independent motion picture finance is more common when a filmmaker's private artistic stake in the film is high and for films requiring a high level of creative effort. This paper also investigates the role of several other factors, the most important of which is reputation, in financial contracting. I find that a filmmaker's commercial reputation affects the amount of resources independent investors, without control, are willing to provide. In contrast, studio investors, who maintain high levels of monitoring and control, appear relatively less concerned about reputation.