The Risk Environment of Film Making - Warner Entre Guerras

EXPLORATIONS IN ECONOMIC HISTORY 35, 196–220 (1998)
ARTICLE NO. 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: m.pokorny@unl.ac.uk.
196
0014-4983/98 $25.00
Copyright r 1998 by Academic Press
All rights of reproduction in any form reserved.
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No. of Pages—25 First page no.—196 Last page no.—220
RISK ENVIRONMENT OF FILM MAKING 197
associated with film consumption through incorporating a bundle of design

features which arouse and satisfy a set of expectations among filmgoers. Histori-
cally, 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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198 SEDGWICK AND POKORNY
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 dispro-
portionate 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 chang-
ing 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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TABLE 1
Selected U.S. Statistics, 1922–1941, 1929 Prices
Real
personal Real Annual
disp. recreational cinema Real Average real B–O/
Population Unemployment CPI income expenditure admissions annual admission recreational
Year (ms) (%) (1929 5 100) ($bn) ($m) (m) B–O ($m) price ($) expenditure
1922 110 6.7 97.9 61.6 2080

1923 112 2.4 99.6 70.0 2630 2236 337 0.15 0.13
1924 114 5.0 99.8 71.5 2392
1925 116 3.2 102.3 71.3 2770 2392 359 0.15 0.13
1926 117 1.8 103.3 74.9 2600
1927 119 3.3 101.4 76.4 3078 2964 519 0.18 0.17
1928 121 4.2 100.0 77.5 3380
1929 122 3.2 100.0 83.3 4331 4160 720 0.17 0.17
1930 123 8.7 97.5 76.4 4094 4680 751 0.16 0.18
1931 124 15.9 88.9 72.0 3715 3900 809 0.21 0.22
1932 125 23.6 79.7 61.1 3063 3120 661 0.21 0.22
1933 126 24.9 75.6 60.2 2911 3120 637 0.20 0.22
1934 126 21.7 78.2 67.0 3123 3640 663 0.18 0.21
1935 127 20.1 80.1 73.0 3283 4160 694 0.17 0.21
1936 128 16.9 80.9 82.0 3733 4576 774 0.17 0.21
1937 129 14.3 83.8 84.9 4034 4576 806 0.18 0.20
1938 130 19.0 82.3 79.6 3940 4420 806 0.18 0.20
1939 131 17.2 81.1 86.7 4257 4420 813 0.18 0.19
1940 132 14.6 81.9 92.5 4594 4160 898 0.22 0.20
1941 133 9.9 86.0 107.8 4931 4420 941 0.21 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 See Gomery (1992), Izod (1988), and Roddick (1983).

5 Gomery (1992).
6 Historical Statistics of the U.S. (1975), Series H.873.
7 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 receiver-
ship 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 meticu-
lous 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.

9 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).
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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)
Coefficient of
Rate of Average variation of
Films Domestic Foreign Total Production Film return production production
Season produced revenue revenue revenue costs profits a (%) b costs costs
1921/1922 3 1112 85 1197 268 485 68.2 89.2 41.2

1922/1923 6 1977 197 2173 803 566 35.2 133.9 23.2
1923/1924 13 4735 468 5203 2450 828 18.9 188.4 60.2
1924/1925 23 5059 792 5851 2337 1347 29.9 101.6 53.8
1925/1926 45 8354 1610 9964 5251 1026 11.5 116.7 64.3
1926/1927 29 8172 2937 11109 4814 2183 24.5 166.0 76.6
1927/1928 38 11662 3274 14936 3957 5453 57.5 104.1 71.2
1928/1929 36 25892 9133 35025 6657 15407 78.5 184.9 94.9
1929/1930 82 36615 15381 51996 25133 7627 17.2 306.5 59.5
1930/1931 60 23381 6004 29385 21260 22749 28.6 354.3 42.2
1931/1932 52 22072 6487 28559 16348 1644 6.1 314.4 27.2
1932/1933 56 27533 15932 43465 15431 11956 38.0 275.6 50.1
1933/1934 54 26039 12659 38698 16851 7522 24.1 312.1 54.3
1934/1935 54 31095 16385 47479 20136 9774 25.9 372.9 73.4
1935/1936 58 29425 15083 44509 19468 8568 23.8 335.7 81.7
1936/1937 58 28334 12633 40967 20649 5160 14.4 356.0 76.8
1937/1938 56 32151 14199 46350 28079 1118 2.5 501.4 97.0
1938/1939 53 37545 16057 53602 26244 7520 16.3 495.2 69.7
1939/1940 47 32104 13993 46097 25574 3465 8.1 544.1 80.4
1940/1941 48 32690 14634 47324 22658 7152 17.8 472.0 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.
13 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.
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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 contribu-
tion 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, rev-
enues 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, suggest-
ing 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).

15 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.
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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).

18 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.
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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 them-
selves, Roddick (1983) has produced a careful and detailed assessment of the
match between the system of production at Warners and the quality and character-
istics 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 commer-
cial 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).

20 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.
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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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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
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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 heterosce-
dasticity 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 appropri-
ate regression equation for testing for the significance of b is
Pi 1
5a 1 b 1 ui. (3)
Ci Ci
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 1
5 235.638 1 0.53
Ci Ci
(4)
(3.19) (9.18)
R 2 5 0.051 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) (5)
R 2 5 0.051 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 signifi-
cantly 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 produc-
tions 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) (6)
R 5 0.667
2
n 5 19 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) (7)
R 5 0.939
2
n 5 19 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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TABLE 3
Annual Rates of Return by Budget Category
Rate of return generated by Rate of

return
Top 20% Middle 40% Bottom 40% on film
Season of films of films of films portfolio
1921/1925 23.1 37.1 56.5 28.8

1925/1926 3.8 6.2 28.2 11.5
1926/1927 26.3 10.1 42.8 24.5
1927/1928 54.3 52.4 69.2 57.5
1928/1929 79.6 78.3 76.3 78.5
1929/1930 12.5 18.9 22.3 17.2
1930/1931 220.8 25.7 1.6 28.6
1931/1932 26.0 8.6 10.6 6.1
1932/1933 43.1 30.6 44.5 38.0
1933/1934 23.6 27.1 20.4 24.1
1934/1935 17.0 33.3 30.2 25.9
1935/1936 14.4 27.0 42.1 23.8
1936/1937 8.1 13.8 34.2 14.4
1937/1938 29.6 10.8 22.7 2.5
1938/1939 19.6 12.6 17.3 16.3
1939/1940 2.8 9.2 21.3 8.1
1940/1941 19.9 15.5 18.0 17.8
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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TABLE 4
Budget Allocations and Profit Contributions by Budget Category
Top 20% of films Middle 40% of films Bottom 40% of films
Proportionate Proportionate Proportionate

allocation of allocation of allocation of
annual Proportionate annual Proportionate annual Proportionate
production contribution to production contribution to production contribution to
Season budget annual profits budget annual profits budget annual profits
1921/1925 0.42 20.04 0.36 0.50 0.22 0.54

1925/1926 0.39 0.12 0.36 0.19 0.25 0.69
1926/1927 0.46 0.50 0.36 0.13 0.18 0.36
1927/1928 0.44 0.41 0.33 0.29 0.23 0.31
1928/1929 0.49 0.50 0.32 0.32 0.19 0.18
1929/1930 0.40 0.28 0.39 0.44 0.21 0.28
1930/1931 0.34 20.78 0.40 20.27 0.26 0.05
1931/1932 0.27 20.15 0.43 0.62 0.30 0.53
1932/1933 0.34 0.40 0.46 0.35 0.20 0.25
1933/1934 0.36 0.35 0.38 0.44 0.26 0.21
1934/1935 0.44 0.27 0.37 0.51 0.18 0.22
1935/1936 0.47 0.27 0.38 0.44 0.14 0.29
1936/1937 0.44 0.24 0.43 0.41 0.13 0.35
1937/1938 0.52 21.90 0.36 1.65 0.12 1.25
1938/1939 0.42 0.52 0.43 0.33 0.15 0.16
1939/1940 0.45 0.15 0.42 0.48 0.13 0.37
1940/1941 0.46 0.52 0.43 0.37 0.11 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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TABLE 5
Estimates of Risk on Film Assets and Film Portfolio
Standard Standard Standard

deviation of deviation of deviation of Estimate of
rates of return rates of return rates of return risk Estimate of
top 20% middle 40% bottom 40% experienced risk taken
Season of films of films of films on portfolio on portfolio
1921/1925 16.9 18.0 22.7 17.5 20.6

1925/1926 20.1 16.7 17.8 17.2 24.7
1926/1927 15.3 13.6 18.9 14.4 26.8
1927/1928 36.8 27.3 32.3 30.7 26.0
1928/1929 36.8 26.0 23.8 29.3 33.0
1929/1930 38.0 27.2 18.7 28.2 19.6
1930/1931 20.4 28.9 19.1 22.2 13.3
1931/1932 18.6 24.6 15.2 19.1 10.4
1932/1933 31.7 26.6 31.9 27.7 19.9
1933/1934 20.8 28.6 18.6 21.9 22.1
1934/1935 18.0 25.6 16.3 19.3 27.3
1935/1936 26.0 20.8 11.9 20.7 28.3
1936/1937 20.8 23.5 9.9 19.6 29.6
1937/1938 24.8 28.8 18.6 24.3 31.2
1938/1939 20.5 22.9 13.8 19.5 25.3
1939/1940 16.6 21.6 17.9 17.9 26.9
1940/1941 18.3 21.5 20.9 18.9 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)
(9)
1 2xTxB Cov (rT, rB) 1 2xMxB Cov (rM, rB).
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. Specifi-
cally, by interpreting the coefficient of variation of the production costs for a given
27 See Lumby (1991, p. 204).

28 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.
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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,
1RT2
R
D ln RTt 5 a 1 b 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 com-
mented 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) (12)
R 5 0.589
2
n 5 16 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 Dropping the six films from the sample produced an RT value of 14.4.
30 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 contempo-
rary 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.
EEH0691
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 perfor-
mance 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.
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Times to 1970.
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EXPLORATIONS IN ECONOMIC HISTORY 35, 196–220 (1998)

ARTICLE NO. EH970691

The Risk Environment of Film Making:

John Sedgwick and Michael Pokorny†

University of North London, London, England

Film is a complex commodity. Each unit of output is unique, consisting of a set

associated with film consumption through incorporating a bundle of design

THE EMERGENCE AND SURVIVAL OF WARNER BROS

contrast to the selected details published in Glancy (1995).

1922 110 6.7 97.9 61.6 2080

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

4 See Gomery (1992), Izod (1988), and Roddick (1983).

ANNUAL PRODUCTION PORTFOLIOS

8 Historical Statistics of the U.S. (1975), Series H 878–893.

1921/1922 3 1112 85 1197 268 485 68.2 89.2 41.2

Source: William Schaefer Ledger.

are estimated as 37% of total revenue (see Note 23 for explanation).

budget as a proportion of the sum of total production and distribution costs.

box-office performance. Both revenue series have broadly similar characteristics,

14 See Dimsdale (1981).

budgets and the recession of 1937/1938 led to a dramatic downturn in profitability

17 See Barrios (1995).

concentrate on A-type pictures and leaving B production to Columbia, Universal,

19 Balio (1995, p. 29).

AN OVERVIEW OF THE RISK ENVIRONMENT

A PORTFOLIO THEORY INTERPRETATION

Rate of return generated by Rate of

1921/1925 23.1 37.1 56.5 28.8

Top 20% of films Middle 40% of films Bottom 40% of films

Proportionate Proportionate Proportionate

1921/1925 0.42 20.04 0.36 0.50 0.22 0.54

Standard Standard Standard

1921/1925 16.9 18.0 22.7 17.5 20.6

27 See Lumby (1991, p. 204).

FIG. 5. Portfolio return against risk taken on portfolio, 1921/1925 to 1940/1941.

FIG. 6. Portfolio return against risk taken, 1921/1925 to 1928/1929.

FIG. 7. Portfolio return against risk taken, 1929/1930 to 1940/1941.

that Eq. (12) provides a comprehensive explanation of the evolution of Warners’

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