Real Options in the Motion Picture Industry: Evidence from Film Marketing and Sequels*

Abstract

We examine the application of real options within two contexts of motion picture investment decisions by studio executives. The first is whether to continue marketing a film following its initial release in theaters (an abandonment option). The second centers on the decision to produce a sequel to an original film (a growth option). Few accounting studies have examined the use of real options but they are of considerable importance to companies managing risk through their cost structure and capital investment decisions. Specifically, a real option allows decision makers to postpone further expenditure commitment until a substantial portion of the uncertainty surrounding the investment has been resolved. Our evidence from the motion picture industry indicates that studios leave a portion of their marketing budget uncommitted until its spending is warranted. We also show that studios invest more in original films that they believe will lead to a sequel. Specifically, we find that studios spend higher production and marketing costs on films with sequels than those without, and that sequels generate higher returns on investment than non-sequels. Overall, our results suggest that the real options framework has applications for accounting research and practice by providing a basis for studying and understanding cost commitments in product or project-based settings.