The Effect of Management Discretion on the Efficiency of Profit Sharing Contracts: Evidence from the Motion Picture Industry

Abstract

Through the examination of a unique sample of profit participation audit reports, I evaluate the implementation of a specific type of profit sharing contract and quantify the effect of management discretion over its outcomes. I show that the level of claimed underreporting of profit participation is increasing in the ambiguity of the compensation contracts’ provisions, and that the amount of discrepancy appears to be driven by a film’s success as opposed to specific characteristics of a studio or participant. The results provide support for the idea that the definition of the profit pool is as important as its division in determining the effectiveness of these contracts.

Keywords: Profit Participation, Contracting

JEL Classification: M41