Democracy In Action

A Senate committee dealt a big blow to the plans of two trading firms looking to create a box-office futures exchange that would allow the movie industry as well as investors to wager on movie ticket sales. … Federal regulators only in the last week had given the first stage of approval to the exchanges. …

Included in the Wall Street Transparency and Accountability Act financial reform package, passed Wednesday by the Senate Agriculture Committee, is a provision banning futures trading on box office. …. [Many are] scheduled to testify along with other motion picture industry leaders before the House Subcommittee on General Farm Commodities and Risk Management, which is also investigating the proposed exchanges. … The next step in the Senate is for the Transparency and Accountability Act to be merged with similar legislation proposed by the Senate Banking Committee. (more; HT Midas Oracle)

This is sad hour for prediction markets.  Movie markets seem a near best case, where the public would:

  1. easily understand the value to be gained by more accurate estimates, since they could personally use prices when deciding what movies to see, and
  2. find it hard to get worked up about supposed “manipulation”; they know all their other sources of info on movies are manipulated as well.

The fact that one can kill these markets by just yelling “manipulation” in a crowded democracy is a very bad sign for other interesting markets in the US anytime soon.

A key confession by Max Keiser on, today’s play money movie markets:

When I was CEO of HSX – I shared a board seat with members who were also on the board of Lionsgate Films.  Lionsgate was constantly moving the prices of their films (or films they had an interest in, or a friend’s film) on HSX as a way to manipulate perception and marketing dollar spends. … I went to war with the rest of the board to defend my creation, … [re] allowing the prices on HSX to be moved per ‘marketing’ requests made by the studios. This lead to a blowout on the board and my leaving HSX as a result.

I’ll take Max at his word.  So does this prove movie markets must be banned because manipulation is possible?  Well consider that the movie industry has been fine for 15 years with play money markets they can manipulate, and scared to death of real money markets, supposedly because someone might manipulate them.  The obvious difference:  it doesn’t cost much real money to manipulate play money markets, when market administrators will keep handing you as much play money as you want.

In contrast, the cost to manipulate real money markets would go through the roof, as savvy speculators jumped in on the other side of those losing manipulation bets.  On average, the movie industry would lose on their manipulation bets, fail to bias the prices, and increase movie market price accuracy.  Now you can see the movie industry’s real concern about manipulation: they might lose their ability to manipulate!

Added 5p: John Lopez at Vanity Fair says “the increased incentive for piracy still seems like a valid concern,” but given the huge incentive to pirate movies in order to watch them, it is hard to see pirating movies to maybe influence these thin markets would make much difference.

Added 6p: At lunch several of my colleagues sensibly suggested that studios are worried that more accurate pre-release movie quality estimates would make it easier for new studios to enter the movie industry.

Added 8p: Can this example finally put to rest the idea that play money markets work just as well as real money markets?

Added 24Apr: Early HSXer Ben Curtis comments below.

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  • RJB

    I see some potentially serious moral hazard problems here that go beyond simply price manipulation. Box office receipts are very sensitive to decisions on how to “window” the release–does it stay in theaters a long time, or go quickly to DVD, on demand, hotel/airline, international venues, etc. Receipts are also very sensitive to marketing decisions. So it isn’t just a matter of insiders pushing prices up or down. Insiders can also push receipts up or down in ways that are profit-neutral for the distributor (e.g., increase receipts by increasing marketing expenses, reduce box office receipts by agreeing to an early window for DVD and on-demand release).

    This is very different from other prediction markets, in which the people who trade the securities don’t have much control over what is being predicted (even if they have an interest in having the price higher or lower).

    I haven’t seen any detail that would suggest the products to be traded would be robust to these problems. I also don’t know if there are any theory papers that would indicate ways these problems are best addressed. Does anyone else?

  • I link this to your post a week or so ago about reluctance to experiment – why the reluctance to simply try it out and see what happens? What’s the worst that could happen?
    – people are fooled into seeing movies they don’t enjoy
    – people miss movies they would have liked
    – some movies make a bit more than they would have, others less.

    In any case it’s really hard to imagine that the effects of futures markets in movies being other than marginal to begin with (there is so much other marketing noise in the system) so plenty of time to observe and assess.

    How would the trial be controlled?
    – allow markets in horror and rom-com, but not action-adventure or sci fi?
    – allow markets in films with titles beginning A-L but not M-Z

  • Joe

    Can’t anyone just set this up offshore?

    • moviegeek23

      Already is. Intrade is an offshore exchange trading box office instruments similar to what is being proposed by the Cantor Exchange and the Trend Exchange. The opportunity for so-called “real money manipulation” already exists. In addition, off-shore sports books carry bets on box office receipts.

  • I see a dark irony in that a democracy can be manipulated into ditching prediction markets due to manipulation concerns.

  • Guy

    My (somewhat basic) understanding is that the problem with this is that it’s relatively easy to cause even a promising movie to tank at the box office (such as by spending the marketing budget inefficiently). So someone can make a movie, bet heavily against it on the futures market, and then let it fail and make more money off the futures bet than it loses on producing the movie. (Since movies are very cheap compared to the amount of money that Wall Street can throw around.)

    Or in other words, anyone trading on this market who does not have some control over the movie`s production, distribution, and marketing (or some assurance that those things will not be manipulated) is setting themselves up to be screwed by those who do have such control.

    This may or may not be a big deal, of course. Arguably anyone who enters this market does so at their own risk. I`m not sure the market is particularly useful at predicting anything though if it devolves into a game where people try to guess whether the movie`s producers are long or short on it.

    • Tim Tyler

      That sounds like insider trading. Surely Wall Street has *exactly* the same issue.

    • Mike Prentice

      That only works if a lot of other people bet for the movie to do well. If promising movies were consistently manipulated to fail, people would step betting for them and the manipulator once again faces a losing investment.

    • bock

      Guy, if the market for a movie got big enough for this possibility, then this possibility would be priced into the markets by short sellers.

    • Just make it a part of their job contract not to trade on the movie with big fines or jail if they do.

      • Or even better, give influential people in the movie shares in the box office receipts in place of wages. To prefer a bomb they would they would have to short sell it on these markets more than would be possible.

    • I have a whole post on manipulation.

  • RJB, so what do you fear going wrong if studios somehow push receipts up or down a little?
    botogol, Explodicle, yes this seems a poster-child for over regulation reducing innovation.
    Joe, but then Americans couldn’t trade in it.
    Guy, that scenario requires far thicker markets than seem likely.

    • Robert Bloomfield

      A little? Accounting is more flexible than you seem to think…this can be a lot more than a little. And it is only the unpredictable part that matters.

  • tom

    Keiser’s post says that Chilton says there were to be be anti-insider-trading rules on the new real exchange. Is that right? I thought this was a market where we were assuming/counting on insider trading.

    I didn’t see this mentioned above, but I love the idea of several different theater chains hedging their bets by betting low while the single studio bets high to keep up expectations. It would be very exciting to have some extra money to play with in the first few weeks while they were figuring it out.

    And as far as theater owners go, how is this any less legitimate/necessary than airlines hedging against oil price increases?

  • I’ve been adding to the post.

  • Industries tend to fear transparent contracts because they give them less latitude and threaten their pricing power. Look at iron ore, steel, and onions. (And, seriously? This was another “and onions” technically?)

    We’re not just talking about manipulating opinion here though. The studios have more direct influence over the outcomes. It’s not compelling to argue that, on average, it doesn’t make sense for studios to go long a title and then increase the number of screens. Trading restrictions and vigorous policing would lessen the opportunities for abuse, but from the CFTC’s perspective, there may always be an unforeseen hole in the dike, and that’s unacceptable headline risk, especially since preventing manipulation and consumer protection are central to their purpose.

    Now, maybe a market traded by theater owners and off-limits to studios, or one based on industry-wide receipts would be more acceptable to the CFTC. Who will spend political capital to pry the amendment out though?

    Do no harm is the bane of libertarians.

  • Bill

    If rivals can manipulate a market more cheaply than, say, increasing their advertising or promotion budget for a film, they will do whatever is cheaper or more effective.

    So, the issue really should be: how do you limit or prevent manipulation.

    The answer could be something as simple as permitting only those who say the film to predict the outcomes. Say, you get a ticket receipt from attending the film, and that becomes the pin or id number entitling you to bet. Only viewers who saw the film could bet/

  • Jason, yes a regulator who can only look bad, never good, wants to allow the min possible.
    Bill I have a whole lit on manipulation; follow the link.

    • Bill

      Read the material, but CFTC and SEC “experiments” would be contrary evidence.

      How about rules instead?

  • Jack (LW)

    I mean, this is always what happens when an industry is against something and there are no other powerful or organized groups invested in the outcome! The political calculations are really obvious: a congressperson can either piss off a powerful industry that fills their campaign coffers. This is always going to happen when you have part of a government empowered to regulate the economy, have that part chosen democratically, and don’t restrict industry’s power to influence elections.

  • The real problem is that a movie futures market would make manipulation hard and expensive. The system right now is far easier for studios to manipulate so its unlikely they will allow this to come to light in the US.

  • Kinch

    I have to say Robin, you don’t really address Guy’s point. Prediction markets can only work if the underlying observable is difficult to corrupt. There are plenty of laws that ensure this is the case for financial markets, they’ll be much harder to enforce in the movie market. Guy’s point about inflating the budget of a movie is pretty good.

    Advocating a thicker market, and then saying the market will work well because it isn’t think enough seems a little disingenuous.

    Of course there are states of the world in which what you say might be true, but you’re hardly making a case that this is such a world.

  • Kinch, consider stock markets. You could similarly argue that allowing short sales means the firm managers could profit from destroying their company.

    • Doug S.

      It does. And that’s yet another reason why trading by insiders is heavily regulated.

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  • Ben Curtis

    I was one of three programmers at when Max was there, from 1997-2001. We learned a lot during that time, and I’m not surprised that it’s taken this long to get such markets approved, and that such approval has resulted in forces pushing to make them illegal.

    At that time, a “real money” market was just a dream, the primary goal of which was to allow independent filmmakers to raise money for promising projects. That market never got much interest, for two reasons mentioned in this post and in the comments and one not yet mentioned:

    1- Unlike pork bellies or light sweet crude, the quality of the resulting movie product is not directly related to the “quality” of the participants. Even if the movie the stock was associated with had a contract with Writer A, Director B, and Big-Draw Stars C, D, and E, and Marketing Firm F — you still could produce a bomb. Studios manage this risk by taking total hiring control, reading the script, watching dailies, and the like. You can do that with a small number of investors; you can’t easily distribute all that for shareholders. Sure, shareholders could buy and sell based on their judgement of what information is distributed, but to have an open market all this information (i.e., the proto-movie itself) must be given away. We built a product called that explored these options, and produced “Shadow of the Vampire” under that aegis. From that experience, it does not work. However, clearly something *could* work; Microsoft faces similar quality-of-product debates, and it’s public.

    2- Big studios currently control the entire market. Small independents find it difficult to enter the market because they don’t have the cash buffer to help absorb risk. Anything that reduces risk or spreads it out therefore acts to destabilize the hold the big studios have on the market. They will therefore act aggressively to ensure that full risk is borne by the filmmakers, because they are the only filmmakers than can easily do so. This may lower the overall quality of movies and therefore reduce the size of the market, but it increases the big studios hold on their share.

    3- Individuals within the big studios see their only method of getting promoted is to take full responsibility for huge successes and to fully deflect responsibility for failures. The system that is in place is well designed through the evolution of millions of such decisions to give the individual decision makers exactly the means to do this. New markets such as these may make sense for the companies, but for the individuals they represent a risk that no one will take because it breaks the mold and so they MUST take full responsibility for a failure, while the market distributes responsibility for success. Just like Greenspan’s oversight, companies do not act in their best interest simply because the individual PEOPLE running the companies are acting in their own best interest. And they do not want the markets touching their movies.

    So, those are the lessons I learned. I was just the programmer. Max was the markets guy. I think that in the end this sort of thing will get enough momentum (overseas, etc.) that it won’t matter much what people are concerned about. I do hope that such markets can be created. I think they may help make more interesting movies.

    • Thanks for the detailed and thoughtful comments.

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