China Box Office Audit: Why Hollywood Needed to Get Tough

The Great Wall
Courtesy of Legendary

The movie business has taken a hands-off approach to ticketing fraud in China over the last few years, worried that if it’s too aggressive, it could alienate the world’s second-largest film market. But as negotiations loom for a new film import agreement, Hollywood is finally getting tough.

The Motion Picture Association of America, Hollywood’s lobbying arm, has tapped PricewaterhouseCoopers to audit the box office results of certain select titles, according to two individuals with knowledge of the situation. Bloomberg News first reported details of the audit.

The audit results could be used in trade negotiations to bolster the major studios’ case for stricter accounting standards or a greater share of the China box office.

“If Pricewaterhouse can show that Hollywood has not gotten their fair due, then that would be an argument for increasing the percentage,” says Stanley Rosen, a political science professor at USC who specializes in China.

Under the current agreement, signed in 2012, studios get 25% of gross ticket receipts, half of what theaters usually cough up in other major territories. The agreement also allows just 34 overseas releases to play in China each year, though that quota was exceeded last year. The agreement is due for renegotiation this year, and the studios will be seeking to sweeten the terms.

China has long been plagued by box office irregularities. In some cases, distributors have skimmed profits from producers by not reporting the full gross. In other cases, tickets for a major Hollywood release might be credited to a Chinese propaganda film to inflate its grosses. Sometimes tickets to a domestic release will be issued and then have the title crossed out, with the name of a Hollywood movie written on top.

China also has a powerful interest in puffing up its overall box office revenue, as it eagerly anticipates becoming the world’s largest film market within the next few years.

An audit “puts a little more pressure on Chinese negotiators,” says Aynne Kokas, author of “Hollywood Made in China.” “The major power they’re able to wield is the size of the box office. But if the box office is smaller than anticipated… that could be helpful” to the U.S. side.

The 2012 agreement includes a provision for auditing of box office results, though this is the first time that clause has been exercised. The agreement states: “The U.S. enterprise shall have the right to receive and to audit information (including box office receipts, where relevant) regarding the implementation of the Chinese distributor’s obligations.”

Lindsay Conner, chair of Manatt, Phelps & Phillips’ media and entertainment group, has negotiated a number of deals between movie companies and Chinese entities, including slate financing pacts for Perfect World and Huayi Brothers. He cautions not to read too much into the MPAA’s more aggressive posture.

“Audits are a regular part of the film and television world in Hollywood and we probably shouldn’t be surprised that they extend to other parts of the world,” he said.

China has become an increasingly important source of revenues for major studio blockbusters. In some instances, Chinese audiences have rescued the likes of “Transformers: The Last Knight” and “Pirates of the Caribbean: Dead Men Tell No Tales” from being box office disasters after the pricey sequels stumbled in their domestic debuts.

But China remains a source of frustration for studios and ties between the studios and Chinese regulators and companies have frayed at the same time that the U.S. government is taking a more skeptical view of Middle Kingdom investments in the entertainment industry. Indeed, these talks will unfold in a much different political climate. The Trump administration has taken a more aggressive posture toward trade agreements than the Obama administration, deep-sixing the Trans Pacific Partnership Agreement and threatening to pull out of the North American Free Trade Agreement (NAFTA).

China has engaged in several crackdowns on ticketing fraud, and the proliferation of mobile ticketing platforms has made it harder to cheat. China’s new film law, intended to address copyright and other concerns, provides stiff penalties for fraud. Earlier this year, 63 cinemas were closed for 90 days, and another 63 for 60 days, under the new regulatory regime.

One question, still unanswered, is whether Pricewaterhouse will be afforded sufficient access to the books of Chinese distributors to ferret out any irregularities.

“It would be interesting to see what is allowed and what is off limits,” Rosen says. “My guess is the most egregious forms of box office manipulation will not be investigated.”