Historically, one of the main problems confronting a record label is the varying performance characteristics of its artists. “Superstar” acts that sell more records require a completely different economic relationship than “new” bands. Yet, record labels persist in forcing both into the same contractual model, that is, an advance against royalties, then royalties payable after the advance has been recouped (if it ever is) at a specified contractual rate. I analyzed this issue in 1986 when I was Vice President of Capitol Records, based in Hollywood, California.
There are several problems with the conventional structure. One of the main ones is that superstar artists end up subsidizing new artists – yet, the superstar artist is unable to capture and retain any of the entreprenurial rents generated by this activity (to the extent they materialize), all of which the record company captures and retains for its own account.
The risk of this inefficient allocation of economic resources leads the superstar to threaten (explicitly or tacitly) to withhold performance under contract unless it is renegotiated – in effect, a form of contractual “hold-up.” See, e.g., Ben-Shahar, O. & Bar-Gill, O., “The Credibility of Threats to Breach”, Michigan Law and Economics Research Paper No. 02-017 (Oct. 2002); Ben-Shahar, O. & Bar-Gill, O., “Threatening an Irrational Breach of Contract”, Michigan Law and Economics Research Paper No. 02-016 (Oct. 17, 2002); and Edlin, A. & Hermalin, B., “Contract Renegotiation and Options in Agency Problems” (Oct 1998).
This in turn induces the record company to offer extraordinary concessions, above and beyond a simple royalties increase. For example, as is well known, Garth Brooks came to own all of his master sound recordings, simply entering into an agreement with Capitol to manufacture and distribute them for a fee. Capitol gave them to him, in consideration for the right to manufacture and distribute future albums, yet to be delivered. That relationship expired in August 2005, when Mr. Brooks entered into an exclusive relationship with Wal-Mart, see, e.g., Duhigg, C., “Garth Brooks a Wal-Mart Exclusive,” Los Angeles TImes (Aug. 20, 2005).
From Capitol’s perspective, was it worth it? It certainly was for Mr. Brooks. Although exclusive, his agreement with Wal-Mart undoubtedly was a license for a term of years. That is, he retains ownership of his catalog (which was given to him by Capitol); and, after the Wal-Mart agreement expires, he can license it again, either to Wal-Mart, or to somebody else. This is the exact reverse of the (then)-typical agreement between artist and label.
By doing so, the record company becomes vulnerable to what might be characterized as “fading diva syndrome.” It must over-pay for current performance, even against the prospect of future inferior performance. As a result, its risk is dramatically enhanced. Recording artists are mercurial. Their delivery schedules are idiosyncratic and do not necessarily coincide with the record company’s quarterly earnings reports.
Market laggards particularly are vulnerable to this phenomenon. Lacking a broader economic base, they become unduly dependent on whatever releases they have. Thus, for example, Capitol also renegotiated its contracts with Tina Turner (following her album “Private Dancer”) and David Bowie (following his album “Let’s Dance”). Each artist’s next album did not perform nearly as well as its predecessor.
I am not particularly criticizing the Tina Turner or David Bowie contract renegotiations, as the alternatives – non-delivery, or a legal action for “specific performance” of the contract – are even more unpalatable. In 1983, for example, CBS Records notoriously sued the band Boston for alleged delay in delivering its third album (which later went on to sell a fraction of the band’s first and second albums). Lest one think this is an isolated example of a miscarriage of artist relations, this trend continues unabated. The band Stone Temple Pilots recently was sued for alleged non-delivery by its label, Atlantic Records (a unit of the Warner Music Group), some quarter of a century following the Boston case. [I was Senior Vice President of Atlantic Records after I left Capitol, but that was way before Stone Temple Pilots.]
Interestingly, I also was involved in (separate) legal actions filed by Tanya Tucker and Brett Michaels, lead singer of Poison – both of whom sued Capitol to stay on the label, after they’d been dropped. It was a weird kind of reciprocal to the Boston and Stone Temple Pilots litigation. No downward renegotiation of their respective contracts would have sufficed, however, given (a) recording costs, (b) marketing and promotional costs, (c) obsolescence risk due to likely high returns, and (d) lost opportunity cost (i.e., inability to focus on other, potentially more promising artists).
This paper primarily was a theoretical exercise. It proposed not only different economic relationships for superstar acts versus new acts, but also the formation of separate special-purpose entities (“SPE”), with different risk-return characteristics. In addition allocating risk-return more efficiently, different SPEs also have several other benefits, such as sources and applications of funds. In this respect, the paper was a precursor to many of the asset collateralization and off-balance sheet financing techniques now commonly deployed in the entertainment industry.
Here’s a .pdf: