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Fun With Contracts And Organizations, Clive Davis Edition…

June 17th, 2013 · 3 Comments
Books · Contracts · Incentives · Music Biz

Well kids, it’s that time of year where I am working to finish a book draft when I should be on the beach somewhere. What this means for you is that you get to be the guinea pigs for my musings on the music industry to some degree. (The book is about the economics of the music industry.) So here’s how this is going to work: I’m going to give you an excerpt that I think will be interesting to you, and you can warn me if it bored you to death instead. You can also tell me if you think of any stories that you’ve come across that might belong in such a book.

This excerpt is about contracting and how even successful organizations seem to be pretty bad at it sometimes:

In his memoir The Soundtrack of My Life, record executive and founder of Arista Records Clive Davis ruminates on, among other things, the perverse incentives that poorly thought-out contracts can create. As part of Arista’s growth strategy, Davis decided to partner with L.A. Reid and Kenny “Babyface” Edmonds as well as Sean “Puffy” Combs in order to diversify its capabilities and reach new markets. As per the emphasis of Arista’s parent company, Bertelsmann, on internal growth as opposed to acquisitions, Davis decided to support Reid and Edmonds by bankrolling their LaFace Records as a joint venture rather than waiting to see if the label succeeded and then acquiring it at a potentially high multiple of earnings or true value later. Similarly, Davis worked with Combs in a joint-venture fashion to found what would be called Bad Boy Records.

Davis was soon dismayed to learn, however, that the start-up costs for these joint ventures were coming out of his personal equity interest in Arista (such that the inevitable start-up losses were being charged to him), whereas the cost of an acquisition would have come out of the organization’s coffers more generally. Specifically, Davis was essentially financing the joint ventures himself but wasn’t the only beneficiary of the eventual upside, and, as a result, Davis had actually been given a disincentive to behave in a way that was in line with the overall company’s goals and values. Given that Davis was the primary decision maker in these matters, Bertelsmann was very fortunate that Davis wasn’t mindful of this part of his contract until after the joint ventures were already underway. (I suppose the implicit management lesson is that, if you’re going to put perverse incentives in a contract, try to make it so the other party doesn’t notice!)

To the parent organization’s credit, it eventually listened to Davis’ reasoning and agreed to change the contract structure to provide proper incentives, but not without more than a little pushback and a trip to Germany on Davis’ part. It’s truly surprising, sometimes, how much of a discrepancy there can be between the stated goals of an organization and the outcomes that these same companies are willing to pay for.

In case you’re curious, the memoir overall reads a bit like a laundry list of all the artists that Clive has signed over the years (though you’ve probably heard of him most with regard to Whitney Houston), but I’m finding it quite interesting for two (nerdy) reasons. First, Davis talks enough about the workings of the industry that it becomes pretty clear what the role of a record label was (I hesitate to say “is” for various reasons), especially where it comes to matching artists with songs. I already knew that this happened a lot in the pop music world, but it was interesting to see how much of that went on in rock, country, etc. (Sidenote: How many of you knew that Elton John hasn’t written his own lyrics in, like ever? As an economist, I applaud the use of efficient division of labor in such cases.) Second, it’s kind of eye-opening to be smacked in the face with how central recorded music was to the profits of the music industry- there’s a passage in the book, for example, where Davis describes Sarah McLachlan’s touring strategy as a way to grow a fan base and make money, and it’s written with a tone of “oh, isn’t that quaint,” whereas now that is the lifeblood of the majority of music careers.

It would also figure that I learned the detailed history of Biggie versus Tupac from an old white guy with a degree from Harvard Law School. Street cred, right there, ladies and gentlemen.

Tags: Books · Contracts · Incentives · Music Biz

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