The 'New Payola' and the American Record Industry: Transaction Costs and Precautionary Ignorance in Contracts for Illicit Services

Abstract

Payola is the practice of making undisclosed payments or other inducements to radio (or television) broadcast personnel in consideration for the inclusion of material in radio (or television) programming. The origin and economic function of payola were first analyzed in 1979 by Professor Ronald Coase.

He argued three fundamental propositions. First, every time a radio station plays a song, it in effect advertises a specific product (namely, a phonograph record) that a record company has for sale. Payola is a price mechanism for efficiently allocating this scarce but otherwise unpriced on-the-air advertising of popular music. There is no reason to believe that a record company that dispenses payola will spend its finite advertising resources promoting bad music rather than good music. Second, long before the commercial development of radio, a similar pricing system was commonplace in the United States with respect to the inclusion of songs in live performances by popular singers and musicians. At that time, the implicit advertisement was for sheet music sold by music publishers. Third, since at least the 1890s, movements to prohibit payola have been used as competitive weapons by record and music publishing firms. Those firms have acted, sometimes in concert, not only to reduce their own advertising costs, but also to restrict advertising alternatives by which new entrants could expose to the public their sound recordings and copyrighted compositions.

Apart from expressing indignation over payola, Senator Gore's remarks suggest that the transaction costs of using payola as a price mechanism for allocating scarce on-the-air exposure to pop music increased between the time that Professor Coase published his article in 1979 and the advent of the new payola. In this Article, we examine how such a degradation in transactional efficiency could have occurred.

In Part I, we analyze the law and economics of record promotion. We show why it was difficult for a record company to specify and monitor contractual performance by independent promoters, and how this difficulty enabled independent promoters to act opportunistically vis-a-vis the record company. In Part II, we analyze the new payola scandal of 1986, which we argue resulted from transactional inefficiency in the contractual relationship between record companies and contractors for record promotion, inefficiency that manifested itself in opportunistic behavior by independent promoters.

In Part III, we argue that the major record companies did not counteract this opportunism through vertical integration into radio broadcasting because FCC regulation effectively blocked such integration, thus causing the desired efficiency outcomes to be approximated more inexpensively through the advent of music video broadcasting and the growth of syndicated radio programming. Finally, in Part IV we propose that payola be deregulated in a manner that would eliminate the inefficiencies of opportunistic behavior by independent promoters while preserving certain efficiencies that they may have created. Specifically, we propose that the FCC amend its sponsorship identification rules so as to require the disclosure of certain information that would enable the market for hit records to function more like an organized exchange.

JEL Classification: K00, K14, K21, L2, L4, L41, L5