Nominal vs. Real Rates: The Golden Rule of Intrinsic Valuation

In the high-stakes game of valuation, where spreadsheets meet storytelling, one golden rule stands above all: match your growth rate with your discount rate. Sounds simple, doesn’t it? But even seasoned attorneys, music publishers, and investors can find themselves in murky waters if they mix up nominal and real interest rates. Let’s clear the air:

Nominal vs. Real: A Quick Refresher

Think of nominal rates as your bedazzled, full-glam version—reflecting the current glitz and inflation of the market. Real rates, by contrast, are the stripped-down, no-frills edition. They focus solely on purchasing power, removing inflation from the equation.

As NYU Professor Aswath Damodaran, known as the valuation guru himself, and whose classes I have taken , reminds us of "Consistency Principle 1: Nominal cash flows should be discounted at nominal discount rates; Real cash flows should be discounted at real discount rates." Mismatching them is the financial equivalent of wearing sneakers to a black-tie gala—it simply doesn’t work.

Why It Matters in Intrinsic Valuation

Intrinsic valuation hinges on precision. When forecasting cash flows, you might account for inflation in your growth rate. If so, your discount rate must include inflation as well—because, like a perfect duet, these rates must harmonize.

Here’s the twist: forgetting to align nominal with nominal or real with real can lead to either undervaluation or overvaluation. For instance:

• Using a nominal growth rate with a real discount rate: You’ll underestimate the present value of cash flows, which can result in undervaluing assets—whether that’s a publishing catalog or a litigation award.
  
  
• Using a real growth rate with a nominal discount rate: You’ll inflate valuations like a poorly mixed cocktail—beautiful at first sip, but ultimately a headache.

Getting it Right: Application for Music Publishing Investors & Attorneys

For investors eyeing music publishing catalogs, growth rates often reflect expected increases in royalties—typically influenced by inflation. In this case, your discount rate should be nominal. Similarly, litigation attorneys evaluating settlement awards or damages tied to future earnings must remain vigilant in aligning these rates to avoid leaving money—or credibility—on the table.

Matchmaker, Matchmaker: Pair Your Rates Like a Pro

Matching your growth rate and discount rate is neither science nor art. It’s about making the best decisions with the data you have.  And with that, should you wish your valuations to sparkle with clarity, my firm Boschan Corp. is here to assist - find more information about our services by clicking here.

Controlled Composition Clauses: Myths Dispelled

Entertainment lawyer Wallace Collins wrote an article for Music Think Tank entitled "Beware of the Controlled Compositions Clause."

While I wholeheartedly agree with the premise of Mr. Collins' post (i.e., watch out for controlled composition clauses) and I appreciate that he couldn't cover all of the details extensively in a single post, the piece does not appear to have been fact checked and when I tried to comment on the Music Think Tank site, I received error messages and the site would not allow my comments to be posted.

In any case, as a royalty auditor who audits compliance with statutory mechanical royalty rates as well as controlled composition provisions, I feel compelled to point out the following regarding Mr. Collins' and Music Think Tank's post. Thus, I am posting my comments here on The Auditrix blog:

Example of language similar to that found in typical controlled composition clauses

First of all, in practice, statutory royalty rates are effectively *maximum* rates, not minimum rates, as Mr. Wallace and Music Think Tank state. (The term "minimum statutory rate" as used in controlled composition provisions references the fact that there is a minimum rate that applies to uses that are five minutes or less; higher rates apply for uses that exceed five minutes.) As much as I wish that my music publishing and composer clients were entitled to minimum rates that would be equivalent to a minimum wage, they are not.  The statutory rates are simply the reportable rates for compulsory licenses and since negotiated licenses virtually never exceed statutory rates, statutory rates are effectively a cap and not minimum rates at all.

Secondly, while I understand that it used to be a common practice of record companies to cross-collateralize mechanical and artist royalties, which is an issue that Mr. Wallace and Music Think Tank warn readers to beware of, I believe many labels were sued over this practice decades ago and I haven't seen it in my 14 years of royalty audits. In fact, modern artist agreements specifically prohibit this. (However, many contracts do allow for recoupment from artist royalties of "excess mechanicals" which are mechanical payments to publishers that exceed the cap set forth in applicable controlled composition provisions. Despite this, such provisions do not prevent the publisher from collecting royalties and, in practice, we do not see many excess mechanical charges against artist royalties in any case.)

Finally, the Digital Performance Right in Sound Recordings Act of 1995 prohibits record companies from applying controlled composition provisions for digital phonorecord exploitations (i.e., permanent downloads) in most but not all cases, which is a glaring omission from the piece, since it drastically reduces the the impact of most controlled composition clauses.  Due to this law (and the fact that streaming services are responsible for paying US publishing royalties for streaming exploitations) the exploitations that are potentially subject to controlled composition provisions are mainly US sales of physical CDs and vinyl, which are less than half of overall US sales. (Not to mention that US sales are equal to or less than foreign sales for most of my clients, and the controlled composition provisions are largely inapplicable outside the US.)

Also, to Mr. Collins' point that there is a question as to whether one writing partner can bind another is the fact that the Department of Justice is considering requiring publishers (or their agents) to engage in what is called 100% licensing, in which any rightsholder can issue a license for 100% of a song. Sony/ATV's Martin Bandier recently wrote a letter to songwriters about this issue (which relates to much more than controlled compositions) and The Association of Independent Music Publishers (AIMP) (of which I am the national treasurer) recently presented a program on the topic, a video of which members can view at AIMP.org (viewing this discussion is well worth the cost of membership, if you aren't already a member).

Of course, there are many more crucial details to understand about controlled composition provisions, especially as they relate to audiovisual content and premium uses, which is why many attorneys consult with us during the contract negotiation process. No one can be expected to know everything about the arcane world of royalties, so such negotiations are usually a team effort.