Mechanical royalties are royalties that are paid by a person making a new recording of an existing piece of music (most often a cover version of a song).
Mechanical royalties are calculated using either a fixed rate per copy (common practice in the US) or as a percentage of the price of the CD (or other medium) on which the recording is sold. In the latter case it is necessary to adjust for the fact that a CD may contain several other works.
In the UK, mechanical royalties are usually collected by Mechanical Copyright Protection Society which then passes them to the music publisher (usually itself a recorded music company). What the publisher receives is then split between the publisher and the creators of the music.
In the US, there is a statutary rate that sets a maximum royalty per song or per minute (whichever is higher). These are published by the US Copyright Office.
Mechanical royalties are one of many income streams a music company generates. Others include the sale of music, synchronisation fees and performance royalties.