The Capitol Records company was founded by the songwriter Johnny Mercer in 1942, with the financial help of movie producer Buddy DeSylva and the business acumen of Glenn Wallichs, (1910-1971) (owner of Music City, at the time the biggest record store in Los Angeles, California). Wallichs Music City record store opened in 1940 and was located in Hollywood on the corner of Sunset and Vine. It was the premier music store in Southern Cal for decades but closed in 1978. Capitol Records opened in a storefront office in the Music City building.

Capitol was the first West Coast label, competing with RCA-Victor, Columbia and Decca, all based in New York. In addition to its Los Angeles recording studio Capitol had a second studio in New York City, and on occasion sent mobile recording equipment to New Orleans, Louisiana and other cities.

The earliest recording artists included Paul Whiteman, Martha Tilton, and Ella Mae Morse. Capitol's first gold single was Morse's "Cow Cow Boogie" in 1942. By 1946, Capitol had sold 42 million records and was established as one of the Big Six record labels. It was also that year that writer/producer Alan W. Livingston created Bozo the Clown for their new children's record library. Some notable music appreciation albums for children by Capitol during that era included Sparky's Magic Piano and Rusty in Orchestraville. The label's 1940s artists included Les Baxter, Bing Crosby, Les Paul, Peggy Lee, Stan Kenton, Les Brown, western swing artist Tex Williams, and Nat King Cole.

Capitol released a few classical albums in the 1940s, some featuring a heavily embossed, leather-like cover. These appeared initially in the 78-rpm format, then on some of Capitol's early LPs (33-1/3 rpm) which first appeared in 1949. Among the recordings was a unique performance of the Brazilian composer Heitor Villa-Lobos' Choros No. 10 with a Los Angeles choral group and the Janssen Symphony Orchestra (1940-1952) conducted by Werner Janssen, Symphony No. 3 by Russian composer Reinhold Moritzovich Glière, and Cesar Franck's Symphony in D minor with Willem Mengelberg and the Concertgebouw Orchestra.

In 1949, the Canadian branch was established and Capitol purchased the KHJ Studios on Melrose Avenue next to the Paramount Pictures Lot in Hollywood. By the mid-1950s, Capitol had become a huge company, concentrating on popular music.