I was listening to Dracula Battle today and all of a sudden I began to question why and how it even existed.

In the early 90's, how did an album like that happen? Who approaches whom and asks whomever else to produce the album? How do questions of demographics and arrangement style factor in?

I was actually just thinking myself how obscure titles like Might and Magic for NES got an arrangment cd... Or perhaps Chocobo's Mysterious Dungeon 1 getting a live instrument performance...

~Andy

My guess is it was a natural progression of events.  Like why did game soundtracks on cassette/CD happen?  A combination of consumer feedback/interest as well as the artist realizing the potential and strengths of their compositions.

In the past, there was a strict limit on video game music. Composers in general couldn't use the sound they wanted, and often were forced to give up or scale down their musical ideas. Thus, so many composers were frustrated that they finally decided to release their original compositions. That's called as arranged albums.

My first thought was to take a look at the liner notes of the oldest arranged album I have (Dragon Quest Suite/Digital Sound Explosion, released October 1986), but apparently they didn't feel the need to explain themselves, possibly because this was preceded by several other arranged albums.

Does anyone have any liner scans of older albums?

Timewise, arrangements and OSTs developed together and basically started appearing at the same time.

The first Arranged album was by Victor Records in March 1986 - Namco's "Video Game Graffiti"  (LP Version: VDR-1165, Cassette Version: VCH-10334)

I don't have scans of the Liner Notes, but here's the Front and Rear pictures of it.

Victor Records and King Records were (and still are) massively huge labels with boatloads of signed artists in all genres, so there was plenty of available singers & musicians to tap from their huge rosters when creating vocal versions & arrangments of songs.

Personal relationships are an important part of company affairs, and music staffers at Namco knew production staffers from Victor Records, thus the idea of making game albums was easy to execute since that's what a record label does. 
(Musician being friends with Producer = natural partnership)

It's the Record Label that creates the albums and they are taking the monetary risk of licensing the tunes and if it'll sell or not, so it really is purely up to them (not the game company) as to the content & quality of what's on an arranged album.

As for Dracula Battle, nobody's done a full english translation of those liner notes either, but here's where it was made, at King Record's Studio.

Really?! When were game soundtracks on cassette??

In the 80's, stuff like Double Dragon, Dragon Slayer IV, Salamander, and a lot of Nintendo stuff to name a few were all released on cassette.  And there was actually a few soundtracks released on vinyl as well.