Advertising Spending, Competition and Stock Return

Marketing decision makers are increasingly aware of the importance of shareholder value maximization, which calls for an evaluation of the long-run effects of their actions on product-market response as well as investor response. However, the marketing literature to date has focused on the sales or profit response of marketing actions such as advertising spending and new-product development, and the goals of marketing have traditionally been formulated from a customer perspective. There have been no studies of the long-term investor response to marketing actions, in particular the stock returns of publicly traded firms. Our research investigates one important aspect of this impact, the long-run relationship between advertising spending and market capitalization. We hypothesize that advertising can have a direct effect on valuation, i.e., an effect over and above its indirect effect via sales revenue and profit response. Our empirical test is based on several years of data for two industries. We use multivariate time-series methods that disentangle the long-run effects and short-run effects, as well as the direct and the indirect effects of advertising on firm valuation. The empirical results provide support for our hypothesis that advertising spending has a positive and long-run impact on firms' market capitalization. Thus, even if product-market response to the advertising is demonstrably weak, investors are willing to pay a premium for aggressive advertisers. We quantify the magnitude of this investor response effect for own firms as well as competition and discuss its implications for future research. Introduction The shareholder value principle advocates that a business should be run to maximize the return on shareholders' investment. Shareholder Value Analysis (SVA) is thus becoming a new standard for judging managerial action (Doyle 2000). In this changing scenario, where short-term accounting profits are giving way to SVA, it is imperative that all investments made by managers be viewed in the context of shareholder returns. Thus, every investment, be it in the area of operations, human resources or marketing may now have to be justified from the SVA perspective. The common yardstick used by most investors in this context is the share price, or more generally, the wealth created by a firm is measured by its market capitalization. This evolution presents a great opportunity for marketing. Indeed, traditional accounting, by focusing on short-term profits at the expense of intangible assets, may marginalize marketing. For example, current accounting criteria may dictate the arbitrary reduction of sales training budgets in order …