Understanding the Effect of Advertising on Stock Returns and Firm Value: Theory and Evidence from a Structural Model

Abstract

This paper brings structural modeling to the literature on financial research in marketing. I propose a dynamic investment-based model to understand the impact of advertising expenditures on stock returns and firm value. In addition, by interpreting advertising expenditures as an investment in brand capital, the approach in this paper provides a novel way to measure brand equity grounded in economic theory. Using the Euler equations from the firm's maximization problem, I derive closed-form expressions for the firm's equilibrium stock returns and market value, which depend on observable firm characteristics. I test the model's predictions by the generalized method of moments and data from a large cross section of publicly traded firms. The model is able to match simultaneously the pattern of average stock returns and firm values of portfolios sorted on advertising expenditures that standard asset pricing models cannot. The estimation results also show that brand equity accounts for a substantial fraction of firm market value (about 23%), and that this value varies substantially across industries. Implications of the findings for research at the intersection of marketing and finance are discussed. Abstract This paper brings structural modeling to the literature on financial research in marketing. I propose a dynamic investment-based model to understand the impact of advertising expenditures on stock returns and firm value. In addition, by interpreting advertising expenditures as an investment in brand capital, the approach in this paper provides a novel way to measure brand equity grounded in economic theory. Using the Euler equations from the firm's maximization problem I derive closed-form expressions for the firm's equilibrium stock returns and market value, which depend on observable firm characteristics. I test the model's predictions by the Generalized Method of Moments and data from a large cross-section of publicly traded firms. The model is able to match simultaneously the pattern of average stock returns and firm values of portfolios sorted on advertising expenditures which standard asset pricing models cannot. The estimation results also show that brand equity accounts for a substantial fraction of firm market value (about 23%), and that this value varies substantially across industries. Implications of the findings for research at the intersection of marketing and finance are discussed.

The Relation of Capitalized or Expensed of Intangible Expenditures to Firm Value

“…Vitorino [23] argues that advertising expenditure is an investment to create brand capital as an intangible asset that summarizes brand awareness of goods and services produced by the company. This brand capital will increase sales, through increasing customer loyalty, and understanding quality, thus becoming an important component of the company's market value.…”

Financial Development and Country-Level Advertising Spending: The Moderating Role of Economic Development and National Culture

“…For example, firms make advertising expenditures to build and maintain brand equity. Vitorino (2014) demonstrates that advertising expenditures operate as investments in brand capital using a structural investment model. To fund investments in tangible and market-based assets, firms often rely on external sources such as banks and equity markets.…”

“…Firms invest in brand equity through advertising. There is an extensive body of research, both conceptual and empirical, on advertising’s contribution to firm value through building and maintenance of brands (e.g., Srivastava, Shervani, and Fahey 1998; Vitorino 2014). Because investing in brand capital is important to the long-term survival and global success of firms, one would expect to observe similar advertising spending patterns across countries.…”

Inalienable Customer Capital, Corporate Liquidity, and Stock Returns

“…(2017), D'Acunto et al. (2018)), whereas only a few papers focus on the implications of product market characteristics for valuation and various corporate policies (e.g., Dumas (1989), Banerjee, Dasgupta, and Kim (2008), Larkin (2013), Belo, Lin, and Vitorino (2014), Gourio and Rudanko (2014), Vitorino (2014), Dou and Ji (2020), Dou, Ji, and Wu (2020a)). We depart from existing literature by investigating the financial implications of the ICC.…”