The Contribution of Changes in Advertising Expenditures to Earnings and Market Values

We examine the asset value of advertising expenditures for a sample of takes the form of future cash flows, which derive from future sales. Future sales are influenced by advertising expenditures, 320 firms with reported advertising expenditures for each of the 10 consecutive years ending in 1994. We find that, depending upon the which alter customer preferences for particular products or vendors. Evidence for the asset value of advertising expendiindustry, changes in advertising expenditures are significantly associated with earnings up to five years following the year of the expenditure. tures is mixed. While some studies support the notion of advertising asset value (e.g., Peles, 1970; Hirschey, and WeyFurthermore, the asset values are significantly associated with the market values of the firms. Across all industries, the asset value of advertising gandt, 1985; Green, Barclay and Ryan, 1995; Chauvin and Hirschey, 1993; Lev and Sougiannis, 1996), others do not expenditures appears to have a 3-year life with the greatest value on the current year and declining value in subsequent years. Asset values are (e.g., Bublitz and Ettredge, 1989; Erickson and Jacobson, 1992; Aaker and Jacobson, 1994). None of the studies directly found to be longest lived in the consumer products and industrial products industries and shortest lived in the sales and services industry. J BUSN RES measures the future effect of advertising expenditures. Our first goal therefore is to extend prior research by establishing 2000. 50.149–155.  2000 Elsevier Science Inc. All rights reserved. a link between advertising expenditures and future earnings. Connecting current-year advertising expenditures with future earnings provides a reasonable estimate of the asset value of advertising expenditures. The relation between asset and Advertising is one of the most visible and least understood market value is well established (Ball and Brown, 1968), and of a firm’s marketing expenditures. Budgets over $60 a connection should exist between items contributing to asset billion were allocated to advertising media by the top value—in our case advertising expenditures—and market 200 consumer products advertisers in 1995. In that same value. Therefore, our second goal is to examine whether adveryear, Proctor & Gamble alone spent $2.7 billion on advertising tising assets, as derived from the association between advertisLeading National Advertisers, 1996), and business-to-business ing expenditures and future earnings, are associated with firm advertising exceeded $11 billion for the category (Kosek, value. 1996). Firms that allocate large amounts of their resources to This article makes four contributions to the literature on advertising expect their expenditures to contribute, ultimately, the asset value of advertising expenditures. First, it looks at to the financial performance of the firm. In this study, we multiperiod rather than single-period effects of advertising. examine the effect of advertising expenditures on financial Studies in our review used single-period advertising models, performance by measuring the contribution made by year-towhich limit generalizability of their results. The second contriyear differences in advertising expenditures to the asset values bution is derived from the first; by using a multiperiod model, and subsequent market values of publicly traded firms. Relawe can estimate asset value directly from future earnings rather tions among advertising and financial performance are investithan infer it from the size of single-period coefficients relating gated over time and across industries. advertising and market value. Third, we avoid a logical inconFor advertising expenditures to have asset value, they must sistency that arises when advertising asset value is implied from result in an expected future benefit to the firm. The benefit its relation with market value in a single regression model. Because market prices are determined largely by reported Address correspondence to Roger C. Graham, Jr., Oregon State University, financial variables, it is circular to suggest that those same College of Business, Department of Accounting, Finance, and Information Systems, Corvallis, Oregon 97331. variables are derived from market values. Fourth, this study