Advertising, R&D Expenditures and the Market Value of the Firm

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This paper provides evidence that advertising and research and development (R&D) expenditures have large, positive and consistent influences on the market value of the firm. Like information on current cash flows, data on advertising and R&D spending appear to help investors form appropriate expectations concerning the size and variability of future cash flows. As a result, spending on advertising and R&D can be viewed as a form of investment in intangible assets with predictably positive effects on future cash flows.

While the significant market value effects of advertising and R&D are generally apparent for all COMPUSTAT firms, such aggregate evidence has the potential to obscure meaningful differences across firm size classes and industry groups. Consistent with the fact that only a handful of firms are responsible for substantial advertising and R&D spending, the valuation effects of advertising and R&D are most uniformly evident in the case of large firms. In fact, the valuation effects of advertising and R&D are typically greater for larger as opposed to smaller firms in both manufacturing and nonmanufacturing sectors. These findings suggest that size advantages make advertising and R&D relatively more profitable for larger firms. Nevertheless, smaller firms do not appear to be precluded from making profitable investments in advertising and R&D. Some evidence emerges to suggest that the well-targeted advertising and R&D efforts of the smallest firms in the economy can be highly profitable. I. Investment Aspects of Advertising and R&D Expenditures

An emerging body of research considers the market value effects of a wide range of corporate investment decisions. McConnell and Muscarella |15~, for example, find that unanticipated increases in planned capital expenditures have a positive effect on the market value of the firm and that unanticipated decreases have a negative impact. Statman and Sepe |20~ report a correspondingly positive market reaction to the termination of investment projects that have poor prospects, while Brickley and Van Drunen |4~ find a negative reaction to operating unit liquidations. Blackwell, Marr, and Spivey |2~ find a significantly negative stock market reaction to plant-closing announcements. Chan, Martin, and Kensinger |5~ and Doukas and Switzer |7~ report interesting evidence on the stock market reaction to a very specific type of corporate investment decision: announcements of increased R&D spending. Chan, Martin, and Kensinger |5~ and Doukas and Switzer |7~ find statistically significant R&D announcement day returns, especially in the case of large "high-tech" industrial firms that devote substantial resources to R&D. The positive share-price reaction to announcements of increased R&D spending discovered in these studies can be taken as evidence of a strong link between R&D spending and the market value of the firm, a link that is especially robust in the case of large firms. To further investigate this relation, our paper considers the cross-sectional influences of both advertising and R&D expenditures on the market value of the firm. This paper considers how the traditionally recognized valuation effects of current cash flow, growth, risk and market share are augmented when both advertising and R&D are considered as potentially important sources of intangible capital. To the extent that advertising and R&D expenditures represent a type of investment expenditure that gives rise to economic benefits lasting more than one year, a market value influence can be anticipated. Of course, current cash flows may also reflect, at least in part, the positive effects of previous investments in advertising and R&D. Once the valuation effects attributable to current cash flows are controlled, any incremental valuation effects of current advertising and R&D expenditures represent evidence of intangible capital or asset-like influences. …