Impact of Advertisement on Firm Value in Indian Industry

INTRODUCTION: Advertisement is a strong tool to fulfill the urge of marketers to reach to a large number of people so that their product may receive optimum exposure. The role of this mass mode of communication in creating brand loyalty, deterring entry and consequently increasing sales revenue and profits of the organization has been emphasized at various points of time by different studies (Robinson, 1933; Kaldor, 1950; Nelson, 1974; Ozga, 1960; Stigler, 1961; Sundarsan, 2007). Empirical studies show that advertisements have an influence on the purchase behaviour of consumers. Marketers expect a return on the investment they make (on advertising). Their expectation stems from the likely impact, marketing investments have on the market performance and thus the profitability of the firm. The return may be in the form of increased profitability, sales and an increase in the firm value. While the effect of advertisement on sales and profitability have been researched in depth (Hanssens et al 2001; Gattignon 1993; Mantrala, 2002; Naik et al, 2007) there has been little effort to study the direct impact of advertisement on firm value. Moreover, these effects have been studied on the US consumers and markets. It therefore is imperative to study the impact of advertising spending on the profitability and firm value in case of Indian firms. With little research focusing on this aspect I concentrate my study towards this end.

REVIEW OF LITERATURE: There is increasing interest in the need to measure the impact of marketing activities on firm performance. Practitioners are increasingly under pressure to report their contribution to the overall firm performance. The inherent complexity in quantifying the marketing activities has often become a barrier in developing metrics for marketing measurement. The literature is mainly concentrated to examine the marketing research regarding the connection between advertising spending and the various surrogates of financial performance.

Marketing serves a number of business functions. Its prime objective is to change consumer behavior by product differentiation which helps overcome the competition and acts as barrier to entry (Bain, 1954). Firm value has been categorized as tangible and intangible value (Simon and Sullivan 1993). From the marketing point of view tangible assets include sales and profits and the impact of market instruments on these has been well researched for short run (Lodish et al.1995; Clarke, 1976; Leone and Schultz, 1980; Hassens, 1980; Assmus, Farley and Lehmann, 1984 and Sethuraman and Tellis, 1991) and long run (Nijs et al 2001, Semester et al 2008). In this competitive scenario a large part of the firm value may relate to its intangible assets such as brand equity (Chan, Lakonishok and Sougiannis, 2001). Intangible assets can be classified as (i) Market specific factors such as regulation; (ii) Firm specific factors such as R&D expenditure and trademarks, patents, etc; and (iii) Brand Equity (Simon and Sullivan, 1993).Till date most of the studies in Finance and Marketing Literature have established a relationship between firm value and factor (i) and (ii) while very few studies have paid an attention to the impact of advertising on firm value through the development of brand equity. The relation between market specific factors such as regulation is more relevant to policy literature hence is not taken into account in this thesis. Firm specific factors such as R & D and Patents have shown to have a positive impact on the firm value. Researchers have linked the firm value to R & D expenditure (Chan, Lokonishok and Sougiannis, 2001; Douker and Switzer, 1992).

The researches over the impact of advertising on sales have been conducted on short term basis. Although the results are mixed, one general indication is that the short impact of advertising on sales is positive (Lodish et al.1995; Clarke, 1976; leone and Schultz, 1980; Hassens, 1980; Assmus, Farley and Lehmann, 1984 and Sethuraman and Tellis, 1991). Some studies have found a negligible or no relation between advertising and sales (Beckwith, 1972; Hassens, 1980; Leone, 1983; Aaker et al, 1982; Basspilon, 1980; Tschoel and Yu, 1991). Jagpal (1981) while applying the multiproduct advertising sales model to a commercial bank finds that radio advertising was relatively ineffective in stimulating sales of the joint outputs (number of savings and checking accounts). Leong et al (1996) using cointegration technique, find a strong positive relationship between advertising expenditure and sales. Lee et al (1996) find that the variables of advertising

and sales are not only integrated of same order but also cointegrated. The results explicated that causal relationship between advertising expenses and sales works in both directions. Leach and Reekie (1996) analyse the effect of advertising on the market share of a brand using variants of the Koyack Distributed Lag model. Further, the results of the Granger causality test show that advertising expenses caused sales but sales do not simultaneously cause advertising. Elliot (2001) reveal that advertising has a significant positive effect on food industry sales and this relationship between advertising expenditure and sales appears to be stable. Pagan et al (2001) studied the effectiveness of advertising on sales using bivariate Vector Auto Regression model and showed that one time increase in advertising expenditure leads to increase in the sales of orange with a one month lag. It was also found that the impact of advertising expenditure on grape fruit sales is more immediate and relatively large. While analysing the relationship between a companys advertising expenditure and its sales during the recession, Kamber (2002) finds a measurable relationship between advertising expenditure and sales, even after controlling other factors, such as, company size and past sales growth, etc. By and large, the literature suggests that advertising plays a role in maintaining a level of brand equity. Certain marketing literature also talked about wear-in and wear-out effect of advertising which was introduced by Henderson and Blair (1988), which can be defined as different rise and decay rates in sales with response to advertising. Advertising can effectively be used to drive long term returns and this investment can potentially be realized in long term profitability of the company (Aaker and Jacobson, 1994). Hence if long term profitability is the major objective of advertising then it needs to be measured and justified in relation to both short term and long term sales and profitability. Short term market response models have been used (Lambin, 1969) and the more recent literature has been aware of long term dynamics and time series analysis has been applied to capture these. This view is also supported by Day and Fahey (1988) who states that adopters of value based planning approaches view a companys primary obligation as concentrating on maximizing the returns from capital. Optimal long term allocation of marketing resources is the beginning to gather interest among academics and practitioners and this is strongly reflected by Dekimpe and Hanssens (1999). These attitudes are not always shared by market Academics who argue that maximization of profits is one of the economics most unrealistic assumptions

(Anderson, 1982). Researchers found out that true accountability comes from linking marketing activities to bottom line (Goring, 1994). Profitability as a measure of performance has been widely researched in Finance, Economics and Marketing literature (Jones, 1990; Hanssens et al, 1990; Sethuraman and Tellis, 1991; Dekimpe and Hanssens, 1995; Rositer and Percy 1997). A number of studies try to study the relationship between various types of marketing expenditure and profits making use of Profit impact marketing study (PIMS) data set (Buzzell 1981, 1985, Schoeffler 1974, Balasubramaniam 1990). The gearing effect of large brand advertising was examined by Jones (1990) and it was concluded that a rise or drop in advertising exerted a greater proportional effect on profits for firms with higher brand power. However, the results were complicated by the fact that the relationship between advertisement and profitability has lagged impacts. This is because a decrease in advertising expenditure increased profits in the current period, but decrease them in the long run if the support has been taken away from the brand .The opposite can be true for increased advertising when the effect in the current period may be decreased profits, but in the long run profits may actually increase because of the increased investment in the brand. Dekimpe and Hanssens (1995a) by applying time series technique such as vector error correction modeling (VECM) find that although advertising had a positive net sales effect, it did not have a long run impact on profits. Jedidi, Mela and gupta (1999) modeled the long term profitability of advertising using the gross margin approach and finds out that a 5% increase in advertising had a small impact on profits.

Recent Theoretical approaches in marketing have advocated the integration of marketing activity more directly with shareholder equity. Doyle (2000) refers to this as Value based marketing. However, the research in this area is limited. Although there is strong interest of the academicians as well as marketers in marketing-finance interface and research is beginning to filter through. Stock markets react favourably to increase in discretionary marketing expenditure (Erikson and Jacobson, 1992). Connolly and Hirschey (1984) indicate that increased advertising has a large positive and statistically significant effect on increasing the spread between the market and book value of assets. Joshi and Hanssens (2002) find that advertising has a positive and persistent impact on market valuation and the effect exists above and beyond the advertising

impact on customer response. The study of Alexander and Sudharshan (2002) questions whether the relationship between marketing and financial performance is linear and it is concluded that there is indeed a curvilinear relationship and determining optimum strategies will vary according to the firms resources, industry and management. Graham and Frankenberger (2000) examined the asset value of advertising expenditures of 320 firms with reported advertising expenditure for each of the 10 consecutive years ending in 1994, to determine the "effect of advertising expenditures on the financial performance by measuring the contribution made by year-to-year differences in advertising expenditures to the asset values and subsequent market values of publicly traded firms." Their results indicate a significant relationship between advertising asset value and the firm's earnings. Also, the regressions show a statistically significant relation between firm market value and advertising asset value.

The review of literature provides an overview of empirical research literature that concentrates on advertising expenditure having an impact on the market value of the firm. The literature survey is also focused on impact of advertising on sales revenue and profits. In general the results show that the advertising has positive impact on the sales revenue of the firm but the impact studied is on short term basis. There is limited research on the impact of advertising on sales in the long run so this is still open for research. Further, effects of advertising on sales have been researched in depth but there has been little effort to study the direct impact of advertising on firm value so this also motivates me to investigate the impact of advertising spending on firm value above and beyond its effect on sales revenue and profits.

Objectives of the STUDY

To study the impact of Adevertisement on the market value of the firm. To observe whether increase in advertising expenditure leads to increase in long run sales revenue and long run profitability.

To comparatively analyse the resultant change in long run sales revenue and long run profitability due to change in advertising expenditure.

To find out the implication for marketers from the firm value effect of advertising. To understand the difference across the industry understudy with respect to the impact of advertising expenditure on firm value.

HYPOTHESES 1) Customer Response Effects Prior Research on short term effects of advertising on sales provides an empirical generalization that the short term elasticity on own brand sales is positive but low ( Leone and Schultz 1980 ) .This generalization is supported in the literature survey of Aaker and Carman (1982) and by meta analysis of Assmus,Farley and Lehmann (1984).On the other hand ,Advertising elasticities have been shown to be higher for new products (Parsons 1975).Hence we propose the first Hypothesis:

Null Hypothesis one H01= Advertisement has no impact on the long run sales revenue of the firm

As mostly reported in the research that the financial links mostly assurmed is sales but srivastava ,shervani and fahey (1998) extended the debate by proposing a cash flow model to assess the increase in shareholder value .However the research on cashflow impact is very limited so the further extension includes the analysis of advertising on profits .This inclusion of this performance variable along with sales is important because advertising expenditure that increase sales may after taking into account all the costs proves to be negative investment of

scarce firm resources (schoeffler,Buzell and Heany 1974,Jacobson 1988b,Dekimpe and Hanssens 1999)..Research using long term profiotibliity modeling has been limited (Dekimpe and Hanssens 1999)with most research finding a positive short term relationship (Aaker and Jacobson 1994)and negative long term relationship (Dekimpe and hassens 1999) between advertising and profits. Some of the authors have indicated that that there is no relationship between advertising and profits (Sherman and tollison1971,Dekimpe and Hassens 1995a) Advertising can effectively be used to drive long term retrurns and this investment can potentially be realized in long term profitability of the company (Aaker and Jacobson 1994).Hence if long term profitability is the major objective of advertising than it needs to be measured and justified in relation to both short term and long term sales and profitability. Hence we propose the second hypothesis: Null Hypothesis Two H02: Change in advertising expenditure has no impact on the long term profitability of the firm H03:There is no change with respect to intensity of firm value effect of advertising across the industry

INVESTOR RESPONSE EFFECTS Advertising seeks to differentiate a firms products from those of its competitors thereby creating brand equity for its products (Aaker 1991) .Heath and tversky (1990) finds that individuals prefer to bet and invest in those areas where they feel confident and have knowledge about uncertainities involved as compared to more ambigious areas.so the investors prefer to invest in the stocks for which the flow of public information is higher .we would expect that heavily advertised stocks are more attractive investment options(Maclnnis and jaworski 1989).Advertising can also act as signal of financial well being or competitive viability of firm. Mathur et al ( 1997) studied on stock marketss reaction to the celebrity endorsement effect on firm valuation .In a syudy of impact of environmental friendliness on firm value ,Gifford (1997) found that merely establishing a proenviornment practice was insufficient ,and the firm has to advertise this fact to the investment community before it translated into increased financial

returns .Rust ,Lemon and Zeithmal (2001) relate advertising expenditure to customer lifetime value and argue that higher advertising can increase CLV through the improvement in brand equity.While the studies provide the evidence may have a direct and positive effect on market value of the firm ,but the possible magnitude is not known..In the short run advertising will likely to work through indirect route i.e increase in the firm value through the increase in sales and profits .The direct effect is expected to appear only in the long run ,when advertising succeeds in differentiating a firms products in the minds of consumers and investors.Based on the argument above we prospose H04: Advertising Expenditure has no long run effect on the value of the firm. RESEARCH METHODOLOGY The Research framework is constructed to examine the impact of advertisement on the market value of the firm. SAMPLE Ten companies from each of the CNX IT Index, CNX Bank Index, CNX FMCG Index, CNX PSE Index, CNX MNC Index, CNX Energy Index, CNX Pharma Index, CNX Infrastructure Index, CNX Reality Index, and CNX Midcap Index will taken as sample. The selection of ten companies from within the index will be done on the basis of the market capitalization. The companies that feature in more than one of the above indices will only be taken under one index and ignored for the other one in order to avoid repetition. DATA COLLECTION The data for the study will be obtained from Annual reports of the companies. The sample size for 100 companies for a period of 10 years (2000-2010) will be taken. The variables which will be included in the data collection will be sales, advertisement expenses, PAT, Asset value of the firm (as a proxy for the size of the firm) and D/E ratio (proxy for capital structure)

DATA ANALYSIS

1. For the attainment of research objectives, we shall use appropriate methods of Data

Analysis. For the purpose of the establishment of dependency among the independent variable (Advertising expenditure) and the dependent variables (Sales, Profits and Firm Value), we shall be applying the Regression function. Regression is suited for the data analysis where we have to find out the dependency rather than just the relationship. In order to further come to the conclusions regarding the impact of advertising expenditure on firm value, panel co-integration method shall be used. This method is best suited to the panel data. The data, spread over various years and various industries in the case of research in hand happens to be a panel data and hence application of Panel Co-integration seems to be the best suited for the purpose. However, we shall be taking it with one year lag for the advertising variable in order to avoid endogenous problem. Thirdly, Tobins Q measure will be applied to find out the direct long term impact of advertisement on the firm value beyond the sales and profitability.