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C a p i ta l M a r k e t Im p a c t o f P r o d u c t
M a r k e tin g S t ra te g y E v i d e n c e F ro m
the R e la t ionsh ip B etw een dver t i sing
Expenses and Cost o f Cap i ta l
M a n o h a r S i n gh
Willamette University
Sheri Faircloth
l i Ne jad malayer i
University of Nevada at Reno
To analyze the prospec t of a irm s advertising decision af-
fec tin g shareholder wealth, this article investigates the re-
lationship betwe en a firm s advertising expenditure and
the marke t-impo sed w eighted average cost of capital. For
a samp le o f U.S.firms, the results show that advertising ex-
penditure is negatively related to the cos t of equity and
positively related to debt utilization, resulting in a lower
weig hted average cost of capitaL A higher debt level, how-
ever, associates with a low er level of in ancial strength. In
addition, and plausibly by lowering the cost of capital
through product m arket advertising, firm s w ith higher ad-
vertising expenditure experience higher performanc e in
ternts o f nmrk et value added.
Keywords: advertising; co st of capital; capital and prod-
uct markets; capital structure; performance
P a u l A n d e r s o n ' s ( 1 9 7 9 ) o b s e r v a ti o n t h a t t o o o f t e n
m a r k e t i n g t e n d s t o f o c u s o n s a le s g r o w t h . . , i t f a il s to r e c -
o g n i z e t h e i m p a c t o f m a r k e t i n g d e c is i o n s o n . . . f i n a n c in g
c o s t , d e b t - t o - e q u i t y r a t io s , a n d s t o c k p r i c e s h o l d s t r u e i n
Journal of the Acade my o f Marketing Science.
Volume 33 , No. 4 , pages 432 ~ .
DOI: 10.1177/0092070305277380
Copyright 9 2005 by Academ y. of Marketing Science.
t h a t t h e m a r k e t i n g d i s c i p l i n e r e s e a r c h h a s t r a d i t i o n a l l y
f o c u s e d o n i d e n t i f y i n g d r i v e r s o f s u c c e s s i n t h e p r o d u c t
m a r k e t , d e f i n e d i n te r m s o f s a l e s r e v e n u e , p r o f i t m a r g i n s ,
a n d m a r k e t s h a r e . T h e m o r e r e c e n t t r en d , h o w e v e r , i n d i-
c a t e s a s h i f t i n e v a l u a t i n g t h e i m p a c t o f m a r k e t i n g s t r a t e -
g i e s o n i m p r o v i n g m a r k e t v a l u e a n d s t o c k p r i c e ( J o sh i a n d
H a n s s e n s 2 0 0 4 ; S r i v a s t a v a , S h e r v a n i , a n d F a h e y 1 9 9 8 ) .
I t i s la r g e l y a c c e p t e d t h a t a d v e r t i s i n g i s a m e a n s o f c r e -
a t in g m a r k e t - b a s e d a s s e t s , w h i c h c o n t r i b u t e s p o s i t i v e l y t o
s h a r e h o l d e r w e a l t h . A d v e r t i s i n g p r o m o t e s b r a n d e q u i t y ,
w h i c h i n t u r n g e n e r a t e s f i n a n c ia l v a l u e t h r o u g h e n h a n c e d
c a s h f l o w s a t t r ib u t a b l e t o c u s t o m e r l o y a l t y , i n c r e a s e d m a r -
k e t i n g e f f i c i e n c y , b r a n d e x t e n s i o n s , a n d h i g h e r m a r g i n s
( K e l l e r 2 0 0 2 ) . T h e s o u r c e s o f s u c h a d v e r t i s i n g - r e l a t e d
c a s h f l o w a u g m e n t a t i o n s a r e t r a c e d t o p r i c e p r e m i u m s
( F a r q u h a r 1 9 8 9 ) a n d c a p t u r i n g g r e a t e r m a r k e t s h a r e
( B o u l d i n g , L e e , a n d S t a e l i n 1 9 9 4 ) . I n a d d i t i o n , c o r p o r a t e
b r a n d i n g s t r a t e g y , i n c o n t r a s t t o a m i x e d b r a n d i n g s t r a t e g y ,
i s p o s i t i v e l y r e l a t e d t o c o r p o r a t e v a l u e i n t e r m s o f T o b i n ' s
q ( R a o , A g a r w a l , a n d D a h l h o f f 2 0 0 4 ) . P r e v i o u s e m p i r i c a l
s t u d i e s w i t h i n t h e m a r k e t i n g l i t e r a t u r e s u g g e s t th a t
c h a n g e s i n m a r k e t in g e x p e n d i t u r e s a r e r e l a te d t o c h a n g e s
i n s t o c k p r i c e s ( C h e n g a n d C h e n 1 9 9 7 ) i n p a r t i c u la r , a n d
t h e r e i s a r e l a t i o n s h i p b e t w e e n m a r k e t i n g s t r a t e g i e s a n d
f i n a n c i a l v a l u e ( C h a u v i n a n d H i r s c h e y 1 9 9 3 ) . M o r e
r e c e n t l y , J o s h i a n d H a n s s e n s ( 2 0 0 4 ) s u g g e s t e d t h a t a d v e r -
t i s i n g h a s a p o s i t i v e , l o n g - r u n i m p a c t o n a f i r m ' s m a r k e t
v a l u e .
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Singh et al. / ADVERTISINGAND COST OF CAPITAL 433
Surprisingly, it seem s that the research to date has looked
at advert is ing ' s pos i t ive value contribut ion to shareholder
wea l th th rough cash f low enhancem ents on ly , and the re
has been l i t t le effort to s tudy the direct im pact of advert is -
ing on s tock price (Joshi and Hanssens 2004). Brand
famil iari ty and perceived bran d qu al i ty in produc t markets
migh t spi ll over to the capi ta l markets where inves tors m ay
e leva te dem and for the s tock of f i rm s wi th e s tab l i shed
brands . In fact , recent evidence sugges ts that inves tors
favor s tocks wi th h ighe r p roduc t m arke t exposure , and
higher adv ert is ing expenditure leads to increases in t rad-
ing vo lum e and num ber o f sha reho lde rs (F r iede r and
S u b r a h m a n y a m 2 0 0 1 ; G r u l l o n , K a n a t a s , a n d W e s t o n
2004). Thus , f rom the ma rket m icros tructure perspective ,
highe r advert is ing expenditure is expected to increase the
bread th o f ow nersh ip and im prove l iqu id ity , the reby low-
e r ing the cos t o f equ i ty and im prov ing f i rm va lue. Th i s
l ine of research, however, is s t i l l in i ts infancy. More
im por tan t, the im pac t on d eb t ho lde rs has no t been exp lor -
ed . Excep t fo r few recen t works such a s Day and F ahey
(1988), l inking advert is ing exp enditure to corporate cos t
of capi ta l and i ts determ inants remains largely unexplored
territory. Furtherm ore, the e xis t ing l i tera ture has not con-
s idered corpora te value as a funct io n of two dis t inct vari-
ables condit ioned by advert is ing expenditure: cash f low
augm enta t ion and a f i rm ' s we igh ted ave rage cos t o f cap i t a l
(WACC).
The a im o f this art ic le is to f i l l this gap in research by
using a unique datab ase to analyze the impact of advert is -
ing prom otion s tra tegies on a f i rm's overal l cos t of capi ta l .
In addi t ion, we explo re the impa ct of advert is ing s tra tegy
on the drivers of a f i rm 's cos t of capi ta l , namely, corporate
capi ta l s t ructure (deb t-to-asset ra tio), equi ty r isk (mark et
beta) , and f i rm financ ial s t rength (A ltma n' s Z-score) . 2
Our f ind ings sugges t tha t h ighe r adve r t i s ing ou t lays
associate with a lower WACC. In addi t ion, advert is ing
seems to be re la ted to high er debt capaci ty and ut i l izat ion.
In terms o f the drivers of the cos t of capi ta l , as influenced
by advert is ing expenditure , the resul ts indicate that for
fi rms with greater ad vert is ing expense, the cos t of equi ty is
lower ( in terms of beta) and that Altman' s Z-score is ad-
versely influenc ed. F inal ly, the resul ts sugges t that higher
advert is ing contributes s ignif ica nt ly to market-based per-
fo rm ance in t e rm s o f the m arke t va lue added (MVA).
The remainder of this art ic le is organized as fol lows.
The fo l lowin g sect ion provides a theoret ical and empirical
f ram ework wi th in which the i s sue i s cons ide red , a long
wi th in form a t ion on hypothes i s deve lopm ent and the
descript ion of mod els re la t ing advert is ing expenditure to a
fi rm's cos t of cap i ta l and the o ther tes t variables . T he sub-
sequent sect ion describes the data col lect ion and method -
ology and p resents a descript ion o f the sample . F inal ly, we
present the resul ts and offer conc lus ions of the s tudy.
L IT E R A T U R E R E V IE W
A d v e r t i s in g C a s h F l o w A u g m e n t a t io n
a n d A c c e l e r a t io n
Marke t ing expenses a re a im ed a t c rea t ing cus tom er
loyal ty, high m argins , brand extens ion, l icens ing opportu-
ni t ies , and increas ing revenue generat ion eff ic iency. In
addit ion, adve rt is ing expenditures are jus t i f ied in terms of
their contribut ion to creat ing brand equity (Aaker 1991).
Grea te r adve r t i sing in tensi ty , by c rea t ing b rand loya l ty
and brand a s soc ia tion , has been a rgued to gene ra te fu tu re
cash f low and hence sha reho lde r va lue (Aaker and J acob-
son 1994). W ithin this perspect ive , Rao et a l . (2004) sug-
ges ted that corporate branding s tra tegy associates pos i-
t ively with Tobin ' s q. Their resul ts are consis tent with
other research in the brand assets l i tera ture (Barth e t a l .
1998; Ka l lapur and Kwan 2004) . Miz ik and J acobson
(2003) reported that the s tock market pos i t ively rewards
f i rm s when they inc rease the i r em phas i s on va lue appro-
pria t ion through advert is ing s tra tegies des igned to create
competi t ive barriers , es tabl ish cus tomer loyal ty, improve
m arg ins , and enhance b rand equ i ty .
Acc ordin g to Srivas tava e t a l . (1998), advert is ing can
create m arket-b ased assets that ma y accelerate the timeli-
nes s o f cash f low occur rence , the reby im proving ove ra l l
sha reho lde r va lue . The au thors p rov ide a sum m ary of
channe l s th rough which adve r t i s ing can add to sha re -
hold er value by creat ing marke t-based assets: lowe r cos ts
of sa les and services to cus tome rs , secure price premium s
through c rea t ion o f pe rce ived va lue iden t i f i ed wi th b rand
equity, and create competi t ive barriers , thereby enhanc ing
and s tab i l i z ing cash f lows and gene ra t ing syne rg ie s
am on g as se t s w i th in a f i rm to im prove produc t iv i ty tha t
m ay prov ide fu r the r com pe t i t ive advan tages .
The d ebate , how ever, is far from being con clus ive. For
exam ple, Pauwels , S i lva-Risso, Srinivasan, and Han ssens
(2004) ana lyze d the different ia l impa ct on a f i rm 's value
for two dis t inct mark et ing s tra tegies : advert is ing expendi-
tu re and new produc t in t roduc t ions . The i r f ind ings sugges t
that a l thou gh both s tra tegies pos i t ively affect sa les reve-
nue in the shor t and long run , on ly the s t ra tegy of new
produc t in t roduc t ions has a s ign i f i can t and pos i t ive long-
te rm im pac t on sha reho lde rs ' wea l th . In fac t , accord ing to
the au thors , m arke t ing p rom ot ions have a long- te rm m ar-
ke t pe r form a nce im p ac t tha t i s no t on ly nega t ive bu t a lso
m o r e t h a n o f f s e t s i t s s h o r t - t e r m b e n e f i t . S i m i l a r l y ,
Kopa l le , Me la , and M arsh (1999) a rgued tha t adve r t i s ing
prom ot ions ' im pac t on s t im ula t ing long- te rm growth and
prof i t ab i l ity m ay be doubt fu l . Thus , a pure adve r t is ing-
in tensive m arke t ing approach m ay no t a lways con t r ibu te
to corporate value; however, in contras t to new product
in t roduc t ions , adve r t i s ing p rom ot ions m ay e f fec t ive ly
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434 JOURNALOF THE ACADEMYOF MARKETINGSCIENCE FALL2005
aug me nt product deman d witho ut incurr ing the risks asso-
cia ted with ne w products (Blat tberg and Nesl in 1990) .
Adv e r t i s ing Ca s h F l ow S t ab il it y
a nd Cos t o f Ca p i t a l
In the f ina nce l i tera ture , the va lue of a corporat ion is
de f ined a s the sum of the p r esen t va lue o f a l l the cash f lows
to the fu-m, wh ich is equiva lent to discounting future cash
f lows based on their level of r isk. Although research in
m ar ke t ing has exp lor ed the l ink be tween adver t i s ing
expendi tu r e and a f i r m ' s cash f low, i t has no t ana lyzed the
imp act of adver t is ing on the r iskiness of the cash f lows that
direct ly determin es corporate cos t of capi ta l (WACC).
Adver t i s ing m ay h ave a dua l im pac t on a f u ' m 's cos t o f
capita l . In i ts f i r s t man ifes ta t ion, adver t is ing ma y ass is t in
r educ ing a f i r m ' s cos t o f f inanc ing by r educ ing cash f low
var iabi l i ty as suppliers of the capi ta l iden tify reduced cash
f low var iabi l i ty with lower r isk. In addit ion, adver t is ing
m a y in f luence inves to r behav ior in t e r m s o f the pe r ceived
r iskiness of a f i rm 's s tocks and bonds . Specif ically, prod-
uct mark et adver t is ing m ay have a posi t ive spi l lover ef fect
on inves tors in f inancial markets . Corporate adver t is ing
increases vis ibi l i ty and famil iar i ty amon g inves tors, creat-
ing a hom e-bia s scenar io, in that , other factors being the
same, inves tors are mo re w il l ing to lend and/or inves t in
the equ ity of f i rms that the y are famil iar with.
A d v e r t is i n g a n d F u n d a m e n t a l R i s k R e d u c t i o n
Accor d ing to Ander son , F or ne l l , and Mazvancher y l
( 2004), cus tom er s a t i sf ac t ion no t o n ly he lps to g r ow the
cus tom er base an d enhan ce f u tu r e cash f lows th r ough cus -
tomer re tent ion; i t a lso reduces the cash f low var iabi l i ty
and, hence , associates with low er corporate risk. The com -
bined im pac t o f g r ea te r cus tom er s a t i sf ac tion i s g r ea ter
corporate v alue. S imilar ly, by helping f i rm s increase their
sales revenue and mark et share and faci l i ta t ing introduc-
t ion of new pr oduc ts , adve r t is ing m ay augm en t the i r cash
f lows. In addit ion, adver t is ing may create and sus ta in
pr oduc t dem and , the r eby r educ ing the s ens i t iv i ty o f a
f trm's sa les to external shocks . Th e resul t ing revenue s ta-
b i l i ty m ay be s een a s r i sk r educ t ion in t e r m s of r educed
cash f low var iabi l i ty . S trong brands can a lso reduce a
f i r m ' s vu lne r ab i l i ty to com pe t i t ion , the r eby r educ ing the
r isk of the future cash f lows (Rao et a l . 2004).
Wi th in th i s f r am ewor k of adve r t i s ing im pr oving the
f i r m ' s f u n d a m e n t a l s a n d c o n s e q u e n t r i s k r e d u c t i o n ,
Sr ivas tava e t a l . (1998) argued that adver t is ing generates
sha r eho lde r w ea l th by enh anc ing and s tab il i z ing a f i r m ' s
f u tur e cash f lows . Accor d ing to the au thor s , h ighe r
degr ees o f cus tom er s a t i s f ac tion , loya l ty , and r e ten tion
help redu ce the v ar iabi l i ty of a f i rm's cash f lows as i ts sus-
ceptibi l i ty to competi t ive or other market-based external
shocks decl ines . In addit ion to the direct contr ibut ion to
sales revenue s tabi l i ty , adver t is ing can actual ly promote
s tab i li ty in a f i r m ' s ope r a t ions by s t r eng then ing cus tom er
and par tnership channels . The autho rs s tress that i t is
im por tan t to r ecognize tha t sus ta ined , long te r m cus to m er
loyal ty resul ts in more s table business an d therefore a
lower cos t o f capi ta l .
I m p a c t o f A d v e r t i s i n g o n
I n v e s to r P e r c e p t io n a n d B e h a v i o r
Huber m an ( 2001) sugges ted tha t inves to rs ' fam i l i a r i ty
wi th a co m pa ny pos i t ive ly in f luences the i r dec i sions to
buy s tock in tha t com p any . I n th i s f r am ewor k , i f adve r ti s -
ing c r ea te s p r oduc t m ar ke t v i s ib i l i ty , then we should
expect that , other factors being the same, inves tors are
m or e l ike ly to buy s tock of com panies w i th h ighe r in ten-
s i ty of adver t is ing act ivi ty. According to Grullon e t a l .
(2004) , the adver t is ing exposure consequ ent increased
br ead th o f owner sh ip and l iqu id i ty m ay he lp r educe a
f i r m ' s cos t o f equ i ty cap i ta l . I n add i t ion , com panies tha t
have h ighe r v i s ib i l i ty in the p r oduc t m ar ke t have gr ea te r
s tock m ar ke t l iqu id i ty in t e rm s o f a low er b id - ask spr ead ,
gr ea te r dep th , and sm a l le r p rice im pac ts . One can a r gue
tha t h ighe r b r ead th o f equ i ty own er sh ip and gr ea te r l iqu id-
i ty would m ani f e s t i t s e l f in lower ove r a l l cos t o f equ i ty
capita l .
Several s tudies in f inance suggest the exis tence of
inves tor bias , where inves tors buy s tock that they are
famil iar with. For example, internat ional cross l is t ing by
f or e ign fi r m s on the New York S tock Ex change inc r eases
vis ibi l i ty to U.S . inves tors and is associated w ith a reduced
b i d - a s k s p r e a d a n d h i g h e r l i q u i d i t y ( K a d l e c a n d
McConne l l 1994) . S im i la r ly , accor d ing to F r ench and
Poterb a ' s (1991) resul ts , inves tors seem to favor dom estic
com pany s tocks ove r s im i la r ly p laced f o r e ign s tocks .
Ther e have a l so been s tud ies ( Am ihud , M ende ls son , and
Laute r bach 1997; Br ennan , Chor d ia , and S ubr ahm anyam
1998) tha t sugges t s tock m ar ke t l iqu id i ty i s a s soc ia ted
wi th a low er cos t o f equ i ty .
F ina l ly , F r iede r and S ubr ahm anyam ( 2001) p r oposed a
theor e t ica l m ode l and conc luded tha t inves to r s p r e f e r
ho ld ing s tocks wi th h igh r ecogni t ion and consequent ly ,
gre ter
in f or m a t ion pr ec i s ion and sm a l le r pa r am ete r e s t i -
m a t ion r i sk I n the s am e f a sh ion , Mer ton ( 1987) and
Klein and Baw a (1976, 1977) sugg ested that inves tors pre-
f e r to buy secur i t i e s tha t have h ighe r r ecogni t ion and low er
in f or m a t ion a sym m et r ie s . Thus , i t can be a r gued tha t
increased adv er t is ing by a f i rm causes increased famil iar -
i ty and, hence, inves tor preference to hold that f i rm's s tock.
H Y P O T H E S ES D E V E L O P M E N T
Althou gh r e sea r ch in the m ar ke t ing a r ea has a t r ad i t ion
of l ink ing adver t i s ing in tens i ty to cor por a te va lue th r ough
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Singh et al. / ADVERTISINGAND COST OF CAPITAL 435
an i nc r ease i n s a l e s r evenue g r owt h and mar ke t sha r e
gr owt h , t he l i nk be t we en adve r t i s i ng- re l a t ed v i s ib i l i ty and
cos t o f cap i ta l has no t been exp l o r ed . T h i s a r t i c le cons t i -
t u t e s t he f i r s t - known a t t empt a t r e l a t i ng a f i r m s ove r a l l
cos t o f cap i t a l to p r od uc t mar ke t v i s i b i li t y and degr ee o f
i nves t o r f ami l i a r it y w i t h t ha t f i r m, p r ox i ed by adve r t i s i ng
expend i t u r e . W e s t a te our f o r m a l hypo t heses a s f o l l ows .
T e s t a b l e H y p o t h e s e s
Cost of Equity
( a . ) Bu i l d i ng on r e sea r ch i n i t i a t ed by H uber m an ( 2001 )
a n d r e s u l t s p r o v i d e d b y F r i e d e r a n d S u b r a h m a n y a m
( 2 0 0 1 ) a n d G r u l l o n e t a l . ( 2 0 0 4) , w e h y p o t h e s i z e t h a t
p r odu c t ma r ke t adve r t i s i ng w i l l r e su l t in i nc r eased v i s i b i l-
i t y among cus t omer s and p r ospec t i ve i nves t o r s who wi l l
be a t t r ac t ed t o t he s t ocks o f f ir ms wi t h e s t ab l i shed b r and
names . T he r e su l t i ng i nc r ease i n l i qu i d i t y , b r ead t h , and
dep t h o f the mar ke t f o r t hose f i rms s t ock is expec t ed t o
r educ e t he cos t o f equ i t y .
( b . ) Based on t he f r amewor ks p r ov i ded by S r i vas t ava
e t a l . (1998) a nd R ao e t a l. ( 2004) , we hy po t hes i ze t ha t ad -
ve r t i s ing m ay r ed uce t he va r i ab i li t y o f comp any cash
f l ows t h r ough m or e p r ed i c t ab l e consum er behav i o r , s t ab l e
p a r t n e r c h a n n e l s , a n d r e d u c e d o p e r a t i o n s v a r i a b i l i t y ,
t he r eby l ow er i ng cos t o f equ i t y . T he r e f o r e , our f i r s t hyp o-
thes i s i s as fol lows:
Hypothesis 1: F i r ms wi t h h i ghe r l eve l s o f p r odu c t mar ke t
adve r t i s i ng w i l l have l ow er cos t o f equ i t y ( be t a ) .
Financial Leverage and Cost of Debt
( a . ) As sugges t ed by t he r evenue augment a t i on and
cash f l ow s t ab i l i t y a r gument by S r i vas t ava e t a l. ( 1998) ,
one m ay exp ec t tha t f ir ms wi t h h i ghe r adve r t is i ng expen-
d i t u r es w i l l have a l owe r de f au l t r i sk and a g r ea t e r capac i t y
t o s e r v i ce deb t , and hen ce expe r i ence a l ower cos t o f deb t .
( b . ) A h i ghe r deb t l eve l , however , may be a s soc i a t ed
wi t h a h i g he r p r oba b i l i t y o f de f au l t ( l ower Z - scor e ) and ,
hence , a h i ghe r cos t o f deb t cap i t a l . I n add i t i on , h i ghe r
adve r t i s i ng expenses m ay t ake away r e sour ces f r om bu i l d -
i ng t ang i b l e a s se t s a s w e l l a s r educ i ng t he ava i l ab il i ty o f
cash f l ows t o s e r v i ce deb t . 3
Gi ven t he t w o con t r a s t i ng t endenc i es , t he re l a t i onsh i p
be t we en adve r t i s i ng expense and t he cos t o f deb t s eems t o
be unpr ed i c t ab l e and shou l d be t r ea t ed a s an empi r i ca l
i ssue.
W e f r a m e o u r s e c o n d h y p o t h e s i s a s f o ll o w s :
Hypothesis 2:
A g r e a t e r d e g re e o f p r o d u c t m a r k e t a d v e r -
t i si ng w i l l a s soc i a t e pos i t i ve ly w i t h deb t l eve l s and
wi l l have a nega t i ve i mpac t on Z - scor es .
Weighted verage Cost of Capital
Gi ven t ha t adve r t i si ng conseque n t cash fl ow augm ent a -
t i on and s t ab il it y , a l ong wi t h pos i t i ve i nves t o r pe r cep t i on ,
may mak e f i r ms l e s s r isky and a t t rac t mor e i nves to r s , we
hyp ot hes i ze t ha t f i r ms wi t h h i ghe r p r od uc t mar ke t adve r -
t i s i ng w i l l have a l ower W ACC. T h i s l eads t o our f i na l
hypo t hes i s :
Hypothesis 3:
H i g h e r p r o d u c t m a r k e t a d v e r t i si n g e x p e n -
d i t u r e w i l l be a s soc i a t ed w i t h a l ow er W ACC.
M e a s u r e m e n t a n d D e s c r i p t i o n o f V a r i ab l e s
Independent test variable
Our i ndependen t t e s t va r i -
ab l e i s p r oduc t mar ke t adve r t i s i ng . F o l l owi ng Gr u l l on
e t a l. ( 2 0 0 4 ), w e u s e t h e lo g o f C O M P U S T A T s ( I te m 4 5 )
advert ising expenditure (Log ADV EX P) as a measure of prod -
uct market advert is ing. As com puted by COM PUSTA T, thi s
va r i ab l e r epr esen t s t he cos t o f adve r t i s i ng medi a ( r ad i o ,
t e l ev i si on , newspaper s , and pe r i od i ca l s ) and p r omo t i ona l
expenses . G i ven t ha t our f ocus i s on adve r t i s i ng conse -
quen t exposur e and i nc r ease d v i s i b i li t y among i nves t o rs ,
we f ee l th i s measur e i s t he mos t app r opr i a t e .
Dependent test variables F or our f i r s t hypo t hes i s , f o l -
l owi ng t he co nven t i on o f p r ev i ous emp i r i ca l s tud i e s ( J i n ,
M e r t o n , a n d B o d i e 2 0 0 4 ; M i s h r a , O B r i e n , a n d B o d i e
2003) , w e use equ i t y be t a ( BE T A ) as t he depende n t va r i-
ab l e t o p r o xy f o r cos t o f equ i t y . W e no t e t ha t i n t he S ha r pe -
L i n t ne r - M oss i n cap i t a l a s se t p r i c ing m ode l ( L i n t ne r 1965 ;
M oss i n 1966 ; S ha r pe 1964) , t he equ i t y be t a is t he d i r ec t
measu r e o f equ i t y s nond i ve r s i f i ab l e r i sk . Becau se i n equ i -
l ibr ium, o nly thi s r i sk i s pr iced, there i s a di rect re la t ion be-
t ween t h i s measu r e and t he co s t o f equ i t y cap i ta l .
I n t e s t ing ou r s econd hypo t hes i s , f o l l owi ng t he conven-
t i on o f t he l i t e r a tu r e on cap i t a l s t r uc t u r e ( s ee Har r is and
Ravi v [ 1991] f o r an ex t ens i ve r ev i ew o f the l i t e ra t u r e ), we
choose t he r a t i o o f t o t a l deb t t o t o t a l a s se t s ( DT A) as a
measu r e o f t he degr ee o f l eve r age i n a f i r m s cap i t a l s t r uc -
t u r e . W e a l so use A l t man s ( 196 8) Z - scor e ( Z S CO RE ) , a s
r e p o r t e d b y C O M P U S T A T , a s a m e a s u r e o f d e f a u lt ri s k
a n d h e n c e a p r o x y f o r t h e c o s t o f d e b t . W e n o t e t h a t a
f i r m s c o s t o f d e b t i s a f u n c t i o n o f t h e r i s k - f re e r a t e a n d
f i r m- spec i f i c c r ed i t sp r ead . E l t on , Gr ube r , Agr awa l , and
M a n n ( 2 0 0 1 ) p o i n t e d o u t t h a t a m a j o r c o m p o n e n t o f a
f i r m s c r ed i t sp r ead i s expec t ed de f au l t r isk . A l t m an s
( 1968) Z - scor e has l ong been used a s a va l i d p r ed i c t o r o f
bank r up t cy ( F r ank and G oya1 2003 ) . L as t ly , in t e st i ng our
ma i n and t h i r d hypo t hes i s , we use W ACC as r epor t ed by
S t em- S t ewar t .
Control variables
I n a l l o f our mul t i va r i a t e r egr es -
s i ons , a s is t he conven t i on , w e use t he l og o f the mar ke t
v a l u e o f c o m m o n e q u i t y ( L o g M V ) a s t h e c o n tr o l fo r a
f i r m s s i ze . I n t e s ti ng our f i r s t and t h i r d hypo t hese s , t o con-
t r o l f o r t he i mpa c t o f mar k e t l i qu i d i t y on t he co s t o f equ i ty ,
a s i n Gr u l l on e t a l. ( 2004) , w e use t he l og o f t he 3 - yea r av-
e r age t r a i li ng s t ock vo l um e ( l og o f VOL 3Y) . I n t e s ti ng our
second hy po t hes i s r ega r d i ng t he l i nk be t ween adve r t i s i ng
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436 JOURNALOF TH E ACADEMY OF MARK ETINGSCIENCE FALL 2005
and cos t o f deb t , we use bo t h DT A ( see T ab l es 4 and 5 ) and
t he r a t i o o f t o t a l shor t - t e r m deb t t o t o t a l deb t ( S T DT D)
( see T ab l e 6 ) t o con t r o l f o r t he i mpac t o f l eve r age on bank-
r up t cy cos t s . N ot e t ha t t o con t r o l f o r conf o und i n g e f f ec t s,
we a l so use equ i t y be t a ( BE T A) , DT A, and t he squa r e o f
t he deb t r a t i o ( DT A 2) in our regress ion analys i s for es t i -
ma t i ng t he i m pac t o f adve r t i s ing on W ACC.
I n ou r ana l ys i s o f t he i mpac t o f adve r t i s i ng on l eve r age ,
w e a d d i t io n a l l y u s e A l t m a n s ( 1 9 6 8 ) Z - s c o r e (Z S C O R E ) ,
r e t u r n on a s se t s ( ROA) , and t he r a t i o o f i ncome t ax t o
pr e t ax i nco me ( T AXR ) t o con t r o l f o r t he impac t s o f d i s -
t r e s s cos t s , p r o f it ab i l it y , and co r por a t e t axa t i on on a f i r m s
l eve r age ( s ee Har r i s and Rav i v [ 1991] f o r a de t a i led d i s -
cus s i on) . W e a l so use t he r a t i o o f i ncome t ax t o p r e tax
i ncom e ( T AX.R) i n our ana l ys i s o f t he i mpac t o f adve r t i s -
i ng on W AC C t o con t r o l f o r d i f fe r en t i a l t ax t r ea tment o f
deb t and equ i t y .
I n a l l o f t he mu l t i p le r egr es s i ons , we use one - d i g i t S t an-
da r d I ndus t r i a l C l as s i f i ca t i on ( S I C) code i ndus t r y dum-
mi es t o con t r o l f o r i ndus t r y e f f ec t s . W e deno t e each o f
t hese dum mi es a s I ND, ; t he i ndus t r y a s soc i a t ed w i t h t he it h
one - d i g i t S I C cod e i ndus t r y . T ab l e 1 p r ov i des desc r i p t i on
and sampl e s t a t i s t i c s o f t he a f o r ement i oned va r i ab l e s .
P ane l B o f T ab l e 1 repor t s va r i a t i ons in t he va r i ab l e s o f i n -
t e r e s t ac r os s s even i ndus t r i e s . T he f o l l owi ng r egr es s i on
mo de l s a r e e s t i ma t ed t o t e s t our hypo t he ses :
Hy pot h es i s 1 : T he e s t i ma t ed m ode l i s a s f o l l ows :
BET A = a + 13, Lo g (ADV EXP ) + 13 Log (MV )
+ 13~ Lo g (VO L3Y ) + 13.,o IND,-7 + e
Hypot hes i s 2 : T he e s t i ma t ed mode l s a r e a s f o l l ows :
DT A = ct + 13~ Lo g (A DV EX P) + 13_,ROA + 13.~ZSCORE
+ 13, Lo g ( M V) + 135TAXR + 136.,2 ND,., +
ZSCO RE = a + 13~ Log (AD VEX P) + 132 Log (MV )
+ 135 DT A + 13, STD TD + 135,, IND,-7 + e
Hypot hes i s 3 : T he e s t i ma t ed mode l i s a s f o l l ows :
WA CC = a + 13, Lo g (ADV EXP ) + 132 Log (M V) + 135 BETA
+ 134 L og (V OL 3Y ) + 135 DT A + 136 DTA 2 + 137 TA XR
+ 13s.j~ NDa.7 +
S M P L E N D M E T H O D
S a m p l e S e l e c t io n
Ou r o r i g i na l sou r ce o f t he s e t o f U .S . f i r ms i n t h i s a r ti c l e
i s the cou n t r y - w i se annua l l i st o f the bes t pe r f o r mi ng co m-
pan i es com pi l ed by S t e r n S t ewar t. F or t he U .S . f ir ms , t he
S t e r n S t ew ar t da t a i nc l ude i n f o r m a t i on on t he cos t o f cap i -
t a l and r e t u r n on cap i t a l f o r t he 1 ,000 bes t pe r f o r m i ng - - i n
t e r ms o f M VA - - - compani es . W e s t ar t w i t h the 1 ,000 f ir ms
on t he 2001 bes t pe r f o r m i ng f i r ms l is t and t r ace t hese f ir ms
back f o r 4 yea r s , t o 1998 . T he n , w e r e t r i eve t he annua l ba l -
a n c e s h e e t a n d i n c o m e s t a te m e n t d a t a f o r t h e s e c o m p a n i e s
f r o m t h e C O M P U S T A T d a t ab a s e . T h e f i n a l sa m p l e c o n -
s i s t s o f 967 f i r ms t ha t cons i s t en t l y appea r i n t he S t e r n
S t e w a r t b e s t p e r f o r m i n g l i s t f o r th e 4 y e a r s f r o m 1 9 9 8
t o 2 0 0 1 a n d a l s o h a v e i n f o r m a t i o n a v a i l a b l e i n t h e
COM P US T AT da t abase . A t t he nex t s tage , we e l i mi na t e f i -
nanc i a l f ir ms w i t h S I C cod es f a l l ing i n t he r ange o f 6000-
6999 . T h i s y i e l ds an ave r age o f 772 f i r ms pe r yea r . A t t he
nex t s t ep , we sour ce our adve r t i s i ng expend i t u r e and ac -
c o u n t i n g d a t a f ro m C O M P U S T A T . F o r t h e p e r i o d b e t w e e n
1998 and 2001 , on ave r age , we f i nd 253 f i r ms t ha t have
va l id adve r t i s i ng , accoun t i ng , and cos t o f cap i t a l i n f o r ma-
t ion . T he f o l l ow i ng i s a b r i e f summ ar y o f the s ampl e s e l ec -
t i on p r oces s :
verage Number
Cri terion o f Firms per Year
Step h All Stem-Stewart irms 967
Step 2: After eliminationof all financial irms 772
Step 3: A ftereliminating firms with non availability
of advertising data 253
Step 4: M aximum balanced panel for time-series
cross section regression 199
Minimum balancedpanel for time-seriescross
section regression 162
T o maxi m i ze t he pow er o f un i va r i a t e t es t s , we use a l l
va l i d obse r va t i ons f o r t he desc r i p t i ve and cor r e l a t i on ana l -
yses repor ted in Tables 1,2, a nd 3. For univ ar ia te tes t s, i t i s
no t neces sa r y t o ma t ch t he number o f ava i l ab l e obse r va -
t i ons f o r a l l va r iab l e s . W h en we c ond uc t t he mul t i p l e r e -
g r es s i on ana l yses , however , a l l va r i ab l e s t ha t a r e i nc l uded
i n th e m o d e l s m u s t h a v e t h e s a m e n u m b e r o f o b s e r v a ti o n s .
T he f u l l s ampl e , t hen , i s r educ ed t o a mi n i mu m o f 162 and
a m a x i m u m o f 1 9 9 o b s e r v a t i o n s p e r y e a r f o r w h i c h w e
have i n f o r m a t i on on a l l va r iab l e s f o r a l l 4 yea r s . T ab l e 1
pr ov i des bas i c d esc r i p t i ve s t a t is t i c s o f t he s am pl e .
D ata na lys is
W e u se a mul t i va r i a t e r egr es s i on ana l ys i s t o i nves t iga t e
t he na t u r e and t he deg r ee o f i n f l uence t ha t adve r t i s ing has
on t he W ACC and i ts d r ive r s . Because our da t a a r e a c r os s -
sec t i ona l t i me- se r i e s combi na t i on , we use t wo d i f f e r en t
me t hods t o e s t i ma t e t he mode l s . F i r s t , we empl oy yea r l y
r egr es s i ons t o i nves t i ga t e t he r e l a t i onsh i ps f o r eac h yea r .
T h i s appr oach ensur es t ha t au t oco r r e l a t i on is no t i n f l uenc -
i ng t he r e su l ts and t ha t t he r e su l ts a r e no t cond i t i ona l on
obse r va t i ons be i ng f r om a pa r t i cu l a r s ampl e yea r . A l so ,
t h is con s t i t u t e s t he f L rs t s t ep o f t he F am a and M a cBe t h
( 1973) me t hod o f hand l i ng c r os s - sec t i on a l r egr es s i ons .
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Singh et al . / ADVERTISING AND COST OF CAP ITAL 437
T A B L E
D e s c r i p t iv e S t a t i s ti c s
P a n e l A . M e a n , m e d i a n , a n d s t a n d a M d e v i a t i o n s i n p a r e n t h e s e s ) f o r t h e e n t i r e s a m p l e
V a r i a b le D e s c r i p t i o n N u m b e r o f F i r m Y e a r s M e a n M e d i a n S t a n d a r d D e v i a t i o n
WACC Weighted average cost of capital (%) 3,765 9.200 8.617 5.657
AD VEX P Advertising expense (MS) 1,057 267.533 65.315 556.627
BETA Equity beta 3,539 1.088 0.956 0.666
ZSCO RE Altman's (1968) Z-score 3,057 7.540 3.644 14.472
DTA Total debt to total assets (%) 3,845 27.693 25.601 20.191
MV Market value of equity (MS) 3,845 I 1,607.570 2,864.120 32,849.770
TA Total assets (MS) 3,767 7,451.770 2,237.750 23,719.430
NI Net income (MS) 3,863 279.684 87.185 1,217.690
RET1 l-yea r stock return (%) 3,860 24.959 12.954 51.445
RET3 3-year stock
return
(%) 3,701 16.436 11.463 26.342
VOL3Y 3-year t ra i li ng vo lume (mil lion s hares) 3 , 439 40 ,975 .990 1 1 , 7 9 1 . 9 1 0 123 , 315 . 990
ROA Return on assets (%) 3,644 3.018 4.507 13.579
ROE Return on equity (%) 3,860 7.108 11.838 162.568
P a n e l B. M e a n s a n d s t a n d a r d d e v i a t i o n s i n p a r e n t h e s e s ) f o r l - d i g i t S I C c o d e i n d u s t r i e s
S I C = 1 S I C = 2 S I C = 3 S I C = 4 S I C = 5 S I C = 7 S I C = 8 S I C = 9
V a r i a b le 1 7 9 ) 7 3 9 ) 8 5 3 ) 2 8 4 ) 4 4 8 ) 4 4 7 ) 9 5 ) 7 2 0 )
WACC 7.980 7.583
10 500
9.085 8.571 10.855 8.239 7 .857
(1.35) (10.42) (3.31) (1.31 ) (1.34) (2.79) (0 .92) (1.40)
ADV EXP 39.606 436.139 283.024 256.902 197.821 179.594 24.699 68.389
(38.80) (693.51) (658.97) (432.59) (286.87) (591.85) (36.41) (93.53)
BETA 0.939 0.835 1.274 1.090 0.928 1.415 1.020 0.713
(0.39) (0.36) (0.73) (0.57) (0.46) (0.94) (0.82) (0.31)
ZSCO RE 2.486 6.397 9.856 2.265 6.164 12.412 5.847 2.972
(1.96) (8.30) (16.42) (2.07) (4.96) (27.26) (4.64) (1.01)
DTA 34.806 29.833 23.995 40.710 25.147 22.144 24.389 36.723
(15.18) (18.59) (17.27) (24.01 ) (20.49) (22.14) (19.46) (15.84)
NO TE: This table reports he m ean, median, an d standard deviation for variables of interest for the entire sam ple as well as m ean and standard deviations (in
parentheses) for one-digit Standard Industrial Classification (SIC) industries. The variable description is also provided. The sample includes all nonfinan-
cial firms in the Stem-Stewart database for wh ich valid accounting data can be found in COM PUSTA T. WA CC = w eighted average cost of capital as re-
ported by Stern-Stewart; AD VEX P = advertising expenses; BETA = equity beta; ZSCO RE = Altm an's (1968) Z-score; DTA = ratio of total debt to total
assets; MV = total market value of commo n equity; TA = total assets; NI = net income; RE TI = 1-year stock return; RET 3 = 3-year average stock return;
VO L3Y = 3-year average railing stock volume; ROA = return on assets or the ratio of net income to total assets; ROE = return on equity or the ratio of net in-
come to equity.
F a m a a n d M a c B e t h ( 1 9 7 3 ) p r o c e e d e d t o r ep o r t w e i g h t e d
a v e r a g e c o e f f i c i e n t s a n d c o r r e s p o n d i n g t st a ti s ti c s. T o c o n -
f i r m o u r f i n d i n g s , t h e n a t u r a l n e x t s t e p w o u l d b e t o r u n
p o o l e d r e g r e s s io n s . T h e m e r e p o o l i n g o f t h e d a t a , h o w -
e v e r , w o u l d c a u s e e c o n o m e t r i c p r o b l e m s s u c h a s s e r i al a n d
c r o s s - s e c t i o n a l c o r r e l a t i o n s i n e s t i m a t i n g t h e m o d e l s . T o
s o l v e t h e s e p r o b l e m s , w e f o l l o w a s i m p l e m e t h o d d i s -
c u s s e d b y J o h n s o n ( 2 0 0 3 ) w h e r e b y w e f i rs t t a k e th e t i m e -
s e r i es a v e r a g e o f o u r v a r i a b l e s ( i . e. , a v e r a g e d u r i n g t h e
p e r i o d o f 1 9 9 8 - 2 0 0 1 ) a n d t h e n r u n a c r o s s -s e c t i o n a l
r e g r e s s i o n . T h i s m e t h o d a v o i d s t h e se r i a l c o r r e l a t i o n
p r o b l e m . T o a v o i d t h e h e t e r o s c e d a s t i c i t y i n h e r e n t in c r o s s-
s e c t i o n a l r e g r e ss i o n s , w e u s e W h i t e ' s v a r i a n c e c o r r e c t i o n
m e t h o d . 4 A s f o r t h e s p e c i f i c a t i o n , i n a d d i t i o n t o o u r t e s t
v a r i a b l e s , w e i n c l u d e a n u m b e r o f c o n t r o l v a r i a b l e s i n th e
r e g r e s s i o n m o d e l s t o a c c o u n t f o r t h e p r e v i o u s l y s h o w n
d e t e r m i n a n t s o f t h e c o s t o f c a p i t a l a n d i ts d r iv e r s . I n a d d i -
t i o n , t o c o n t r o l f o r p o s s i b l e i n d u s t r y e f f e c t s , w e i n c l u d e
s e v e n o n e - d i g i t S IC i n d u s t ry d u m m i e s i n th e r e c e s s i o n s .
R E S U L T S A N D D IS C U S S I O N
S a m p l e D e s c r i p t io n
T a b l e 1 p r o v i d e s t h e d e s c r i p t i v e s t a t is t ic s f o r t h e p o o l e d
s a m p l e . T h e p o o l e d m e a n ( m e d i a n ) W A C C i s 9. 2 0 p e rc e n t
( 8 .6 2 % ) . T h e a b s o l u t e d o l l a r a m o u n t o f a v e r a g e e x p e n d i -
t u r e o n a d v e r t i s i n g i s 2 6 7 . 5 m i l l i o n . T h e m e d i a n is m u c h
s m a l l e r a t 6 5 . 3 m i l l i o n . T h e f i r m s iz e d i s t r ib u t i o n o f o u r
s a m p l e s e e m s t o b e s k e w e d a s e v i d e n c e d b y t h e la r g e d if -
f e r e n c e b e t w e e n t h e m e a n a n d m e d i a n m a r k e t v a l u e a n d
t o t al a s s e ts . T h e a v e r a g e d e b t r a t i o o f t h e s a m p l e f i r m s i s
a b o u t 2 8 p e r c e n t . T h e s a m p l e f i r m s s e e m t o b e o f a v e r a g e
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4 3 8 JO U R N A L O F TH E A C A D EM Y O F M A R K ETIN G SC IEN C E FA LL 2 0 05
T ABL E 2
Corre la tion A na lys is for the Re la t ionship Am ong the Test Var iab les
Lo g AD VEX P WAC C ZS C O RE BETA
WACC -.2540 ** ( .000)
Z S O R E
-.15 73 ** (.000) .2283 ** 6000)
BETA -.140 9 ** 6000) .5172 ** 6000) .2335 ** 6000)
DTA .0933*** (.003) -.418 7 ** (.000) -.209 3*** (.000) -.166 3 ** 6000)
NOTE : This table reports the correlation am ong a set of variables of interesL WAC C = weighted average cost o f capital as reported by Stem-Stewart;
ADVE XP = advertising expenses; BETA = equity beta; ZSC OR E = Altm an's (1968) Z-score; DTA = ratio of total debt to total assets, p-value s are in paren-
theses. Coefficients that are statistically different from zero are marked t t he 10%, 5%, and 1% levels with *, **, ***, respectively.
T ABL E 3
Corre la t ion Between Contemporaneous and Lagged Adver t is ing Expense
and 1 ) W eighted Average Cost o f Capi ta l and 2 ) Debt Rat io
Panel A
WAC C9 WAC C99 WAC Co WAC Co ~
Log ADVEXPgs - .2535*** ( .000) - .2915 ** ( .000) - .3202 ** ( .000) - .3199 ** ( .000)
Log ADVEXP99 - .2351 ** ( .000) - .2669*** ( .000) - .2990*** ( .000) - .3014 ** ( .000)
Log ADVEXP0o - .1654 ** ( .009) - .2168 ** ( .000) - .2392 ** ( .000) - .2449 ** ( .000)
LOg ADVEXP0I - .0107 ( .858) - .1854 ** ( .001) - .2548*** ( .000) - .2640*** 6000)
Panel B
DTA9 DTA99 DTAoo DTAot
Log ADVE XP98 .0646 (.324) .0067 (.919) .1345 * (.040) .1410 * (.031)
Log ADVE XP99 .0723 (.261) .0286 (.655) .1594 * (.013) .1577 * (.014)
Log ADVE XP00 .0621 6312) -.0043 (.945) .0907 (.139) .1146 (.062)
Log ADVE XPol .0702 (.226) .0091 (.875) .0928 (.108) .1054 (.068)
NOTE : This table reports (1) the correlation between contemporaneous and lagged w e i g h t e d v e r g e cost of capital (W ACC) and log of advertising ex -
pense (ADVE XP), (2) the correlation between contemporaneous and lagged total debt r t i o (DTA) and log of advertising expense (ADVEX P). Subscript
with the variables indicates the year to w hich the variable pertains, p-values are in parentheses. C oefficients t h t re statistically different from zero r e
marked t t h e 10%, 5% and 1% levels with *, **, ***, respectively.
m ar ke t r i sk hav ing a be ta o f 1 .09 ( m ean) and 0 . 96 ( m edi -
an) . F inal ly, the fLrms have on average R OA of 3.02 per -
cen t and RO E o f 7 .11 pe r cen t.
Univariate Correlation Analysis
I n t e r m s of p r e l im ina r y ev idence , the f o r em o s t obser -
vat ion of the cor rela t ion matr ix in Table 2 is the s ignif icant
nega t ive cor r e la t ion be tween adver t i sing expendi tu r e and
a f i r m s W ACC. T he ev idence l ends suppor t to our f unda-
m enta l hypothes i s tha t p r oduc t m ar ke t adve r t i s ing m ay
have a f avor ab le cap i ta l m ar ke t im pac t in t e r m s of r educ -
ing the corporate cos t of capi ta l . In addit ion, the resul ts
show tha t adve r t i s ing i s nega t ive ly r e la ted to f inanc ia l
s trength in terms of the Z-score . Also, adver t is ing seems to
r educe a f i r m s be ta and hence i t s cos t o f equ i ty cap i ta l .
The resu l ts with respect to f i rm leverage, given a posi t ive
c o r r e l a t i o n c o e f f i c i e n t , i m p l y t h a t a d v e r t i s i n g h e l p s
increase debt capaci ty and debt ut i l izat ion. Thus , overal l ,
our u nivar ia te cor rela t ion ana lys is indicates that adver t is ing
favorably af fects a f i rm s capi ta l s t ructure and helps reduce
the cos t o f equity as w ell as the overal l cos t of capi ta l .
Pauw els e t a l . (2004) argu ed that adver t is ing may con-
vey add i t iona l in f or m a t ion about a f i r m s va lue tha t cannot
be captu red in the shor t run a lone. Thus , i t is conceiva ble
that the re la t ionship betwee n the tes t var iables is not con-
tem por aneous . To ana lyze the l agged im pac t o f the adve r -
t i s ing expen di tu r e on the co s t o f cap i ta l and the cap i ta l
s t r uc tur e o f s am ple f i rm s , we co nduc t l agg ed cor r e la t ion
analys is . In Table 3, Panel A resul ts su ggest that adv er t is -
ing expendi tu r e , a l though r e la ted con tem por aneou s ly to
the cos t of the capita l , is more s trongly re la ted to the
lagged cos t o f cap i ta l. I n f ac t, the con tem por aneous cor r e -
la t ion coe f f ic ien t a t -. 25 i s the lowes t wi th a m onoton ic
increase in the coe f f ic ient with greater lag. The reverse
r e la tionsh ip , in t e r m s of cur r en t W ACC a f f ec t ing l agged
adver t is ing, does no t hold so s trongly.
In Panel B, we re la te adver t is ing expenditure to the
lagged d ebt- to-asset ra t io. T he resul ts indicate that w hereas
adver t is ing doe s not af fect capi ta l s t ructure contem porane-
ously, i t does so with the lag. G iven the s ign if icant posi t ive
correla t ion, i t appears that adver t is ing expenditure leads to
a future increase in debt capaci ty and d ebt ut i l izat ion. Fur -
thermore, because previous debt level does not re la te
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S i n g h e t a l. / A D V E R T I S I N G A N D C O S T O F C A P I T A L 4 3 9
T A B L E
Regress ion for Weighted Average Cost o f Capi ta l as Determined by Adver t is ing Expenditure
White 's Variance White 's Variance Wh ite 's Variance Wh ite 's Variance Time Series Adjusted
Corrected 1998 Corrected 1999 Corr ected 2000 Corrected 2001 fo r Cross Section
P a n e l A . R e s u l t s w i t h o u t i n d u s t r y d u m m i e s
I n t e r c e p t 7 . 3 4 7 7 * * *
( 6 . 5 0 )
Lo g A DV E X P - 0 . 3 1 2 9 * *
( -2 .81)
L o g M V - 0 . 0 0 2 3
( - 0 . 0 1 )
B E T A 1 . 3 5 9 6 * *
( 3 . 7 9 )
L o g V O L 3 Y 0 . 37 8 4 * *
( 2 . 3 9 )
D T A - 0 . 0 5 8 9 * * *
( - 3 . 8 3 )
D T A 2 0 . 0 0 0 3 * *
( 1 . 8 2 )
T A X R - 1 . 4 0 10
-1.09)
P a n e l B . R e s u l t s w i t h I n d u s t r y D u m m i e s
( o n l y c o e f f i c i e n t s o n t e s t v a r i a b l e a n d
i n d u s t ry d u m m i e s a r e r e p o r t e d )
Lo g A DV E X P
M e a n i n d u s t r y d u m m y c o e f f ic i e n t a
5 . 1 7 6 3 * * * 7 . 9 6 9 7 * * 7 . 2 1 51 * * * 8 . 3 87 1 * * *
( 4 . 5 8 ) ( 6 . 6 8 ) ( 6 . 7 6 ) ( 7 . 2 5 )
-0 .5654 *** -0 .437 1 ** - -0.3244*** -0 .3849** *
(-5.05 ) (--.4.05) (-3.2 7) (-3. 70)
0 . 3 6 6 6 * 0 . 3 2 6 1 * 0 . 2 5 6 0 0 . 2 7 7 6 *
( 2 . 1 9 ) ( 2 . 1 2 ) ( 1 . 5 4 ) ( 1 . 6 9 )
1 . 3 0 9 3 * * 1 . 2 3 8 1 * * 1 . 2 8 2 9 * * 1 . 4 7 8 8 * *
( 3 .6 1 ) ( 3 . 5 3 ) ( 4 . 5 6 ) ( 4 . 1 6 )
0 . 3 0 2 8 0 . 1 7 6 0 0 . 2 1 6 9 0 . 1 9 7 0
( 1 . 6 8 ) ( 0 . 9 7 ) ( 1 . 2 1 ) ( 1 . 1 1 )
0 . 0 0 03 - 0 . 0 6 9 6 * * * - 0 . 0 4 6 2 * * * - 0 . 0 6 6 1 * *
(0 . 95 ) ( - -4 . 74) ( -3 . 76 ) ( - -4. 25)
- 0 . 0 0 0 6 * 0 . 0 0 0 4 * * * 0 . 0 0 0 1 0 . 0 0 0 3 * *
( - 1 . 6 4 ) ( 2 . 5 7 ) ( 1 . 3 8 ) ( 2 . 0 3 )
- 0 . 3 1 1 2 - 2 . 7 4 7 9 * * * -- 4 .0 3 5 7 * * * - 5 . 4 7 0 8 * * *
( - 0 . 2 4 ) ( - 2 . 6 9 ) ( - - 4 .5 5 ) ( - 3 . 5 4 )
- 0 . 2 5 0 6 * * - 0 . 3 3 7 5 * * * - 0 . 3 2 9 5 * * * - 0 . 2 8 2 2 * * * - 0 . 3 2 3 3 * * *
(-2 .28) ( -3 .01) ( -2 .97) ( -2 . 79) ( -2 .98)
0 . 5 8 3 3 1 . 1 6 3 8 0 . 6 6 1 5 0 . 7 1 6 5 0 . 7 3 6 3
( 0 . 6 8 ) ( 1 . 2 1 ) ( 0 . 7 3 ) ( 0 . 8 4 ) ( 0 . 8 3 )
F - s t a t i s t i c 1 7 .9 6 1 3 . 3 7 2 0 . 6 7 2 4 . 9 2 2 3 . 0 0
p va l ue . 0001 . 0001 . 0001 . 0001 . 0001
N 1 7 8 1 7 8 1 7 8 1 7 8 1 7 8
A d j u s t e d R 2 . 4 00 1 . 3 2 7 3 . 4 3 6 2 . 4 8 4 8 . 4 6 3 9
N O T E : T h i s t a b l e r e p o r t s t h e r e s u l t s o f t h e f o l l o w i n g r e g x e s s i o n :
W AC C = ~ t + 13, L og (A DV E X P) + 13,.L og (M V) + 13 , BE T A + 13, L o g (V OL 3Y ) + 13~ DT A + 13~ DT A + 137 T A XR + 13 , ., , IND , . , + e
w h e r e t h e d e p e n d e n t v a r i a b l e , W A C C , i s t h e w e i g h t e d a v e r a g e c o s t o f c a p i t al a s r e p o r t e d b y S t e m - S t e w a r t . T h e t e s t v a r i a b le i s lo g o f A D V E X P , t h e a d v e r -
t i s in g e x p e n s e s . C o n t r o l v a r i a b l e s a r e l o g o f M V , t h e t o t al m a r k e t v a l u e o f c o m m o n e q u i t y ; B E T A , t h e e q u i t y b e t a ; l o g o f V O L 3 Y , t h e 3 - y e a r a v e r a g e t r a i li n g
s t o c k v o l u m e ; D T A , t h e r a t i o o f t o t a l d e b t t o t o t a l a s s e t s ; a n d T A X R , t h e r a t i o o f i n c o m e t a x t o p r e t a x i n c o m e , t - s t a t is t i c s a r e i n p a r e n t h e s e s . T h e r e p o r t e d c o -
e f f i c i e n t s a r e W h i t e ' s h e t e r o s c e d a s t i c i t y ( v a r i a n c e ) a d j u s t e d . C o e f f i c i e n t s t h a t a r e s t a t i s t ic a l l y d i f f e r e n t f r o m z e r o a x e m a r k e d a t t h e 1 0 % , 5 % a n d 1 % l e v e l s
w i t h * , * * . * * * , r e s p e c t i v e l y .
a . A v e r a g e c o e f f i c i e n t a n d t - s t a t i s t i c s f o r s e v e n i n d u s t r y d u m m i e s a r e a l s o r e p o r t e d .
s ignif icant ly to future adver t is ing expenditures , we can
conclu de that adver t is ing s tra tegy adds to debt capaci ty.
Multivariate Analysis
At the nex t s tage of our an alys is , we analyze the re la-
t ionsh ip be tween WA CC an d adver t i sing expendi tu r e in a
mult ivar ia te f ramew ork. In Table 4, w e repor t the regres-
s ion resul ts for year -by-year as well as mult i -year aver -
aged cross sect ions . Th e resul ts indicate a s trong negat ive
r e lat ionsh ip b e tween adver t is ing expendi tu re and WACC.
All f ive coef f ic ients of the adv er t is ing var iable are nega-
t ive and s ig nif ican t a t the 1 percent level. The im plicat ion
is that f i rms having greater adver t is ing outlays exper ience
a s ignif icant ly lower W ACC . In terms of control var iables ,
we f ind that larger fi rms may have a higher cos t of capi ta l,
a l though the re la t ionship does not seem to be s trong. As
expected , equity beta po si t ively re la tes to WA CC, indicat-
ing that f i rms with r isky equity wil l exper ience higher
overal l cos t of capi ta l . In terms of market m icros tructure
factors , i t appears that higher t rading volume actual ly
rela tes posi t ively to the WAC C. The eviden ce, however , is
no t ve r y conc lus ive a s the r e la tionsh ip ho lds on ly f o r two
of the f ive m o de ls .
Given that the overal l cos t of capi ta l is a funct ion o f the
individual component capi ta l cos ts , as well as the capita l
s tructure , we control for the debt ra t io in the mult iple
regress ion analys is . Fur thermore, a l though higher levels
of l eve r age m ay r educe the cos t o f cap ita l due to deb t t ax
shields , i t is poss ible that higher leverage ma y increase the
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4 4 0 J O U R N A L O F T H E A C A D E M Y O F M A R K E T I N G S C I E N C E F A L L 2 0 05
T A B L E
Re gr e s s i on f o r Ca p i t a l S t r uc t u r e a s De t e r m i ne d by Adv e r t i s i ng Ex pe nd i t u r e
DTA98 DTA99 DTAoo DTAol
P a n e l A . R e s u l t s w i t h o u t i n d u s t r y d u m m i e s
I n t e r c e p t 4 1 . 5 3 7 * * ( 4 . 5 7 )
Log ADVEXPg8
0 . 1 5 1 0
1.72)
R O A 9 8 - 0 . 2 8 3 0 * * * ( -- 4 .1 0 )
Z S C O R E 9 8 - - 0 .1 4 1 0 * ( - 2 . 0 7 )
L o g M V g s - - 0 .1 4 4 0 ( - 1 . 6 0 )
T A X R ~ 8 - - 0 .0 8 5 0 ( - 1 . 2 8 )
P a n e l B . R e s u l t s w i t h i n d u s t r y d u m m i e s
( o n l y c o e f f i c i e n t s o n t e s t v a r i a b l e a n d
i n d u s t r y d u m m i e s a r e r e p o r t ed )
Log ADVEXPg8
M e a n i n d u s t r y d u m m y c o e f f i c i e n t a
4 0 . 0 7 * * * ( 4 . 6 0 ) 3 4 . 6 6 * * * ( 4 . 0 0) 3 1 . 3 7 * * ( 3 . 5 0 )
0 . 1 4 3 0 ( 1 . 5 8 ) 0 . 2 0 2 0 * * ( 2 . 2 2) 0 . 1 9 9 0 * ( 2 . 2 0 )
- 0 . 1 9 3 0 * * ( - 2 . 7 1 ) - 0 . 1 4 8 0 * ( - 2 .0 6 ) - 0 . 2 0 3 0 * * * ( - 2 . 8 5 )
- 0 . 1 4 1 0 * ( - 2 . 0 0 ) - - 0 .1 2 7 0 ( - 1 . 8 0 ) - 0 . 1 3 0 0 ( - 1 . 8 5 )
- - 0 .1 3 8 0 ( - 1 . 4 9 ) - 0 . 1 2 4 0 ( - 1 . 3 4 ) -- 0 .0 8 2 0 ( - 0 . 8 9 )
- 0 . 0 6 4 0 ( - 0 . 9 3 ) - - 0 . 0 7 1 0 ( - 1 . 0 2 ) - - 0 . 0 1 6 0 (- - 0 . 2 3 )
0 . 1 3 3 7 1 .41) 0 . 1 4 9 5 ( 1 . 5 4 ) 0 . 2 2 1 8 * ( 2 . 25 ) 0 . 2 0 8 4 * 2.13)*
- -0 . 16 6 3 ( - 1 . 1 0 ) - 0 . 1 4 6 3 ( - 0 . 8 6 ) - 0 . 1 3 2 6 ( - - 0 .7 5 ) - - 0 . 0 8 6 0 ( - 0 . 4 6 )
F - s t a t i s t i c 6 . 8 6
4.11
3 . 61 4 . 08
p v a l u e . 00 0 (3 . 0 0 1 0 . 0 0 4 0 . 0 0 2 0
N 1 9 9 1 9 9 1 9 9 1 9 9
A d j u s t e d R 2 . 1 2 8 0 . 0 7 2 0 . 0 6 1 0 . 0 7 2 0
N O T E : T h i s t a b l e r e p o r t s t h e r e s u lt s o f t h e f o l lo w i n g r e g e s s i o n :
DT A = c t + 13, L og (A DV E X P) + 13: RO A + 13, Z S CO RE + 13 , L og (M V) + [82 T A XR + 13 ,.,., IND, . , + e
w h e r e t h e d e p e n d e n t v a r i a b l e , D T A , i s t h e r a t i o o f t o t a l d e b t t o t o t a l a s s e t s . T h e t e s t v a r i a b l e i s l o g of ADVEXP, he a d v e r t i si n g e x p e n s e s . C o n t r o l v a r i a b l es
a r e R O A . t h e r e t u r n o n a s s e t s ; Z S C O R E , A l t m a n ' s ( 1 9 6 8 ) Z -s c o r e ; l o g o f M V , t h e t o ta l m a r k e t v a l u e o f c o m m o n e q u i t y ; T A X R , t h e i n c o m e t a x t o p r e t a x i n -
c o m e r a t i o ; a n d N I , t h e n e t i n c o m e , t - s t a t i s t i c s a r e in p a r e n t h e s e s . T h e r e p o r t e d c o e f f i c i e n t s a r e W h i t e ' s h e t e r o s c e d a s t i c i t y ( v a r i a n c e ) a d j u s t e d . C o e f f i c i e n t s
t h a t a r e s t a t i s t i c a l l y d i f f e r e n t f r o m z e r o a r e m a r k e d a t t h e 1 0 % , 5 % , a n d 1 % l e v e l s w i t h * , * * , * * * , r e s p e c t i v e l y . S u b s c r i p t w i t h t h e v a r i a b l e s i n d i c a t e s t h e
y e a r t o w h i c h t h e v a r i a b l e p e r ta i n s .
a . A v e r a g e c o e f f i c i e n t a n d t - s t a t i s t i c s f o r s e v e n i n d u s t r y d u m m i e s a r e a l s o r e p o r t e d .
cost of capi ta l due to an increase in the probabil i ty of bank-
ruptcy. Our resul ts ind icate that a t lower levels o f debt , the
weighted average cos t of capi ta l is negat ively re la ted to
leverage, thereby point ing toward tax shie ld benefi ts . At
high er levels of debt , however, W ACC rela tes pos i t ively to
the degree o f f inanc ia l l eve rage , sugges t ing bankrup tcy
considerat ions . We, therefore , observe a nonlinear, U-
shaped , re la t ionsh ip be tween f inanc ia l leve rage and the
overal l WAC C. These resul ts are consis tent with the theo-
re t i ca lly p red ic ted re la t ionsh ip b e tween l eve rage and cos t
o f cap i t a l in the p resence o f bankrup tcy cos t s (Cope land
and Wes ton 1992; K rause and L i tzenberge r 1973; Modig-
l iani and M il ler 1958). F inal ly, f i rms with a higher average
tax ra te have a low er cos t o f cap i t a l. In P ane l B , where we
adjus t for industry-specif ic effects , the resul ts perta ining to
the tes t variable are ident ical to those reported in Panel A .
Overal l , the resul ts in Table 4 sugges t that a higher
degree o f adv e r t i s ing fac i l i t a te s a low er cos t o f cap i t al . The
f ind ings m ay be d r iven b y e i the r o f two fac to rs : i t m ay be
tha t adve r t i sing he lps cash f low enh ancem en t and s tab i li ty
and the reby redu ces cos t o f cap i t al o r tha t p roduc t m arke t
vis ibi l i ty , through advert is ing, may resul t in a spi l lover
effect on the c api ta l m arket as i t m ay at t ract a larger inves-
tor base , enha nce l iquidi ty, and provide depth with conse-
quen t reduc t ion in the cos t o f cap i t al .
I m p a c t o f A d v e r t i s i n g o n
Dr i v e r s o f t he C os t o f Ca p i ta l
a p i t a l
t r u c t u r e
To iden t i fy the source o f favorab le im pac t o f adve r t i s -
ing on cos t o f cap i t a l , a t the fa s t s t age o f the ana lys i s , we
look a t the cap i t a l s t ructu re a s in f luenced by the f i rm s
advert is ing expend itures . Given the univaria te corre la t ion
resu l ts (w here ad ve r t i s ing s eem s to a f fec t leve rage wi th a
lag) in Table 5, column 1, the dependent variable is the
contem p oraneous 1998 deb t ra t io , whereas subsequent
co lum n s have I - , 2 - , and 3-yea r lagged deb t ra t ios . The
resul ts indicate that a l though adv ert is ing does not re la te to
the con tem poran eous deb t ra t io s ign i f i can tly , i t pos i t ive ly
contributes to increas ing debt capaci ty and ut i l izat ion in
the sub sequen t years . I t is plaus ible to argue that fLrmS n a
pa r t i cu la r tax b racke t m a y inc rease l eve rage to cap ture t ax
sh ie ld bene f i t s , the reby reduc ing the a f t e r -t ax cos t o f deb t .
I t is a lso poss ible that a higher debt level may lower a
f i rm s Z -score and co nsequent ly gene ra te nega tive im pac t
on pre tax cos t o f deb t . As long a s the t ax bene f i t s o f
inc reas ing l eve rage ou twe igh the cos t in t e rm s o f h ighe r
pretax cos t of debt , i t is ra t ional to increase leverage to
reduc e overal l cos t of capi ta l . In terms of control variables ,
cons i s ten t wi th p rev ious re sea rch , we f ind tha t a f i rm s
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S i n g h e t a l. / A D V E R T I S I N G A N D C O S T O F C A P I T A L 4 4 1
T A B L E 6
R e g r e s s i o n f o r Z s c o r e a s D e t e r m i n e d b y A d v e r t is i n g E x p e n d i t u r e
White's Variance Whi te's Variance Whi te's Varia nce Whi te's Varianc e Ti me eries Adjusted
Corrected 19 98 Corrected 1999 Corrected 2000 Corrected 2001 for Cross Section
P a n e l A . R e s u l t s w i t h o u t i n d u s t ry d u m m i e s
I n t e r c e p t 6 . 0 3 0 8
0 . 8 7 )
Log AD VEX P -3 .0416 **
(-3.58)
L o g M V 1 .9 2 5 6 *
( 1 . 9 3 )
D T A - 0 . 1 2 8 3 * *
( - 2 . 4 6 )
S T D T D 0 .1 0 4 7 *
(2.09)
P a n e l B . R e s u l t s w i t h i n d u s t r y d u m m i e s ( o n l y
c o e f f i c i e n t s
o n t e s t
v a r i a b l e a n d i n d u s t r y
d u m m i e s a r e r e p o r t e d )
L o g A D V E X P
M e a n i n d u s t r y d u m m y c o e ti ~ c ie n t
- 0 . 9 7 7 8 3 . 5 4 4 1 ' 3 . 9 0 6 7 * * * 7 . 3 6 4 6 * *
( - 0 . 1 6 ) ( 1 . 8 1 ) ( 2 . 3 6 ) ( 2 . 1 2 )
-3.5002*** -0.311 0 -0.5602 -1.3300 **
(--4.55) (-1.23) (-2.86) (-3 .1~
2 . 5 6 3 7 * * * 0 . 6 6 2 3 * * * 0 . 5 6 3 9 * * * 0 . 6 7 8 6
( 2 . 9 7 ) ( 2 . 5 2 ) ( 2 . 5 1 ) ( 1 . 4 3 )
- - 0 .0 0 0 3 - 0 . 0 9 4 3 * * * - 0 . 0 7 2 5 * * * - 0 . 1 0 1 8 * *
( - 0 . 5 9 ) ( - 5 . 5 1 ) ( - 5 . 6 2 ) ( - 3 . 4 5 )
0 . 1 3 0 4 * * 0 . 0 1 3 2 0 . 0 3 8 5 * * * 0 . 0 9 5 3 * * *
( 2 . 6 5 ) ( 0 . 9 6 ) ( 3 . 4 2 ) ( 3 . 1 2 )
-2.6917 ** -3.3493*** -0.3208** -0.748 1 ** -1.3023 **
(-2.92) (-4.01) (-2.21) (-3.84) (-2.86)
- 0 . 5 9 4 7 1 .9 4 7 3 - 5 . 1 0 3 1 - 1 . 4 6 7 3 - 1 . 0 8 2 6
( 0 . 0 2 ) ( 0 . 2 7 ) ( - 1 . 5 3 ) ( - 0 . 5 2 ) ( - 0 . 1 2 )
F - s t a t i s t i c 7 . 1 8
p va l u e . 0001
N 1 6 2
A d j u s t e d R 2 . 1 3 2 5
7 . 3 3 1 3 . 7 4 1 8 . 6 7 1 0 . 3 0
.0001 .0001 .0001 .0001
162 162 162 162
. 1 3 5 2 . 2 3 9 4 . 3 0 3 8 . 1 8 6 8
N O T E : T h i s t a b l e r e p o r t s t h e r e s u l t s o f t h e f o l l o w i n g r e g r e s s i o n
Z S CO RE = ~ t + 13, L og (A DV E X P) + 132 L o g (M V) + 13, DT A + 13, ST D T D + 13 ,. ,, IND , . , +
w h e r e t h e d e p e n d e n t v a r i a b le , Z S C O R E , i s A l t m a n ' s ( 1 9 6 8 ) Z - s c o r e . T h e t e s t v a ri a b l e is l o g o f A D V E X P , t h e a d v e r t i s i n g ex p e n s e s . C o n t r o l v a r i a b le s a r e
l o g o f M V , t h e t o t a l m a r k e t v a l u e o f c o m m o n e q u i t y ; D T A , t h e r a t io o f t o t a l d e b t t o t o t a l a s s e t s ; a n d S T D T D , t h e r a t i o o f to t a l s h o r t - t e r m d e b t t o t o t a l d e b t . t -
s t a t i s t i c s a r e i n p a r e n t h e s e s . T h e r e p o r t e d c o e f f i c i e n ts a r e W h i t e ' s h e t e r o s c e d a s t i c i t y ( v a r i a n c e ) a d j u s t e d . C o e f f i c i e n t s t h a t a r e s t a t is t i c a l l y d i f f e re n t f r o m
z e r o a r e m a r k e d a t t h e 1 0 % , 5 % , a n d 1 % l e v e l s w i t h * . * * , * * * , r e s p e c t i v e ly .
a . A v e r a g e c o e f f i c i e n t a n d t - s t a t i s t ic s f o r s e v e n i n d u s t ry d u m m i e s a r e a l s o r e p o r te d .
per fo rmance and Z - score nega t i ve l y r e l a t e t o t he deb t
r a t io . F i rm s i ze and ave rage t ax l i ab i li t ie s , however , do n o t
seem t o cons i s t en t l y r e l a t e t o t he cap i ta l mi x .
Overal l , the resul t s in Table 5 suggest that adver t i s ing
may he l p c r ea t e add i t i ona l deb t capac i t y , whi ch , i f used
op t i ma l l y , may r e su l t in r edu ced a f t e r - tax cos t o f deb t a s
we l l a s r educ ed W ACC. I t i s p l aus ib l e t o r e l a te h i ghe r deb t
capac i t y t o g r ea t e r vo l ume and s t ab i l i t y o f f u t u r e cash
f l ows t ha t adve r t i s i ng ma y y i e l d .
Financ ia l S t rength Z-score )
W e a rgue t ha t h i ghe r adve r t i s i ng expend i t u r es may
resu l t i n a r educ t i on i n cash f l ows ava i l ab le fo r s e rv i c i ng
deb t , t he r eb y adv e r se l y a f f ec t i ng t he f inanc i a l s t reng t h o f a
f i rm. In add i t i on , h i ghe r adv e r t is i ng , by a l l owi ng g r ea t e r
l eve rage , may r e l a t e to a l ower Z - score , a s a p roxy fo r a
f i rm s f i nanc i a l s t r eng t h . W e t e s t t he d i r ec t i mpac t o f
a d v e r t is i n g o n a f i r m s Z - s co r e . W e r e p o r t th e r e c e s s i o n
resu l ts f o r yea r -by-y ea r a s we l l a s mu l t i - yea r ave raged
c ross s ec t i ons i n T ab l e 6 . T he r e su l ts cons i s t en t l y show t he
s i gn i f i can t nega t i ve i mpac t o f adve r t i s i ng expense on a
f i rm s Z - score . T he i mpl i ca t i on o f t he nega t i ve r e la t i on-
sh i p i s t ha t adve r t i si ng m ay adve r se l y a f f ec t a f t rm s ab i l -
i t y t o s e rv i ce i ts deb t ob l i ga t i ons ; t h i s may b e due t o h i gh e r
l eve l deb t and / o r usage o f com pany f i nances fo r c r ea t i on
of i n t ang i b l e ma rke t -based a s se t s t h rough ad ve r t is i ng .
As expec t ed , t he con t ro l va r i ab l e s i nd i ca t e t ha t l a rge
f i rms have h i gh e r Z - scores and t ha t fu -ms wi t h h i ghe r deb t
l eve l s have l ower Z - scores . A l so , i t appea r s t ha t f irms w i t h
h i ghe r r e l a t i ve shor t - t e rm deb t have a h i ghe r Z - score .
Overa l l , i t appea r s t ha t ev en a f t e r con t ro l li ng fo r cap i t a l
s t r uc t u r e , f i rm s i ze , and deb t compos i t i on , adve r t i s i ng
nega t i ve l y a f f ec t s a f i rm s Z - score .
C o s t o f E q u i t y C a p i ta l
I f adve r ti s i ng he l ps enha nce and s t ab i l i ze cash f l ows
and he l ps c r ea t e a b roade r i nves t o r base and i nc r eased
l iquidi ty for i t s s tock, w e exp ect to f ind a negat ive re la t ion-
sh i p be t wee n equ i t y be t a and adve r t i s i ng expense . W e t e s t
t hese p r ed i c t i ons i n a mul t i p l e r egres s i on f r amew ork and
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4 4 2 JOUR N AL OF T HE AC ADE M Y OF M AR KE T I NG SC I ENC E FAL L 2 0 05
T A B L E
R e g r e s s i o n f o r E q u i ty B e t a a s D e t e r m i n e d b y A d v e r t is i n g E x p e n d i t u r e
White s Variance White sVariance White sVariance Whit e sVariance llme Series Adjusted
Corrected 19 98 Corrected1999 Corrected20 00 Corrected 001 for Cross Section
Panel A. Resu l ts wi thout industry dumm ies
In tercep t 0 .1038
(0.51)
Log ADVEXP -.0.0348
(-1.55)
Log M V - -0.1395"**
--4.16)
L o g V O L 3 Y 0 . 23 8 1 * *
(8.43)
Panel B . Resu l ts wi th industry dumm ies
(only coefficients on tes t variable and
industry dum mies are repor ted)
Log ADVEXP
Me an industry dum my coef fic ien t a
- 0 . 3 1 5 3 - 0 . 4 0 8 3 - 0 . 2 6 1 9 - 0 . 2 2 2 4
(-1 .50) ( -1 .93) ( -1 .05) ( -1 .12)
-0.0608*** .-0.0582*** -0.0762*** .-0.0597***
(-2. 78) (-2.61) (-2. 97) (-2. 79)
- -0 .0856*** -0 .169 9"** -0 .2749 *** -0 .1656" **
(-2.5 8) (-5.4 5) (-6.7 4) (---4.94)
0.2445*** 0.319 8"** 0.4047*** 0.3020***
(7.58) (10.12) (10.73) (9.86)
.-0.0110 --0.0380* -0.0467** --0.0593** .-0.0406**
(-0.48) (-1.65) (-2.00) (-2.23) (-1.87)
0.1003 0.0455 0.3088 0.2573 0.1888
(0.51) (0.24) (1.33) (0.98) (0.92)
F-s tatist ic 24.91 23.06 35.00 40.98 35.31
p value .0001 .0001 .0001 .0001 .0001
N 179 179 179 179 179
Ad ju s t e d R2 .2861 .2699 .3630 .40 12 .3651
NOTE: This tab le repor ts the resu l ts o f the fo llowing regression :
BETA = ct + [3, Log (AD VE XP ) + 13,.Log (M V) + ~ Log (VO L3Y ) + ~.~,o ND~.~ +
where the depend ent var iab le ,
BETA,
s the equ i ty beta . The test var iab le is log of ADVEXP, the a dver t is ing expenses. Contro l var iab les are log of MV, the
to ta l marke t va lue of co mm on equi ty ; and log o f VOL3Y, the 3 -year average t ra i l ing stock vo lume, t - s ta t is t ics are in paren thes es. The repor ted coeff icien ts
are W hite 's h e teroscedast ic i ty (var iance) ad justed. Coef fic ien ts tha t arc s ta tis tica lly d i f feren t from zero are marked a t the 10%, 5%, and 1% levels w i th *
9*, ***, respectively.
a . Average coef f ic ien t and t - s ta t is t ics fo r seven industry du mm ies are a lso reported .
T A B L E 8
C o r r e l a ti o n B e t w e e n A d v e r t is i n g E x p e n d i tu r e a n d M e a s u r e s o f V a lu e A d d e d
ADVEXPgs ADVEXP99 ADVEXPoo ADVEXPol
MVA 98 .569** (.000)
MVA 99 .398** (.000) .406** (.000)
MVA 0o .367** (.000) .373** (.000) .408** (.000)
MV Aol .396** (.000) .396** (.000) .406** (.000) .377** (.000)
NOT E: T his table reports the correlation betw een contemporaneous and lagged advertising expense (ADVEX P) a nd the mark et value added (MVA ). p-value s
are in parenthe ses. Coefficients that are statistically differen t from zero are mark ed at the 1 0% , 5% , and 1% levels with *, **, ***, respectively. S ubsc ript
with the var iab les ind ica tes the year to w hich the var iab le per ta ins.
pr esen t the r e su l t s f o r yea r - by- yea r a s we l l a s poo led-
mu lt i -yea r average cross sect ions in Table 7.
As expected, adver t is ing expenditure re la tes s ignif i-
can t ly an d neg a t ive ly to the m ar ke t be ta o f s am ple f i r m s .
This ind ica te s tha t th r ough pr oduc t m ar ke t adve r t i s ing ,
f i rms are able to create capi ta l market vis ibi l i ty and reduce
var iabi l i ty of their earnings with respect to market var ia-
t ions . They a r e thus ab le to r educe the i r equ i ty r i sk and
conseq uent ly the cos t o f equ i ty . Th is lower cos t o f equ i ty
m a y d i r ec t ly r e su l t in the r educ t ion o f a f i rm s WAC C. The
contro l var iables coef f ic ients are as expected. Overal l , the
resul ts in Table 7 sugg est that greater adver t is ing expend i-
ture is re la ted to lo wer cos t of equ ity capi ta l , which in turn
r educes WACC.
I m p a c t o f A d v e r t is i n g o n M V A
The fundamental ques t ion that ar ises per ta ins to the
i m p a c t o f a d v e r t i s i n g e x p e n s e s o n c o r p o r a t e v a l u e .
Alth oug h this is not our focus , we p resent in Table 8 evi-
dence pe r ta in ing to pos i t ive cor r e la t ion be tw een a f i r m s
adver t i sing expendi tu re and the MV A - - a m easur e o f cor -
por a te pe r f or m ance pr oposed by S te r n S tewar t . The
resul ts suggest a s ignif icant posi t ive re la t ionship betwee n
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Singh e t a l . / ADVERTISING AND COST OF CAPITAL 443
a d v e r t i s i n g e x p e n d i t u r e s a n d M V A , i m p l y i n g t h a t f i r m s
w i t h h i g h e r p r o d u c t m a r k e t a d v e r t i s i n g a l s o e x p e r i e n c e
g r e a t e r p e r fo r m a n c e i n t e r m s o f M V A .
O N L U S I O N
I n t h i s a r ti c l e , w e a d d r e s s t h e i s s u e o f s p i l l o v e r e f f e c ts
o f p r o d u c t m a r k e t a d v e r t i s i n g i n t o t h e c a p i t a l m a r k e t . S p e -
c i f i c a l l y , w e i n v e s t i g a t e t h r e e q u e s t i o n s : W h a t i s t h e
i m p a c t o f a f h m s p r o d u c t m a r k e t a d v e r t is i n g o n i ts o v e ra l l
c o s t o f c a p i ta l ? H o w d o e s a d v e r t i s i n g a f f e c t t h e m i x o f
d e b t a n d e q u i t y ? A n d , w h a t i s a d v e r t is i n g s i m p a c t o n a
f t rm s b e t a a n d A l t m a n s Z - s c o r e ? U s i n g a s a m p l e o f U . S .
b e s t p e r f o rm i n g f i rm s f r o m t h e S t e rn S t e w a r t d a t a b a se , w e
c o n c l u d e t h a t p r o d u c t m a r k e t a d v e r t i s i n g e x p e n d i t u r e s
h a v e a p o s i t i v e s p i ll o v e r i m p a c t o n c a p i t a l m a r k e t s i n t e r m s
o f r e d u c i n g a f i r m s o v e r a l l c o s t o f c a p i t al . T h e i m p a c t
s e e m s t o b e s i g n i f i c a n t e v e n a f t e r c o n t r o l l i n g f o r o t h e r
d e t e r m i n a n t s o f c o s t o f c a p i t a l . I n a d d i t i o n , w e f i n d t h a t
g r e a t e r a d v e r t i s i n g a s s o c i a t e s w i t h l o w e r c o s t o f e q u i t y ,
h i g h e r d e b t u t i li z a t io n , a n d l o w e r A l t m a n s Z - s c o r e .
F i n a l l y , i n a n a l y z i n g c o r p o r a t e v a l u e c o n t r i b u t i o n s o f
a d v e r t i s i n g , w e f i n d t h a t f i r m s w i t h h i g h e r a d v e r t i s i n g o u t -
l a y s a r e a l s o t h e o n e s t h a t e x p e r i e n c e h i g h e r p e r f o r m a n c e
i n t e rm s o f M V A .
N O T E S
1. We use the term product market adver t is ing to connote adver t is ing
to promote product/services outpu t to ultim ate (final consu me rs) or inter-
media te (businesses) ac tual o r po ten t ia l customers. The term
product
market i s used in terchangeably wi th goods market in the f ie ld o f econom -
ics to d i fferen t ia te goods (consu mable goods a nd serv ices as ou tpu ts- - f i -
nal or intermediate) ma rket from capita l ( labor and financial capital)
market.
2. The Z-score represents the likeliho od of insolvency and is gener-
a ted th rough mult ip le d isc r iminan t analysis (Al tman , 1968) .
3. Whereas point a suggests an increase in debt capacity and usage,
point b indicates restricted deb t usage.
4. In White 's adjustment, the variance-covariance matrix is corrected
for cross-sectional correlations. Note that witho ut heteroscedasticity, the
of f -d iagonal e lements o f the var iance-covar iance matr ix ( i . e . , c ross-
secti onal correlations) are zero. Whi te's me thod forces these elem ents to
be zero, whereas the true variance mea sures are estimated.
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B O U T T H E U T H O R S
M a n o h a r S i n g h ( m s i n g h @ w i l l a m e t t e .e d u ) i s a n a s s o c ia t e p ro -
f e s s o r o f f i n a n c e a t W i l l a m e t t e U n i v e r s i t y i n S a l e m , O r e g o n . H e
h o l d s a P h . D . i n f i n a n c e f r o m S o u t h e r n I l l i n o i s U n i v e r s i t y a t C a r -
b o n d a l e . H i s p u b l i s h e d r e s e a r c h i n c l u d e s p u b l i c a t i o n s i n t h e
Journal of Banking and Finance, Financial Review, the Journal
of Multinational Financial Management, and the Pacific Basin
Finance Journal, a m o n g o t h e r s . H i s r e s e a r c h i n t e r e s t s i n c l u d e
c o r p o r a t e g o v e r n a n c e a n d c o r p o r a t e f i n a n c e a n d s t r a te g y .
S h e r i F a i r d o t h ( f a ir c lo s @ u n r . n e v a d a. e d u ) i s a n a s s o c ia t e p r o -
f e s s o r o f f i n a n c e a t t h e U n i v e r s i t y o f N e v a d a a t R e n o . S h e h o l d s a
P h . D . i n f i n a n c e f r o m t h e U n i v e r s i t y o f T e x a s a t A r l i n g t o n . H e r
r e s e a r c h i n t e r e s t s i n c l u d e c o r p o r a t e f i n a n c e , i n v e s t m e n t s , a n d
r e a l e s ta t e f i n a n c e . S h e h a s p u
