New academic research by LeighMcAlister, Raji Srinivasan and MinChung Kim gives us a new perspective on how advertising makes financial sense. By analysing 644 companies on NYSE between 1979 and 2001 they find that advertising lowers the systematic risk of a firm. Systematic risk, or beta, measures how vulnerable stocks are to market downturns. The advertising effect is found to large and highly significant, even after finance and accounting factors such as growth, leverage, liquidity, asset size, earnings variability, dividend payout, firm age, and competitive intensity have been controlled for.

Why then does advertising lower the firm’s systematic risk? Well, the researchers believe that:

- A highly recognised company is more reliable when it comes to providing the market with proper information. For investors, greater information precision is preferable to less information.

- A more visible company has a broader base of investors. This broader ownership has an insulating effect against market downturns.

- There are brand equity effects: a stronger brand as an effect of advertising creates both customer loyalty and greater bargaining power over channel distribution partners, two factors that alleviates the impact of market downturns.

In reality, these research results imply that advertising can be used not only for generating sales, market share, cash flow and ROA, but also for reducing a firm’s systematic risk and consequently a lower discount rate and cost of capital. Especially in times market downturns it’s important to not reduce advertising programs as this will have a double negative effect.

In other words: keep on advertising in bad times!

The article Advertising, Research and Development, and Systematic Risk of the Firm was published in the January 2007 issue of Journal of Marketing.

Executive summary

Thanks Michael Dahlén at Stockholm School of Economics for presenting this article at the latest APG Sweden seminar!