IMPACT OF ADVERTISEMENT EXPENDITURE

ON FIRM’S PERFORMANCE:
A CASE OF FMCG INDUSTRY IN INDIA

Ph.D. THESIS SUBMITTED IN FULFILLMENT OF

THE REQUIREMENTS FOR THE AWARD OF THE
DEGREE OF

DOCTOR OF PHILOSOPHY

SUBMITTED BY
MANDEEP KAUR MAHENDRU
(Registration Number 950913009)

L M THAPAR SCHOOL OF MANAGEMENT

THAPAR UNIVERSITY
PATIALA 147004 (INDIA)

MAY 2014
 CERTIFICATE

Certified that the thesis entitled “IMPACT OF ADVERTISEMENT

EXPENDITURE ON FIRM’S PERFORMANCE: A CASE OF FMCG
INDUSTRY IN INDIA”, which is being submitted by Ms Mandeep
Kaur Mahendru, in fulfillment of the requirements for award of the
Degree of Doctor of Philosophy in Management, to Thapar
University, Patiala, is a record of the candidate’s own work, carried
out by her under my supervision and guidance. The matter embodied
in this thesis has not been submitted in part or full to any other
University or Institute for the award of any degree.

(Dr K. K. De)
Professor and Head
L M Thapar School of Management
Thapar University
Patiala – 147004

Place: Patiala, Punjab (India)

Date: 26th May 2014

This thesis is dedicated to the Almighty, my parents,
my husband and my siblings
 ACKNOWLEDGEMENTS

This research is the outcome of the continuous encouragement and support by my

mentors, colleagues and friends.

I thank my PhD Supervisor Dr Kalyan K De, for his constant support, patient
guidance and confidence in me. He always spared time for me and gave me
feedback despite his busy schedule. He helped me grow and mature as a
researcher and supported me throughout my research. Dr Kalyan K De sets an
unparalleled example as an academician and mentor that I can only aspire to
follow one day.

My doctoral research committee has always been an asset for me. Members of the
committee gave timely suggestions for the betterment of my thesis. Prof (Dr) Ravi
Kiran deserves my heartfelt thanks. She has spent a great deal of time reading and
commenting on drafts and helping me improve this dissertation. I have been really
fortunate to gain from her great experience as a researcher, teacher and member of
the Research Committee. She was a wonderful role model to me and will
definitely influence my personal and academic career in many ways.

I am really grateful to Dr Piyush Verma who always guided me to improve my

dissertation. I respect him a lot as my mentor. He is the one who inspired me to
learn and apply Econometric tools.

I would also like to take this opportunity to express my appreciation to the other
members of my doctoral research committee – Dr Shaliender and Dr Alok
Chakraborty for their valuable advice and support during this research.

My Special thanks are also due to Prof (Dr) Parkash Gopalan (Director, Thapar
University) and Prof (Dr) K K Raina (Deputy Director, Thapar University). I
remain indebted towards Dr P K Bajpai (Dean, RSP) and Dr Padmakumar Nair
(Director, L M Thapar School of Management) for their continuous support.
The research papers emerging out of this research have been published in Global
Journal of Management and Business Research (GJMBR), Asia-Pacific Journal of
Management Research and Innovation (APJMRI) and Indian Journal of
Marketing. I am thankful to the teams of the journals for timely publishing the
papers.

(Mandeep Kaur Mahendru)

 ABSTRACT

This dissertation builds on the existing literature by studying the impact of

advertisement expenditure on firm’s performance in India. The research takes a
sample of 100 FMCG companies in India and studies the impact of advertising
and firm’s performance for the period ranging from 2001-02 to 2010-11. The
study uses sales, profits and firm value as measures of firm’s performance. While
the data for advertisement expenditure, sales and profits are obtained from the
annual reports of the firms concerned as also from the CMIE Prowess database,
the computations have been made to arrive at the firm value. Tobin’s Q ratio has
been used as a proxy for firm value. Various tools including Mean, Standard
Deviation, Coefficient of Variation, Kurtosis, Skewness are applied for getting
insights into the data. Econometric analysis including Augmented Dickey-Fuller
unit-root test, Vector Auto Regression, Variance Decomposition Analysis,
Impulse Response Function, Johansen’s Cointegration and Vector Error
Correction Model have been employed to find out the relationship between the
variables under reference. The study points towards the positive impact of
advertisement expenditure on sales, profitability and firm value. The study further
observes that sales Revenue and profitability has a positive impact on firm value.
 LIST OF TABLES

S. No Table Title of the Table Page No

No
1 1.1 Performance of BSE sectoral indices 14

2 2.1 Summary of related literature 53

3 3.1 List of the sample companies 65

4 4.1 Descriptive Statistics of Advertising Expenditure, Sales 80

and Profitability
5 4.2 Unrestricted Cointegration Rank Test (Trace) 81

6 4.3 Unrestricted Cointegration Rank Test (Maximum 82

Eigenvalue)
7 4.4 Unrestricted Cointegrating Coefficients 82

8 4.5 Unrestricted Adjustment Coefficients 82

9 4.6 Cointegrating Equations 83

10 4.7 Augmented Dickey-Fuller unit-root test (dlog of 85

advertisement expenditure)
11 4.8 Augmented Dickey-Fuller unit-root test (dlog of sales) 85

12 4.9 Augmented Dickey-Fuller unit-root test (dlog of profit) 86

13 4.10 Group unit-root test 86

14 4.11 Vector Autoregression (VAR) 87

15 4.12 Variance Decomposition Analysis of dlog of 88

advertisement expenditure
16 4.13 Variance Decomposition Analysis of dlog of sales 89

17 4.14 Variance Decomposition Analysis of dlog of profit 89

18 4.15 Vector Error Correction Estimates 91

19 4.16 Descriptive Statistics of Firm Value (Approximated by 93

Tobin’s Q)
20 4.17 Unrestricted Cointegration Rank Test (Trace) 94

21 4.18 Unrestricted Cointegration Rank Test (Maximum 95

Eigenvalue)
22 4.19 Unrestricted Cointegrating Coefficients 95
23 4.20 Unrestricted Adjustment Coefficients 95

24 4.21 Cointegrating Equations 96

25 4.22 Augmented Dickey-Fuller unit-root test (dlog of firm 97

value)
26 4.23 Vector Autoregression (VAR) 98

27 4.24 Variance Decomposition Analysis of dlog of 99

advertisement expenditure
28 4.25 Variance Decomposition Analysis of dlog of firm value 99

29 4.26 Vector Error Correction Estimates 101

30 4.27 Unrestricted Cointegration Rank Test (Trace) 103

31 4.28 Unrestricted Cointegration Rank Test (Maximum 103

Eigenvalue)
32 4.29 Unrestricted Cointegrating Coefficients 104

33 4.30 Unrestricted Adjustment Coefficients 104

34 4.31 Cointegrating Equations 105

35 4.32 Vector Autoregression 107

36 4.33 Variance Decomposition Analysis of dlog of firm value 108

37 4.34 Variance Decomposition Analysis of dlog of profit 109

38 4.35 Variance Decomposition Analysis of dlog of sales 109

39 4.36 Vector Error Correction Estimates 111

 LIST OF FIGURES

S. No. Figure No. Title of the Figure Page No.

1 1.1 The five Ms of advertisement 5
2 1.2 Growth of FMCG sector 15
3 1.3 Growth Drivers of FMCG industry 16
4 1.4 Five-forces model and FMCG industry 17
5 1.5 Segments in FMCG industry 18

Direct and indirect impact of advertisement

6 2.1 29
expenditure on firm value
Impulse Response Function (dlog of
7 4.1 90
advertisement expenditure, sales and profits)
Impulse Response Function (dlog of
8 4.2 100
advertisement expenditure and firm value)
Impulse Response Function (dlog of sales, profits
9 4.3 110
and firm value)
 TABLE OF CONTENTS

CHAPTER DESCRIPTION PAGE

NO. NO.
Certificate

Acknowledgements

Abstract

List of Tables

List of Figures

1 OVERVIEW OF THE STUDY 1-23

1.1 Introduction 1

1.2 Conceptual Foundation 3

1.3 Problem Statement 18

1.4 Objectives of the study 21

1.5 Hypotheses Development 21

1.6 Scope of the study 22

1.7 Organization of the study 23

2 REVIEW OF LITERATURE 24-63

2.1 Conceptual foundation 27

2.2 Advertisement, Sales and Profits 30

2.3 Advertisement, Sales, Profits and Firm Value 41

2.4 Theoretical Framework 52

3 RESEARCH DESIGN 64-78

3.1 Sampling Design and Data Collection 64

3.2 Data Analysis and Reporting 67

4 EMPIRICAL RESULTS 79-114

4.1 Impact of advertisement expenditure on sales and 79

profitability

4.2 Impact of advertisement expenditure on firm 92

value

4.3 Impact of sales and profitability on firm value 102

4.4 Managerial implications for marketers 113

5 CONCLUSION AND IMPLICATIONS 115-123

5.1 Summary of the Research Methodology 115

5.2 Summary of the Findings 118

5.3 Summary of Implications for Marketers 121

5.4 Limitations of the Study 122

5.5 Scope for further Research 123

REFERENCES 124-146
 CHAPTER ONE

OVERVIEW OF THE STUDY

1.1 Introduction

Business environment throws dynamic challenges in the form of ever-growing

competition. Product and brand extensions pose a challenge in terms of getting
customer attention. Marketing metrics become a serious concern for marketers,
who apply a variety of tools to overcome the competition. Advertisement is a vital
tool used by marketers to sell their products or services. Advertisement reaches
consumers through their TV sets, computers, radios, newspapers, magazines,
mailboxes and more.

The usage of advertisement as a measure to build long-term competitive edge

gains momentum in twentieth and twenty-first century only. Economists of the
nineteenth century and before hardly paid any attention to advertisement. It so
happens since the attention of the economists of nineteenth century was devoted
largely towards the theory of perfect competition, which hardly sees any role for
advertisement (Bagwell, Ramey and Spulber, 1997). It is argued that under perfect
competition, there is no merit in advertisement as the market will take as much as
any seller wants to sell at the market price (Pigou, 1924). Under perfect
competition, advertisement expenses don’t offer any returns to the producers. This
is so since on one side the demand curve is fixed and cannot be altered directly by
producers, while on the other hand, the producers can sell all that they can
produce at the market price and none of them can produce more at that price
(Braithwaite, 1928). Near the beginning of the twentieth century, Marshall (1890,
1919) offers some insights into the economic analysis of advertisement.
Chamberlin (1933) further builds on Marshall’s work and integrates selling costs
into economic theory. Towards the end of the twentieth century, advertisement is
seen as one of the strongest tools of marketing. The emergence of large-scale

1
advertisement is also attributable to income growth, advances in IT, literacy, and
urbanization.

Advertisement is regarded as being persuasive, informative and complementary

with the advertised product (Bagwell, Ramey and Spulber, 1997). American
Marketing Association defines advertisement as any paid form, non-personal
presentation of ideas, products and services by an identified sponsor. Similarly,
Advertisement is any paid form of non-personal communication about an
organization, product, service, or idea by an identified sponsor (Alexander, 1965).
Burnett (2008) also views advertisement as a tool of non-personal communication
aimed at disbursing marketing related information to a target audience, usually
paid for by the advertiser and delivered through mass media in order to achieve
the specific objectives of the sponsor Historically, the research work studying
advertisement has focused largely on sales and profit response of marketing
actions. The foremost function of advertisement has been seen in terms of
increasing sales revenue. Thinkers find that advertisement helps in generating
sales both in short-run and long-run (Dekimpe and Hanssens, 1995; Lee et al,
1996; Leong et al, 1996; Leach and Reekie, 1996).

The aim of marketing in past has been formulated from customer perspective
which in turn focused on marketing-sales relationship. Most of the earlier studies
investigating the nature of advertisement have typically relied on relating
advertisement to either the sales or profitability of the firm or industry. In recent
times, however, the practitioners have started showing keen interest in the
financial impact of marketing actions. It is being argued that advertisement is
directed at increasing the sales of business, which shall further lead to an increase
in profits. Increased profits may help increase the market price of the company’s
share, finally leading to increased firm value and shareholders’ wealth. Marketers
are now aiming to achieve better financial returns with the same amount of
marketing actions. It is very difficult to justify the relationship between marketing
expenditure and firm value with reducing budget, unless it is linked to the stock
price.

2
A debate about usefulness of advertisement has been raging for a long time now.
The effectiveness of advertisement has been an issue in marketing (Borden 1952).
On one side, advertisement expenditure is viewed as being wasteful altogether,
the other school of thought maintains that advertisement has been consistent in its
contribution towards increasing the sales revenue, profits and value of the firm.
Market/sales response to advertisement has been a vastly debated topic in
marketing research (Vakratsas and Ambler, 1999). Researchers have not been
able to arrive at a consensus with regard to the advertisement-sales relationship.
Finding out different levels of return on advertisement, Telser (1962) suggests
that managers should consider other variables, such as the economic condition
and the level of competition in the market when estimating the effect of
advertisement on sales.

1.2 Conceptual foundation

1.2.1 Advertisement

Advertisement is a mass communication tool. Advertisement is largely defined as

any form of non-personal communication about an organisation, product, service
or idea by an identified sponsor (Alexander, 1965). The non-personal component
indicates that advertisement involves transmission through the mass media, such
as TV, radio, magazines, newspapers and billboards to a large group of
individuals. In the present times of information technology revolution,
advertisement is also used through electronic media such as internet and mobile.
In fact, the traditional role of advertisement is changing in the market due to a
number of factors, mostly due to greater empowerment of consumers and rapidly
changing technology. The change in technology allows consumers to have more
control and greater access to information, increasing the efficiency of information
transfer from producers to consumers and further reducing costs. Consumers are
no longer passive receivers of information through advertisement but they are
now informationally empowered (Rust and Oliver, 1994).

3
Advertisement is an expense that the seller has to initially bear with the hope the
expenditure will generate sales and profits in the long-term. Advertisement is
profitable not because it lowers the elasticity of demand for the advertised good,
but because it increases the level of demand (Nelson, 1974). It is possible that the
level of competition increases advertisement outlays for the competitors in the
industry yet there is no re-distribution and a zero sum game results which in effect
are profit reducing. That is overall primary demand remains the same. It may also
be the case that advertisement induces select demand resulting in a re-distribution
within the industry and certain products profit at the expense of the others.

Advertisement has the ability to induce a response in consumers when

differentiation is difficult to achieve using other marketing mix variables (Rositer
and Percy 1997, Belch and Belch 1998). The aim of advertisement is to create and
foster this brand equity in order to maintain a position in the market and be easily
recognisable and differentiated from the competition. Advertisement is the most
effective way to build the long-term franchise of a brand and therefore very
important to find the link between marketing communications especially
advertisement to shareholder value (Belch and Belch 1998).

Five Ms of advertisement play a major role in developing an advertisement

program. As shown in figure 1.1, these include Mission, Message, Media, Money
and Measurement.

4
 Figure 1.1

The five Ms of advertisement

 What are the objectives?

Mission
 What is the key objective?

 How much is it worth to reach my objectives?

Money
 How much can be spent?

 What message should be sent?

Message
 Is the message clear and easily understood?

 What media vehicles are available?

Media
 What media vehicles should be used?

 How should the results be measured?

Measurement  How should the results be evaluated and

followed up?

1.2.1.1 Mission (setting the advertisement objectives): Advertisement Objectives

can be classified as to whether their aim is:

a) To inform: This aim of Advertisement is generally true during the

pioneering stage of a product category, where the objective is building a
primary demand. This may include telling the market about a new product,
suggesting new uses for a product, informing the market of a price change,
informing how the product works, describing available services, correcting
false impressions, reducing buyers’ fears and/or building a company
image.

5
 b) To persuade: The advertisements made with a view to persuade, aim at
building selective brand.

c) To remind: Such advertisements are highly effective in the maturity stage

of the product. The aim is to keep the consumer thinking about the
product.

1.2.1.2 Money: This M deals with deciding on the Advertisement Budget. The
advertisement budget can be allocated based on departments or product
groups, calendar, media used, specific geographic market areas. There are
five specific factors to be considered when setting the Advertisement
budget.

a) Stage in PLC: New products typically receive large advertisement budgets

to build awareness and to gain consumer trial. Established brands are
usually supported with lower advertisement budgets as a ratio to sales.

b) Market Share and Consumer base: high-market-share brands usually

require less advertisement expenditure as a percentage of sales to maintain
their share. To build share by increasing market size requires larger
advertisement expenditures. Additionally, on a cost-per-impressions
basis, it is less expensive to reach consumers of a widely used brand them
to reach consumers of low-share brands.

c) Competition and clutter: In a market with a large number of competitors

and high advertisement spending, a brand must advertise more heavily to
be heard above the noise in the market. Even simple clutter from
advertisements not directly competitive to the brand creates the need for
heavier advertisement.

d) Advertisement frequency: the number of repetitions needed to put across

the brands message to consumers has an important impact on the
advertisement budget.

6
 e) Product substitutability: brands in the commodity class (example
cigarettes, beer, soft drinks) require heavy advertisement to establish a
different image. Advertisement is also important when a brand can offer
unique physical benefits or features.

1.2.1.3 Message generation: Message generation can be done in the following

ways:

a) Inductive: By talking to consumers, dealers, experts and competitors.

Consumers are the major source of good ideas. Their feeling about the
product, its strengths, and weaknesses gives enough information that could
aid the Message generation process.

b) Deductive: John C. Meloney proposed a framework for generating

Advertisement Messages. A buyer expects four types of rewards from a
product, i.e. rational, sensory, social ego satisfaction. Buyers might
visualize these rewards from Results-of-use Experience, Product-in-use
Experience or Incidental-to-use Experience.

1.2.1.4 Media: The next ‘M’ to be considered while making an Advertisement

Program is the Media through which to communicate the Message
generated during the previous stage. The decisions involved in this stage
are –

a) Deciding on geographical media;

b) Deciding on media timing;

c) Selecting specific media vehicles;

d) Choosing among major media types; and

e) Deciding reach, frequency and impact

7
1.2.1.5 Measurement: Evaluating the effectiveness of the Advertisement Program
is very important as it helps prevent further wastage of money and helps
make corrections that are important for further advertisement campaigns.
Researching the effectiveness of the advertisement is the most used
method of evaluating the effectiveness of the Advertisement Program.
Research can be in the form of communication-effect research and sales-
effect research.

In a nutshell, advertisement is an important form of communication and its basic

responsibility is to deliver the message to the target audience. It is a very
important tool of promotion. It is expected to perform the following functions:

(a) Contribute to increase demand leading to increased sales and increased

profits;

(b) Help other promotion mix elements;

(c) Create satisfied customers and ensure them to make publicity by words of
month;

(d) Provide competitive edge over the other competitors in business;

(e) Help in building brand image;

(f) Encourage new product development, innovation and reduces risks;

(g) Increase the value of firm; and

(h) Overall, contribute in development of the business.

1.2.2 Firm performance

In order to view the impact of advertisement expenditure on firm’s performance,

this study uses three indicators of firm’s performance, i.e., sales, profits and firm
value.

8
1.2.2.1 Sales: Sales revenue is the total amount of money that the firm gets from
the sale of all its goods and services in a given period of time. Sales in
business terms are the actual sales in money values, received by a firm
after necessary collections are made from different sales channels of the
original total production put on the market (Mc Cathy et al, 1994). Sales
stimulate production in a company and consequently profits, which are
affected by various factors some of which are controllable like quality and
others are uncontrollable like competition and general price changes.

Sales performance also refers to the total amount of firm’s output sold to
the market. This is affected by many factors including customer
relationship, marketing management of the firm and sales-force skills and
motivation and even the pricing of the goods and services (Amanda D.H,
2002).

1.2.2.2 Profit: Profit is the financial benefit that is realized when the amount of
revenue gained from a business activity exceeds the expenses, costs and
taxes needed to sustain the activity. Any profit that is gained goes to the
business's owners, who may or may not decide to spend it on the business.
Profit is the money a business makes after accounting for all the expenses.

Profit is also understood as the surplus remaining after total costs are
deducted from total revenue, and the basis on which tax is computed and
dividend is paid. On the other hand, Helfert (1991) describes profitability
as the effectiveness with which the firm has employed both the total assets
and the net assets as recorded in the balance sheet. The effectiveness is
judged by relating net profit to the assets utilized in generating the profit.
It is the best known measure of success in an enterprise.

Major types of profit used in accounting terminology include –

a) Gross Profit equals sales revenue minus cost of goods sold (COGS),
thus removing only the part of expenses that can be traced directly to

9
 the production or purchase of the goods. Gross profit still includes
general (overhead) expenses, interest expense, taxes and extraordinary
items.

b) Earnings Before Interest, Taxes, Depreciation and Amortization

(EBITDA) equals sales revenue minus cost of goods sold and all
expenses except for interest, amortization, depreciation and taxes. It
measures the cash earnings that can be used to pay interest and repay
the principal. Since the interest is paid before income tax is calculated,
the debtholder can ignore taxes.

c) Earnings Before Interest and Taxes (EBIT)/ Operating Profit equals

sales revenue minus cost of goods sold and all expenses except for
interest and taxes. This is the surplus generated by operations. It is also
known as Operating Profit Before Interest and Taxes (OPBIT) or
simply Profit Before Interest and Taxes (PBIT).

d) Earnings Before Taxes (EBT)/ NET Profit Before Tax equals sales
revenue minus cost of goods sold and all expenses except for taxes. It
is also known as pre-tax book income (PTBI), net operating income
before taxes or simply pre-tax Income.

e) Earnings After Tax (EAT)/ Profit After Tax equals sales revenue after
deducting all expenses, including taxes (unless some distinction about
the treatment of extraordinary expenses is made). In the US, the term
Net Income is commonly used. Income before extraordinary expenses
represents the same but before adjusting for extraordinary items.

f) Retained Earnings are computed by deducting the payable dividends

from Earnings After Tax.

1.2.2.3 Firm Value: Determining the value of a company is a process very

important and controversial at the same time. Knowing the value of a firm
is indispensable not only in case of sale or merger but it is also useful to

10
identify sources of value creation. There is no standard method used for
determining the value of the company, but it differs depending on the
purpose, being a process that involves a high degree of subjectivism.

In conventional opinion, firm value is obtained by adding the market value

of equity to the market value of debt. However, this firm value measure
includes all assets owned by the firm including its cash holdings. Netting
cash out from firm value yields enterprise value, which can be considered
to be the market value of just the operating assets of the firm.

Firm Value = Market value of Equity + Market value of Debt

Enterprise Value = Market Value of Equity + Market value of Debt –

Cash Holdings

Ratio ‘Q’ developed by James Tobin of Yale University, Nobel laureate in

economics, has been extensively used as a proxy for firm value. Tobin
(1969) hypothesizes that the combined market value of all the companies
on the stock market should be about equal to their replacement costs. The
Q ratio is calculated as the market value of a company divided by the
replacement value of the firm's assets:

A number of improvised models of ‘Q’ have been developed by the

researchers after Tobin giving the ‘Q’ ratio. These include L-R algorithm
and many other improvised methods. The present study uses the simplified
version of approximated ‘Q’ as suggested by Chung and Pruitt (1994),
which seems simpler and more objective as compared to the original ‘Q’
as given by Tobin –

11
 Approximated Tobin’s q =

1.2.3 FMCG Industry

India is a South Asian country that is the seventh largest in area and has the
second largest population in the world. The land covers an area of 3,287,240
square km (India geography) and the population stands at 1,210,569,573 people
(2011 census). India has great plains, long coastlines and majestic mountains.
Thus, the land has abundant resources. India shares its borders with China,
Bangladesh, Pakistan, Nepal, Sri Lanka and Myanmar. Large, dynamic and
steadily expanding, the Indian economy is characterized by a huge workforce
operating in many new sectors of opportunity. The Indian economy is one of the
fastest growing economies and is the 12th largest in terms of the market exchange
rate at $1,242 billion (India GDP). In terms of purchasing power parity, Indian
economy ranks the fourth largest in the world. However, poverty still remains a
major concern besides disparity in income.

Fast Moving Consumer Goods (FMCG) goods are popularly named as consumer
packaged goods. Items in this category include all consumables (other than
groceries/pulses) people buy at regular intervals. The most common in the list are
toilet soaps, detergents, shampoos, toothpaste, shaving products, shoe polish,
packaged foodstuff, and household accessories and extends to certain electronic
goods. These items are meant for daily or frequent consumption and have a high
return. The Indian FMCG sector is the fourth largest sector in the economy with a
total market size. It has a strong MNC presence and is characterised by a well-
established distribution network, intense competition between the organised and
unorganised segments and low operational cost. Availability of key raw materials,
cheaper labour costs and presence across the entire value chain gives India a
competitive advantage. Indian FMCG market is set to treble from US$ 11.6
billion in 2003 to US$ 33.4 billion in 2015 (CII, 2014). Penetration level as well
as per capita consumption in most product categories like jams, toothpaste, skin

12
care, hair wash etc in India is low indicating the untapped market potential.
Burgeoning Indian population, particularly the middle class and the rural
segments, presents an opportunity to makers of branded products to convert
consumers to branded products. Growth is also likely to come from consumer
'upgrading' in the matured product categories. With 200 million people expected
to shift to processed and packaged food by 2010, India needs around US$ 28
billion of investment in the food-processing industry. Various other aspects of the
FMCG industry in India are discussed below –

a) Evolution of FMCG sector: Fast moving Consumer Goods (FMCG) also

known as inelastic products are the goods purchased by the consumers for
their own use and purchased repeatedly. The purchase is on daily or
weekly basis in small quantity. The price of such products per unit is low
but the consumption is very high due to the requirements of every one.
This has led to the emergence of a separate sector called FMCG sector in
India. India has always been a country with a big chunk of world
population, be it the 1950’s or the twenty first century. In that sense, the
FMCG market potential has always been very big. However, from the
1950’s to the 80’s, investments in the FMCG industries were very limited
due to low purchasing power and the government’s favouring of the small-
scale sector. The consumer markets in India are constantly evolving. The
first phase of consumer market evolution in the 1980s and the 1990s was
characterized by some major structural changes: changes in income
distribution, increased product availability (in terms of both quality and
quantity), increased competition, increased media penetration and
improved advertisement (impacting lifestyle). These raised the levels of
consumer awareness and propensity to consume, etc. The late 1990s
witnessed a surge in consumer finance products owing to steady financial
sector reforms in the economy and innovative marketing. The consumer
markets in India have entered the second phase of evolution with the turn
of the century. The Fast Moving Consumer Goods (FMCG) sector is the
fourth largest sector in the economy with a total market of Rs 160,100
13
 crores estimated to grow to US$ 100 billion by 2025. This industry
essentially comprises Consumer Non-Durable (CND) products and caters
to the everyday need of the population. Slowdown of the economy does
not hamper the growth of FMCG sector in India. It is one of the
outperformer sector in the country.

Table 1.1

Performance of BSE sectoral indices

(Source: Sector Indices are taken as on December 2012, the multiples for BSE FMCG Index
and BSE Index are based on TTM as on 18th April 2013)

The FMCG sector in India is growing due to increasing awareness and

penetration of mass communication into rural areas. This leads to rural
tastes converging onto urban lines, which in turn is resulting in a huge
surge in the demand for many personal use products in rural areas. The
most attractive growth drivers in FMCG sector are packaged food
category, detergents, hair care products, cosmetics, toiletries and edible
oil. To capitalize on this current growth many FMCG companies (Indian
and MNCs) are trying to increase their presence in various sub-segments
of the FMCG space. These companies are continuously trying to navigate
to new growth areas to avoid stagnation in one sub-segment and also

14
 fighting tough competition at the same time. In spite of ups and downs
FMCG sector remains most attractive opportunity for foreign players who
are eyeing presence in the emerging market. Amid the recent gloomy
scenario of the Indian economy, most of the FMCG companies have
bucked the trend by posting stellar top line growth driven by sustained
volumes. Major companies like Marico, Emami, Dabur and Hindustan
Uniliver Limited (HUL) have recorded 17%, 15%, 12% and 10% volume
growth respectively during the fourth quarter of FY12-13.

b) Industry Overview: The Indian FMCG sector is the fourth largest sector in
the economy with a total market size of US$ 33.4 billion1 (including
F&B, personal care, household care, tobacco, paints and spirits etc).The
market is estimated to grow to US$ 100 billion by 2025, according to
market research firm Nielsen. In the last decade the sector has grown at an
average of 11% per year; in the last five years, annual growth accelerated
to 17%.The graph below shows the growth of FMCG sector in INR
billions.

Figure 1.2

(Source: UBS, Indian Consumer Sector, March 2013, Converted at USD INR – 50)

Figure 1.3 exhibits the growth drivers of the FMCG industry.

15
 Figure 1.3

(Source: Dinodia Capital Advisers Report-May2013)

The industry is characterized by well established distribution network, low

penetration levels, low operating cost as well as low per capita
consumption, high purchasing frequency as well as sales in both the
organized and unorganized sectors with increased sale in both rural and
urban population of the country. With changing life style and increased
consumer demand the industry is expected to grow to cross $80 billion by
2026 in towns with population of up to 10 lakh .The applicability of
Porter’s Five Forces model on FMCG industry is shown in figure 1.4.

FMCG sector is proving to be a boon for the economy in terms of growth

as well as generation of employment in developed as well as developing
regions. The sector in contributing in reducing the carbon footprints by
generating the required energy from renewable sources and earn CRE
credits for the same.

16
 Figure 1.4

Five-forces model and FMCG industry

(Source: DINODIA Capital Advisers Report September, 2012)

c) Segments of FMCG industry: The FMCG industry may further be

classified into three segments as presented in Figure 1.5. The detergents
segment dominates the household care segment and has been growing at
an annual growth rate of 10-11% in the past five years. The Indian
personal care segment is set to change significantly in the coming years as
consumption habits, fuelled by rising disposable income and changing
lifestyles, align themselves with global trends. E.g. bath soaps are likely to
be replaced by shower gel or liquid soap variants and there will be
growing use of hair conditioners and electronic tooth brushes. The Food
and Beverages segment comprises of the food processing industry, health
beverage industry, bread and biscuits, chocolates & confectionery,

17
 Mineral Water and ice creams. India is one of the fastest growing branded
restaurants markets in the world, where the organized eating-out market is
currently estimated at US$ 2 billion and growing at a CAGR of 25%.

Figure 1.5

Segments in FMCG industry

FMCG

1.3 Problem Statement

Advertisement is a form of non-personal communication directed at increasing the

sales of business, which shall further lead to an increase in profits. Increased
profits may help increase the market price of the company’s share, finally leading

18
to increased firm value and shareholders’ wealth. It is important for marketer to
understand whether advertisement helps achieve these objectives or not. Such
understanding may help a firm in taking a call on its advertisement expenditure.

However, there is no consensus in empirical studies on whether or not

advertisement expenditure is able to achieve these goals. Leong et al (1996),
Leach and Reekie (1996), Metwally (1997), Graham, R.C. Jr and Frankenberger
(2000), Joshi and Hanssens (2002), Joshi and Hanssens (2010), Elliot (2001),
Pagan et al (2001), Kamber (2002), Yiannaka et al (2002), Ouyang et al (2002),
Kim and Morris (2003), Zhou et al (2003), Belch and Belch (2004), Pauwels et al
(2004), Esteve and Requena (2006), Shah and Akbar (2008), Agyapong et al
(2011), Banerjee et al (2012) provide the evidence of the impact of advertisement
expenditure on sales revenue. However, Beckwith (1972), Hamilton (1972), Aaker
et al (1982), Bass and Pilon (1980), Hanssens (1980), Jagpal (1981), Leone
(1983), Connolly and Hirschey (1984), Baltagi and Levin (1986), Bublitz and
Ettredge (1989), Aaker (1991), Tschoel and Yu (1991), Erikshon and Jacobson
(1992), Chauvin and Hirschey (1993), Kwoka (1993), Chauvin and Hirschey
(1994), Aaker and Jacobson (1994), Blattberg, Richard and Edward (1995),
Doyle (2000), Andras and Srinivasan (2003), Sharma and Sharma (2009) find
only a minor or no relationship between advertisement and sales.

Mixed results with regard to the contribution of advertisement expenditure in

firm’s performance as shown in the above empirical studies focusing on
numerous countries and numerous industries lead managers to no clear-cut
suggestion as to how much should they spend on advertisement. Hence, there is a
clear-cut need to conduct country-specific and industry-specific studies about the
contribution of advertisement expenditure in firm’s performance. Besides, the
years of economic liberalization coupled with the information technology
revolution and changing lifestyle are redefining the entire business dynamics.
One, advertisements are going global at a much faster pace leading to a global
response to advertisement. Two, the forms of advertisement are changing to
include electronic advertisement and mobile advertisement to the overall

19
advertisement portfolio of firms. This leads to change in the costing patterns of
advertisement. Three, urbanization has changed the entire lifestyle of people
across the world. Shortage of time at the disposal of individuals and families is
forcing firms to rethink their advertisement media as well as advertisement
content. As a result of all these changing patterns taken together, the impact of
advertisement expenditure on firm’s performance is bound to see a resultant
change. Therefore, there is a strong need to conduct research studies about
effectiveness of advertisement expenditure taking data till the recent years.

Extensive literature studies relationship among advertisement, sales, profits and

firm value, but majority of these studies focus on developed countries. In recent
years, the developing economies such as India and China have outperformed
developed economies such as USA and UK in terms of GDP growth rates, making
them favourite destinations for the firms and marketers. However, studies about
effectiveness of advertisement expenditure have still not shifted their focus
towards the developing economies, which is highly called for.

The present study builds on the existing literature by studying the inter-linkage
between advertisement expenses, sales, profits and firm value in a developing and
emerging economy, i.e. India. Further, the study focuses on the manufacturing
sector. Among the manufacturing sector, the study targets the FMCG industry,
which happens to be the most diverse industry in terms of product portfolio.
Moreover, Growing at a Compound Annual Growth Rate (CAGR) of 12%,
FMCG industry in India is expected to become a Rs 4,000 billion industry in 2020
(Booz & Company, 2011). The industry is characterized by a well-established
distribution network, low penetration levels, low operating cost, lower per capita
consumption and intense competition between the organized and unorganized
segments. Considering these factors, the research studies the relationship between
advertisement expenses, sales, profits and firm value in Indian FMCG industry.

20
 1.4 Objectives of the study

The study attempts to carry out the under-mentioned objectives–

 To study the impact of Advertisement on the market value of the firm.

 To observe whether increase in advertisement expenditure leads to

increase in sales revenue and profitability.

 To study the impact of sales revenue and profitability on the market

value of the firm

 To suggest the implications for marketers from the firm value effect of
advertisement.

1.5 Hypotheses Development

The impact of advertisement, sales and firm value are tested through spillover
and signaling effects (Joshi and Hanssens, 2010). Advertisement seeks to
differentiate a firm’s products from those of its competitors, thereby creating
brand equity for its products (Aaker, 1982). Besides, advertisement can also
act as a signal of financial well-being or competitive viability of a firm. (Joshi
and Hanssens, 2010). The present study attempts to test the following
hypotheses for studying the impact as such.

Hypothesis 1: Advertisement expenditure has a positive impact on firm value.

Hypothesis 2: Advertisement expenditure has a positive impact on sales

revenue and profitability of the firm.

Hypothesis 3: Sales Revenue and Profitability has a positive impact on market

value of firm.

21
 1.6 Scope of the study

This study is conducted mainly to understand the effectiveness of advertisement

expenditure in terms of its ability to influence a firm’s performance. The study
uses sales, profitability and firm value as measures of the firm’s performance.

The advertisement spending is higher in manufacturing companies’ than the

service companies. Moreover, the sales in currency and the sales in units are both
visible in case of manufacturing companies, whereas, in service companies only
the sales in currency are observable, sales in units are not. Hence, picking a
manufacturing industry for the purpose of such study makes logic. FMCG
industry, being one of the most diverse manufacturing industries, forms the scope
of the study. One hundred Bombay Stock Exchange (BSE)-listed companies from
the FMCG industry selected randomly are used as the sample for the study. The
sample period for the study is 10 years ranging from 2001–2002 to 2010–2011.

The findings of the study will be of particular interest to the marketers and
managers in arriving at the decision regarding the advertisement budget of the
firm. The study aims to establish the advertisement effectiveness in terms of its
contribution to the sales, profits and firm value. In case the findings of the study
show the impact of advertisement expenditure on sales and profits, the marketers
will be tempted to stretch their advertisement budgets in order to build a
competitive edge over the competitors. Furthermore, in present era, the
shareholders are observed to be closely tracking every development in the firm.
Shareholders are keeping a close eye on the advertisement spending by the firm,
the amount spent on public relations by the firm and other similar issues. The
findings of the study with regard to the contribution of advertisement expenditure
in firm value will be of keen interest to the shareholders. As of now, the
shareholders are not in a position to make out if an advertisement campaign is
beneficial for them or not. The study may offer some strategic inputs to the
shareholders in this regard.

22
The study leaves a scope for future research in the area. While on one hand, future
researchers may cover other industry(s) for their studies, on the other hand,
research efforts may also be made in future to include more than one countries.
Inter-industry or inter-country studies may also be undertaken.

1.7 Organization of the study:

The thesis is organized as follows –

The current chapter, i.e., Chapter One entitled ‘Overview of the study’
introduces the study while also defining the research problem and building the
problem statement. Moreover, the chapter defines the concepts involved in the
study. The objectives and scope of the study also form part of this chapter.

Chapter two of the thesis is titled ‘Review of Literature’. This chapter reviews
the literature regarding various objectives of the research and brings forth the
gaps in literature for the purpose of building a case to undertake the present
research. The chapter also reviews the tools put to use by previous researchers
on the topic.

The third chapter of thesis – ‘Research Methodology’ – presents the

methodology employed with regard to sampling, data collection, data analysis
and report presentation. The chapter discusses in detail the tools applied for
data analysis.

‘Empirical Analysis’ is the fourth chapter of this thesis. The chapter presents
the findings of the study with respect to the objectives as outlined in Chapter
one of the study. In addition to the quantitative and diagrammatic presentation
of the findings, the chapter also analyses the findings through text tool.

Chapter five entitled ‘Summary and Conclusion’ concludes the study. The
chapter presents a broad-based summary of the thesis with issues ranging
from problem statement through the findings of the study. The chapter also
outlines the managerial implications from the study, in particular.

23
 CHAPTER TWO

REVIEW OF LITERATURE

Economic literature starts paying attention to the advertisement only in the

twentieth century. Prior to that, there is hardly any evidence of economic thinkers
highlighting the value of advertisement for a firm. The economists of nineteenth
century were mainly focusing towards the theory of perfect competition. Perfect
competition hardly sees any role for advertisement (Blagwell, 2005). Under
perfect competition, the market takes as much as any seller wants to sell at the
market price, thereby making advertisement a negligible tool (Pigou, 1924). It is
near the beginning of the twentieth century that Marshall (1890, 1919) offers
some insights into the economic analysis of advertisement.

Marshall (1919) suggests that advertisement can play a constructive role by

conveying information to consumers about existence, location, functions and
qualities of the products. Fogg-Meade (1901), Pigou (1924), Shaw (1912),
Sherman (1900) and Shryer (1912) also contribute significantly to the economic
analysis of advertisement. Economic analysis of advertisement, however, stops
short of integrating advertisement into economic theory, a work that is completed
by Chamberlin (1933) by embracing this integration. Chamberlin (1933) argues
additionally that a firm can use advertisement and other promotional activities to
further differentiate its product from those of its rivals. Advertisement-induced
product differentiation is beneficial to a firm as a means of expanding its market;
in graphical terms, by advertisement, a firm generates an outward shift in its
demand curve. Chamberlin (1933) establishes that advertisement affects demand
by conveying information (to consumers) with regard to the existence of sellers,
the price and qualities of products in the marketplace, thereby altering consumers’
“wants” or tastes.

The interest in advertisement grows significantly towards the end of the twentieth
century with Borden (1942), Wood (1958), Chandler (1990), Harris and Seldon

24
(1962), Simon (1970), Schmalensee (1972), Comanor and Wilson (1979), Pope
(1983), Ekelund and Saurman (1988), Tirole (1988), Schmalensee (1989), Stiglitz
(1989) exploring the need for advertisement in economic activities.Further, There
has been controversy regarding the accounting treatment of advertisement
outlays.A number of studies in the existing literature support the notion of
advertisement having an asset value (e.g. see Chauvin and Hirschey,1993;
Hirschey 1985; Hirschey and Spencer1992; Lustgarten and Thomadakis 1987;
Morck et al. 1988; Morck and Yeung 1991, among others). The conclusions are,
however, not unequivocal. There are other researchers (e.g. see Aaker and
Jacobson 1994; Bublitz and Ettredge 1989; Erickson and Jacobson 1992;
Sougiannis 1994, among others) who argue for supporting the notion that
advertisement does not generate benefits beyond the period in which this
expenditure is incurred. The difficulties in accounting for advertisement
expenditure are mainly because of the complexity of identifying the costs
associated with the particular activities, projects or achievements, and the
determination of the magnitude of future benefits and the length of its useful life.
Since management can anticipate current profit levels with more certainty as
compared with future profitability, they would normally prefer to write off all
expenditure in the current period. Han and Manry (2004), for instance, indicate
that investors believe the economic benefits of advertisement expenditure expire
in the current period, similar to other expenses. As a consequence, management
often seems more inclined to record all the expenditure on advertisement in the
current period when profit levels are known with more certainty, than risking the
carrying of these costs over into future periods as capitalized costs. The firm
might not have sufficient revenues in future periods to absorb amortization of
these costs. Following these kind of arguments, advertisement expenditure is
generally written off in the current period. Peles (1970) remarks that the dominant
accounting practice is to charge advertisement expenditure to current expenses,
producing an implicit rate of amortization of 100%. This practice is based on tax
benefit considerations, conservatism, and a lack of other acceptable and non-
arbitrary systems of amortization. But there are still others (e.g. Hirschey 1982;

25
Hirschey and Weygandt 1985) who believe that advertisement expenditure should
be capitalized and amortized over their useful lives. In their view, since
investment in advertisement would benefit current as well as future periods, the
cost should be recorded as an intangible asset and amortized against current and
future revenues. Abdel-Khalik (1975) points out that choices of treating
advertisement as expense or capitalizing it over its useful life are significant
‘because of their potential impact upon the measurement of income, earnings per
share, and possibly the balance sheet’. If advertisement expenditure is treated as
an expense, it will, on the one hand, reduce earnings but, on the other hand, could
provide tax benefits to the firm. Similarly, according to the matching principle,
expenses of a period should be matched with revenues of a period. If all
advertisement expenditure is expensed in one period while its benefits accrue in
the future periods, the matching principle of accounting will be jeopardized.
Further, the immediate expensing of advertisement has an impact on various
measurements such as the return on equity, return on assets and other similar
indicators of the financial health of the firm. Supporting the long-lived view of
advertisement, Hirschey (1982) and Hirschey and Weygandt (1985) conclude that
advertisement is long-lived and should be capitalized and amortized over time
rather than expensed when incurred. White and Miles (1996) also argue that
advertisement is indeed a strategic investment in the organization’s stock or
intangible assets, future cash flows, and market value. As an investment in an
invisible asset, advertisement should be subjected to the same capital budgeting
analysis as any other expenditure that produces multi-period cash flows. Failure to
do so is inconsistent with the financial objective of shareholder wealth
optimization. Barth and Kasznik (1999) use advertisement and R&D as proxies
for intangible assets and argue that ‘we select research and development and
advertisement expenses because firms making investments in these activities
likely have intangible assets related to, e.g. developed technology and brand
names, many of which are not recognized in firms’ financial statements’.
Similarly, Graham and Frankenberger (2000) conclude that real dollar

26
advertisement changes are associated with future earnings and with market
values.

Since then, empirical literature has extensively studied the concept and relevance
of advertisement expenditure. Researchers have debated the usefulness of
advertisement expenditure with regard to its capability to impact firm
performance. Further, much research has been conducted on the variables of firm
performance. Sales, profits and firm value have largely been studied as the
indicators of firm performance. Some studies attempt to establish the relationship
between advertisement expenditure and one or more variables of firm
performance.

The literature reviewed in this section is mainly divided into four sub-sections –
(i) conceptual foundation; (ii) relationship between advertisement expense, sales
and profits; (iii) relationship between advertisement expense, sales, profits and
firm value; (iv) theoretical framework.

2.1 Conceptual foundation

Advertisement is a paid form of non-personal communication by an identified

sponsor (Alexander, 1965:9), which aims to push the audience towards a purchase
decision. It involves transmission through the mass media in the form of
billboards, newspapers, magazines, television, radio and internet, etc. It represents
an important means by which organizations communicate with their customers,
current as well as potential (Clow and Baack, 2004). Advertisement expenditure
is also viewed as a tool to prevent the competing businesses from entering the
industry (Schmalensee, 1976; Beath et al., 1987; Beath and Ulph, 1990). It helps
the business achieve competitive advantage by selling its products and
overcoming the rivals. Since advertisements have empirically been found to have
an influence on the purchase behaviour of consumers (Kundu, Kulkarni and
Murthy, 2010), the corporate world is investing a massive amount of money on
advertisement. Companies spend money on the advertisements and publicity in
order to make sure that the masses are aware of its products, their features and

27
advantages over the competitors. Basic purpose of advertisement is to increase the
sales of the advertised products/companies. Basically, it is meant to sell a product,
service or an idea Similar as well as diverse opinions are found about the concept
of advertisement. Researchers largely agree that advertisement is a non-personal
communication. Bovee and Arens (1992) opine that advertisement is the non-
personal communication of information usually paid for and usually persuasive in
nature about products, services or ideas by identified sponsors through the various
media. More recently, Jones, Gregory and Munro (2009) regard advertisement as
a sort of machine-made mass production method of selling, which supplements
the voice and personality of the individual salesman much as in manufacturing the
machine supplements the hands of the craftsmen. Typically, advertisement was
considered merely as a print-media activity. This is evident when Starch (1961)
considers advertisement as the presentation of a proposition usually in print to the
people in such a way that they may be induced to act upon it. However,
advertisement has evolved immensely over the recent years. Advertisement
includes those activities by which visual or oral messages are addressed to the
public for purpose of informing them either to any merchandise, to act, to inclined
favourably towards ideas, institution or persons featured. Now advertisement is
viewed more as the art of disseminating marketing information through various
media of communication at the expense of the company for the purpose of
increasing or maintaining effective demand (Thompson et al, 1993). In a broad
sense, advertisement consists of all the activities in presenting to a group, a non-
personal, visual, openly sponsored message regarding a product, service or idea
(Pires, Stanton and Cheek, 2003). Business expects a return on all the investments
being made, including advertisement expenditure. Therefore, it is all the more
important for the marketers to examine its impact on their performance.

There have been studies about the impact of advertisement on firm’s performance.
The studies have ranged from the indirect effect studies to the dynamic studies
like the Strategic Planning Institute’s PIMS (Profit Impact of Market Strategy)
study that finds the companies having increased advertisement during recession
outperforming the average of all businesses by almost 250% and that the cost of
28
spending had no significant effect on ROI. The study of firm value is a study of
tangible and intangible value of the firm (Simon and Sullivan, 1993). The
distinction between the two types of effects is visible in Figure 2.1 below –

Figure 2.1

Direct and indirect impact of advertisement expenditure on Firm Value

[Source: Joshi and Hanssens (2010)]

While tangible assets include sales and profits (Blattberg, Briesch and Fox 1995;
Lodish et al 1995; Nijs et al 2001, Pauwels et al 2002), intangible assets may be
classified as: (i) market specific factors such as regulations that lead to imperfect
competition, (ii) firm-specific factors, such as R&D expenditures and patents, and
(iii) brand equity (Simon and Sullivan 1993).

Sales and profits form part of the tangible firm value, from the marketing angle.
Lodish et al (1995) study the impact of marketing instruments on the tangible
value for the short-run while Nijs et al (2001) and Simester et al (2009) study this
impact for the long-run. Tangibly, value of the firm comprises of the present
value of cash flows during the value growth period and the long-term, residual

29
value of the product/business at the end of the value growth period (Day and
Fahey 1988; Rappaport 1986). Market-based assets of the firm can enhance
shareholder value by improving market performance through helping a product or
service penetrate markets faster, getting price premiums, making brand extensions
easier, lowering costs for sales and service, and/or obtaining higher customer
loyalty and retention (Han, Kim and Srivastava, 1998). Better market
performance based on superior market-based assets can accelerate and enhance
cash flows, reduce volatility and vulnerability of cash flows, and increase the
residual value of cash flows that, in turn, generate higher shareholder value (Han,
Kim and Srivastava, 1998).

On the other hand, intangible value of the firm is reflected in its intangible assets,
such as brand equity (Chan et al, 2001). The intangible assets are not required to
be reported in the accounting books in most of the countries, which adds
complications to the firm valuation exercise. Simon and Sullivan (1993) classifies
intangible assets as (a) market-specific factors, such as regulations leading to
imperfect competition; (b) firm-specific factors, such as Research & Development
expenditure and patents; and (c) brand-equity.

2.2 Advertisement, Sales and Profits

A number of studies concerning advertisement expenditure presume an impact of

advertisement on sales to start with. This presumption doesn’t seem much realistic
though, since the relationship between the two variables is not just one-sided.
Besides the impact of advertisement on sales, there is also a possibility of sales on
advertisement expenditure (Abe, 1995; Hsu et al, 2002; Lee et al, 1996; Tellis and
Fornell, 1998). The causal relationship between the two variables appears to run
in both directions when proper econometric tools are used to detect it (Lee et al,
1996).

The initial evidence of advertisement on sales is provided by Hollander (1949).

Afterwards, Jastram (1955), Vidale and Wolfe (1957), Nerlove and Waugh
(1961), Palda (1964, 1965), Alexander (1965), Tull (1965), Verdon et al (1968),

30
Abdel-Khalik (1975), Lambin (1969, 1970, 1976), Clarke (1976), Peles (1970,
1971), Simon (1969), Leone and Schultz (1980), Hanssens (1980), Assmus, Farley
and Lehmann (1984), Jose, Nichols and Stevens (1986), Sethuraman and Tellis
(1991), Baghestani (1991), Simon and Sullivan (1993), Zanias (1994), Dekimpe
and Hanssens (1995), Natarajan et al (2010) report the positive effect of
advertisement on sales. The number of other studies (e.g. Dean 1951; Jastram
1955; Vidale and Wolfe 1957; Nerlove and Waugh 1961, among others) that
report the existence of a lagged effect of advertisement. Perhaps one of the more
detailed studies providing more comprehensive evidence on the issue of the carry-
over effect of advertisement came from Palda (1964, 1965). Palda (1965), while
pointing towards a relative lack of empirical evidence regarding the cumulative
effects of advertisement expenditure, provides a unique analysis of the effects of
advertisement on sales. The study tests a number of models using multivariate
regression. The results in Palda (1965) indicate that advertisement is an intangible
asset that is subject to amortization and that, on average, 95% of the
advertisement expenditure was amortized during a period of almost seven years.
Similarly, Lambin (1969, 1970, 1976), Peles (1970,1971), Simon (1969) and Tull
(1965) provide evidence of an influence of advertisement on sales.

Abdel-Khalik (1975) examines the effects of advertisement on sales revenues by

employing OLS regression with a sample of firms from the food, automobile,
tobacco, soap and cleaners, drugs and cosmetics industries in United States from
1955 to 1973. The paper finds long-lived effects of advertisement on sales in the
food and the drugs and cosmetic industries and short-lived effects for the rest of
the groups. The study further argues for different treatments of the promotional
cost of firms in different industries. Baghestani (1991) takes annual advertisement
and sales data from the Lydia Pinkham Company from 1907 to 1960 and found
that both are cointegrated and share a long-term relationship. Zanias (1994) also
analyzes the Lydia Pinkham data set and finds bivariate granger causality between
advertisement and sales. The two series were also found to have a valid long-term
relationship. Dekimpe and Hanssens (1995) find out that advertisement has a
strong effect on sales for a chain of home improvement stores.
31
Clarke (1976) reviews the econometric literature to determine the duration of
cumulative advertisement effects on sales. Clarke classifies around 69
econometric studies into various groups on the basis of the data collection interval
as used by these studies. Based on his survey of the studies and analysis, Clarke
(1976) suggests that ‘the long implied duration intervals obtained from the annual
models are due to data interval bias’. Clarke (1976) concludes that if one
considers the monthly, bimonthly, and quarterly results to be most likely to be
free of data interval bias, the duration of cumulative advertisement effect on sales
is between 3 and 15 months: thus this effect is a short-term (about a year or less)
phenomenon. Leading brands (e.g. Cadburys, Pepsi, Persil, Ford, BT, among
others) have managed, however, to maintain their reputation and brand leadership
for so many years. Both current and past advertisement seems to have played a
key role in building such strong images for these leading brands. The findings in
Dekimpe and Hanssen (1995), for instance, differ from Clarke (1976) that 90% of
the measurable effects of advertisement on sales are consumed within a few
months. The findings in Dekimpe and Hanssen (1995) suggest that Clarke’s
conjecture may be valid in stable environments but should not be generalized to
evolving markets. Dekimpe and Hanssen (1995) believe that ‘if the distinct nature
of evolving environments is not taken into account, one may seriously
underestimate the long-run effectiveness of advertisement’. Clarke’s survey of
econometric studies of the cumulative effects of advertisement ignited a lively
debate, and a number of authors have put forward their own arguments in
commenting on, and/or disputing the conclusions of the survey. Bloch (1974),
citing a number of empirical studies, remarks that, despite the findings in these
studies which demonstrate that advertisement has a long-lasting effect on sales
yet, normal accounting practice is to treat advertisement expenditures as a current
expense in the calculation of reported profit and net worth ... so that the net worth
of the firm is understated the reported profit of the firm is misstated. Lee et al.
(1996) question earlier studies for failing to detect the simultaneous causal
relationship between advertisement and sales. Lee et al. (1996) believe that the
causal relationship between advertisement and sales appears to run in both

32
directions when proper econometric tools are used to detect it. Using
advertisement data derived from various sources, Duffy (1996) finds no evidence
to back up the view that aggregate cigarette advertisement serves to expand the
total market for cigarettes. Similarly, Duffy (1999) suggests that food
advertisement has no effect upon the share of household budgets devoted to food
consumption. Using quarterly data derived from various sources, Elliott (2001)
examines whether there is a long-term, stable, equilibrium relationship between
advertisement and sales for food and drinks industries. Cointegration between
advertisement and sales for the food industry, but not for the soft drinks industry
data, has been identified. Similarly, Yiannaka et al. (2002) examine the
effectiveness of advertisement for an unbalanced panel data set of 34 meat
processing firms in Greece over 1983–1997. Yiannaka et al. (2002) indicate total
advertisement by the firms of the sector as a very important determinant of their
sales. Ouyang et al. (2002) show the existence of a long-term impact of
advertisement on the sales of consumer durables (colour television sets,
refrigerators, washing machines, microwave ovens and video CD/VCD players)
in China. Similarly, Zhou et al. (2003) investigate the impact of short-term
advertisement on long term consumer durables and non-durables in China using
cross-sectional time-series television advertisement and sales data. Results in
Zhou et al.(2003) show that advertisement had a long-term effect on sales of
consumer durables (colour television sets, refrigerators, washing machines and air
conditioners), but did not have long term effects on sales of consumer non-
durables (shampoo and skincare cream).

In some more studies, Leong et al (1996), Leach and Reekie (1996), Metwally
(1997), Graham, R.C. Jr and Frankenberger (2000), Joshi and Hanssens (2002),
Joshi and Hanssens (2010), Elliot (2001), Pagan et al (2001), Kamber (2002),
Yiannaka et al (2002), Ouyang et al (2002), Kim and Morris (2003), Zhou et al
(2003), Belch and Belch (2004), Pauwels et al (2004), Esteve and Requena
(2006), Shah and Akbar (2008), Agyapong et al (2011), Banerjee et al (2012)
provide the evidence of the impact of advertisement expenditure on sales revenue.
Leong et al (1996) reveal a strong positive relationship exist between
33
advertisement expenditure and sales by applying cointegration technique.
Application of Granger causality test by Leach and Reekie (1996), show that
advertisement expenses cause sales but sales do not simultaneously cause
advertisement. Metwally (1997) explains the variations in the growth rates of
advertisement expenditure of consumer goods and services in Australia during the
period 1975-1995 by developing and testing a number of hypotheses. His
application of regression results indicate that the growth in advertisement
expenditure is strongly correlated with the growth in sales and that movement in
market shares exerts a significant effect on the growth in advertisement
expenditure. Elliot (2001) finds that advertisement has a significant positive effect
of on the food industry sales and he concludes this relationship to be stable.
Pagan et al (2001) uses bivariate Vector Auto Regression model to study the
effectiveness of advertisement on sales and reveals that one time increasing in
advertisement expenditure leads to increase in the sales of orange with a one
month lag. Kamber (2002) finds a measurable relationship between advertisement
expenditures and sales, even after controlling factors like company size, past sales
growth, etc. Examining the effectiveness of advertisement for an unbalanced
panel data set of 34 meat-processing firms in Greece over 1983–1997, Yiannaka
et al. (2002) indicate total advertisement by the firms of the sector as a very
important determinant of their sales. Ouyang et al. (2002) observe a long-term
impact of advertisement on the sales of consumer durables in China. Zhou et al.
(2003) show that advertisement had a long-term effect on sales of consumer
durables, but did not have long-term effects on sales of consumer non-durables.
Pauwels et al. (2004) study stock market performance in United States using the
data period of 1996 to 2001. The study claims that advertisement expenditure
affects sales revenue in the short term and the long term. Esteve and Requena
(2006) establish a long run relationship between advertisement and sales across
different markets over the period 1971 – 2001 in the UK car industry and found
out two structural breaks during the recession periods. Agyapong et al (2011) find
strong relationships between marketing communication and sales performance of

34
Vodafone in Ghana. Banerjee et al (2012) find evidence of cointegration between
marketing communication and sales in the personal care industry in India.

Some of the recent studies have found only a minor or no relationship between
advertisement and sales. These include Beckwith (1972), Hamilton (1972), Aaker
et al (1982), Bass and Pilon (1980), Hanssens (1980), Jagpal (1981), Leone
(1983), Connolly and Hirschey (1984), Baltagi and Levin (1986), Bublitz and
Ettredge (1989), Aaker (1991), Tschoel and Yu (1991), Erikshon and Jacobson
(1992), Chauvin and Hirschey (1993), Kwoka (1993), Chauvin and Hirschey
(1994), Aaker and Jacobson (1994), Blattberg, Richard and Edward (1995),
Doyle (2000), Andras and Srinivasan (2003), Sharma and Sharma (2009).

Studying the sales of a commercial bank, Jagpal (1981) observes that radio
advertisement was ineffective in generating sales (number of savings and
checking accounts). Baltagi and Levin (1986) investigate the relationship between
advertisement expenditure and sales by using a dynamic demand tier cigarettes
which uses a pooled data of 46 states from year 1963 to 1980. Running an
empirical analysis using panel data analysis and Hausman-Taylor Estimators, the
paper claims that negative relationship between advertisement expenditure and
sales and indicated insignificant income elasticity and significant low price
elasticity. Their findings were consistent with Hamilton (1972), that there is a
negative relationship between advertisement expenditure and sales which was
worked out in the (US cigarette industry). Kwoka (1993) studies the advertisement
and sales for the United States automobile industry. In his study which uses a data
set of 22 years from I960 to 1982 by using Hausman's test and OLS model to
determine the impact of advertisement, Kwoka (1993) claims that there is a
positive relationship between the 13 advertisement and sales for the U. S.
automobile industry. He also shows that advertisement in the automobile industry
increases a car's model sales, but it is just short-lived.

Sharma and Sharma (2009) reveal that the effect of advertisement on sales is
more for manufacturing companies and less for non-manufacturing companies.

35
This finding is consistent with the findings of Andras and Srinivasan (2003).
Conversely, non-manufacturing companies need to spend more on advertisement
to have the same level of sales revenue. This explains why non-manufacturing
companies spend more on advertisement as compared to manufacturing
companies.

Empirical researches also find evidence to suggest that the advertisement-sales

relationships could be influenced by other marketing activities of the firm and/or
competitors as well as exogenous variables such as population and income (Telser
1962; Palda 1964; Quandt 1964). Studying various cigarette brands, Telser
(1962) finds that there are different levels of return on advertisement depending.
The study suggests that managers need to consider other variables, such as the
economic condition and the level of competition in the market when estimating
the effect of advertisement on sales (Telser 1962, 1964). Quandt (1964) also
argues that economic variables such as disposable income and geographic-
demographic variables such as education should be considered exogenous
variables that can affect the relationship between advertisement and sales. Bass
and Clarke (1972), Rao and Miller (1975) look at other marketing mix variables,
such as sales promotion measures, and other market performance variables, such
as market share. In the later periods, more researchers involve in studying the
market response analysis approach (Assmus et al. 1984; Leone and Shultz 1990;
Lodish et al. 1995; Sethuraman and Tellis 1991; McDonald 1992; Parker and
Gatignon 1996). Market response analysis approach generally relates
advertisement as well as price and promotional measures directly to market
performance measures such as sales, market share, and brand choice (Vakratsas
and Ambler, 1999). On one hand, studies deal with market- level data such as
brand advertisement expenditures and brand sales or market share

(Bass and Clarke 1972; Rao 1975; Blattberg and Jeuland 1981; Hanssens et al.
1990); while on the other hand, individual - level data such as the number of
exposures for an individual and individual brand choice is examined (Tellis 1988;
Pedrick and Zufryden 1991; Deighton et al.

36
1994). Market response to advertisement differs across different periods of
research. For instance, Winer (1979) suggests that the carryover effects of
advertisement expenditure on sales declines over time, while the current
advertisement effects increase during the same period. Leone (1995) suggests that
advertisement’s effects on sales would disperse after six to nine months instead of
earlier estimates (Assmus, Farley, and Lehmann 1984) of three to fifteen months.
Dekimpe and Hanssens (1995) argue that the effects of advertisement do not
dissipate within a year.

The persuasive view of advertisement maintains that advertisement creates brand

loyalty and works to deter entry. Bain (1956) and Comanor and Wilson (1967,
1974) argue, this conclusion may be indirectly evaluated by examining the
association between advertisement intensity and profitability.

Comanor and Wilson (1967, 1974) observe a strong and positive relationship
exists between advertisement intensity and profitability for U. S. manufacturing
industries that produce consumer goods. Using the US data, other studies
including Backman (1967), Boyer (1974), Connolly and Hirschey (1984), Connor
and Peterson (1992), Domowitz et al (1986a, 1986b), Esposito and Esposito
(1971), Gomes (1986), Hirschey (1978, 1985), Jones et al (1977), Kwoka and
Ravenscraft (1986), Mann (1966), Martin (1979a,b), Miller (1969), Porter (1974,
1976a, 1976b, 1979), Ravenscraft (1983), Vernon and Nourse (1973) and Weiss
(1974). Similarly, Cowling et al (1975), Geroski (1982) and Nickell and Metcalf
(1978) use U. K. data and report evidence of a positive relationship between
advertisement and profitability. Similar findings are reported by Jones et al (1973,
1977) and Orr (1974b) for Canadian data and by Caves and Uekusa (1976) and
Nakao (1979) for Japanese data. More recently, Siong (2010) finds a positive
relation between advertisement and firm profitability. Hamid, Nadar and Meena
(2012) provide evidence to show the existence of long term relationship between
advertisement expenses and profitability. Notta and Oustapassidis (2001) find
television advertisement effects on profitability to be positive and significant only
in the consumer industries where television advertisement intensity is high.

37
There are also some dissenting studies. For example, Salinger (1984) finds that
advertisement interacted with concentration fails to exert a significant and positive
influence on profitability measure. Eckard (1991) also reports that cigarette-
industry profit margins increased after the 1970 U.S. ban on TV advertisement.
Landes and Rosenfield (1994) offer evidence that the relationship may reflect the
omission of firm-specific variables such as product quality. Greuner, Kamerschen
and Klein (2000) conclude that firms cannot increase their profits above normal
levels by increasing their advertisement expenditures. Advertisement serves
primarily to transmit information, not to create entry barriers.

Graham and Frankenberger (2000) provide general evidence of advertisement

asset values, arguing that advertisement expenditure contributes to earnings for
more than one period. Similarly, Notta and Oustapassidis (2001) examine the
effects of each of the TV, radio, newspaper and magazine advertisement on firm
profitability in the period 1993–1996. Using firm-level panel data for 350 firms in
the Greek food manufacturing sector, Notta and Oustapassidis (2001) indicate
that only TV advertisement increases profitability. The majority of earlier
advertisement profitability studies (e.g. Comanor and Wilson 1974; Weiss 1969,
among others) have focused on adjusting profit rates only for accounting
treatment of advertisement expenditure. They have apparently ignored (for one
reason or another) other factors such as investments in R&D, and training and
development costs that are expensed despite the fact that they yield benefits in the
future. Specifically, there is enough empirical evidence (see e.g. Core et al.2003;
Green et al. 1996; Hirschey 1982; Chauvin and Hirschey 1994, among others)
emerging regarding R&D that the market appears to treat such expenditure as if it
were investments in long-term intangible assets. In addition to advertisement,
these other factors may potentially cause a bias in the profit rates. Grabowski and
Mueller (1978), for instance, support similar arguments by commenting that
‘profit rates should be adjusted for the capital investment character of R&D (along
with advertisement), before one investigates the relative importance of R&D and
the other structural determinants of profitability’.

38
The role and contribution of advertisement has been different in different
industries. Telser (1964) observes that in producer goods industries,
advertisement may play a less central role in the selling costs of the firm. Weiss et
al (1983) provide some empirical support for a diminished role of advertisement
for manufacturers of producer goods. Therefore, the relationship between
advertisement intensity and profitability is expected to be weaker in producer-
goods industries. Providing an evidence consistent with this expectation,
Domowitz et al (1986a, 1986b) find that the positive relationship between
advertisement intensity and profitability is weakened in manufacturing industries
that supply producer goods. Esposito and Esposito (1971), Jones et al (1977) and
Miller (1969) also provide a similar evidence about relation between
advertisement and profitability.

Backman (1967), Telser (1968, 1969a) and Weiss (1969) note that the positive
advertisement-profitability relationship is spurious, being derived from a
measurement approach that biases the profit rate upward in the presence of heavy
advertisement. Comanor and Wilson (1974) also confirm this conclusion. On the
other hand, Bloch (1974) and Ayanian (1975) argue that advertisement does not
have a statistically significant effect on the true rate of profit.

Advertisement-profit relationship also leads one to attempt exploring if

advertisement and profitability and jointly determined. Schmalensee (1972,
1976a, 1989) emphasizes that advertisement intensity and profitability may be
positively associated, because they are endogenous and positively related to
omitted variables that induce large mark ups. In particular, Firms of superior
efficiency may advertise more and earn more. Therefore, it may be possible to
disentangle the causal possibilities somewhat by looking at how the relationship
between advertisement and profitability varies within an industry between large
and small firms. Gomes (1986), Kwoka and Ravenscraft (1986) and Porter (1979)
provide inter-industry evidence that the advertisement-profitability association
indeed is significantly greater for large firms.

39
The conclusions from advertisement and profitability studies are, again, somewhat
mixed. While some studies report an advertisement and profitability relationship
(see e.g. Graham and Frankenberger 2000; Sougiannis 1994), others are unable
to detect a significant relationship between advertisement and profitability (see
e.g. Reekie and Bhoyrub, 1981). The most common point of disagreement is
whether a higher or lower advertisement depreciation rate is assumed in
estimating advertisement capital (see e.g. Ayanian 1983; Bloch 1980; Comanor
and Wilson 1974, 1979). It is also interesting to note that studies using industry
data (e.g. Comanor and Wilson 1974; Weiss 1969) find a significant and positive
relation between advertisement and profitability, while studies using firm-level
data (e.g. Ayanian, 1975, 1983; Bloch 1974) report no such relationship between
advertisement and profitability. This may point to the potential problem of
aggregation of data in studies using industry data being one of the reasons for the
different results. Similarly, there are still other problems in arriving at accurate
profit rates. For instance, firms adopt various depreciation policies according to
their own arbitrary measure of estimated useful lives of their tangible assets.
Inappropriate depreciation policies might also cause accounting profit rates to be
distorted. Finally, there are issues related to the direction of causation between
advertisement and profitability and the consequent implications for public policy.
A common criticism of the single equation advertisement intensity model is the
potential endogeneity of profitability and other variables (e.g. concentration).
Endogeneity exists when a model includes an endogenous explanatory variable. If
profitability or concentration, for instance, is endogenously determined with
advertisement intensity, ordinary least squares estimates of the model parameters
will be biased (see Willis and Rogers, 1998). Chenhall and Moers (2007) explain
that a variable is endogenous if it is determined within the context of the model,
while an exogenous variable is a variable that affects the values of endogenous
variables, but whose values are determined outside the model. They argue that the
potential for endogeneity exists in virtually all studies involving accounting,
finance and economic variables. Attempts have been made to control for such
endogeneity using simultaneous estimation (see e.g. Comanor and Wilson 1974;

40
Rosenbaum 1993). Schmalensee (1989) argues that valid instruments for
endogenous variables in cross-sectional industry studies are virtually non-existent.
Notta and Oustapassidis (2001), however, indicate that consistent estimates can
be obtained when instrumental variables are used. According to Notta and
Oustapassidis (2001), a formal Hausman–Wu test can indicate whether or not an
instrumental variable technique needs to be used to obtain satisfactory estimates
of parameters from a particular sample. Similarly, use of better theory and logic in
formulating the research questions, use of good quality data and panel data
techniques can often help to alleviate problems associated with endogeneity.

2.3 Advertisement, Sales, Profits and Firm Value

Marketing literature particularly studies the indirect effect of advertisement

expenditure on firm value. These studies attempt to understand the impact of
advertisement on firm value by understanding the impact of advertisement on
sales, of sales on profits and of profits on firm value. The studies with a direct
impact of advertisement expenditure on intangible value of the firm are rather
lacking. Valuation models are increasingly being used to investigate various kinds
of relationships involving a number of relevant variables of interest. Green et al.
(1996), for instance, examine the relationship between firms’ market value and
R&D expenditure. However, the use of valuation models to investigate the value
relevance of advertisement expenditure is preferred largely due to the ability of
the firm value to reflect all factors that have impact on the future profitability of
the firm.

Though Drucker (1973) cites innovation and marketing as the two factors crucial
to long-term corporate health, yet no important research attempts to link the
advertisement expenditure with firm value are visible till Hirschey (1982) makes
an important contribution to the literature by studying advertisement expenditure
as an intangible asset that impacts largely on the firm value brand-related
intangible assets. Linkages have been found between advertisement and brand-
related intangible assets including perceived quality (e.g. Moorthy and Zhao,

41
2000) and brand attitude (Berger and Mitchell, 1989). As a consequence, we may
expect advertisement to have an indirect impact on firm value through the
increase in sales and profits (e.g. Graham and Frankenberger 2000), as well as a
direct effect by virtue of building brand-related intangible assets. As against the
earlier studies that attempt to relate advertisement with either sales and/or
profitability, Hirschey (1982) applies a market valuation model, and regresses
deflated market values on contemporaneous deflated values of a number of
relevant variables including profit, advertisement, R&D, concentration, growth
and risk. The study takes a sample of 390 firms from 12 major product groups for
the year 1977. Hirschey (1982) observes significant firm value effect of
advertisement and R & D expenditure. The study suggests that both advertisement
and R&D be treated as intangible capital assets while commenting that ‘we find
support for their treatment as intangible capital since each has a highly significant
positive influence on market value ...’ A compelling virtue of an approach based
on the market value of the firm is that such an approach minimizes the effect of
accounting bias (Hirschey, 1985). Good amount of research has followed-up
Hirschey (1982) by studying the impact of advertisement on firm value. These
include Connolly and Hirschey (1984); Hirschey and Weygandt (1985); Jose,
Nichols and Stevens (1986); Lustgarten and Thomdakis (1987); Morck and Yeung
(1991); Hirschey and Spencer (1992); Chauvin and Hirschey (1993); Aaker and
Jacobson (1994); Lev and Sougiannis (1995); Mathur and Mathur (1995);
Srivastava et al. (1998); Graham and Frankenberger (2000); Houston, Johnson
and Simon (2002); Joshi and Hanssens (2002); Ailawadi et al. (2003); Chauvin
and Hirschey (2003); Kim and Morris (2003); Jeong (2004); Grullon, Kanatas,
and Weston (2004); Yew, Keh and Ong (2005); Singh et al. (2005); Qureshi
(2007); Shah and Akbar (2008); Kimbrough and McAlister (2008); Srinivasan
and Hanssens (2009); Joshi and Hanssens (2010); Kundu, Kulkarni and Murthy
(2010).

Some of the studies including Connolly and Hirschey (1984); Hirschey and
Weygandt (1985); Jose, Nichols and Stevens (1986); Lustgarten and Thomdakis
(1987); Morck and Yeung (1991); Hirschey and Spencer (1992); Chauvin and
42
Hirschey (1993); Aaker and Jacobson (1994); Lev and Sougiannis (1995);
Mathur and Mathur (1995); Srivastava et al. (1998); Graham and Frankenberger
(2000); Joshi and Hanssens (2002); Houston, Johnson and Simon (2002);
Grullon, Kanatas, and Weston (2004); Yew, Keh and Ong (2005); Singh et al.
(2005); Qureshi (2007) indicate the impact of advertisement expenditure on firm
value. Connolly and Hisrchey (1984) observe the increase in advertisement to
have a positive and significant effect on increasing the spread between the market
value of assets and book value of assets. A feedback relationship between return
on investment (ROI) and advertisement is observed due to which high ROI leads
to higher expenditure on advertisement. Stock prices, in turn, react favourably to
this expenditure. Adopting Tobin’s q approach and regressing q on advertisement
intensity, R&D intensity, industry concentration, growth and risk, Hirschey and
Weygandt (1985) find that ‘a one-unit increase in advertisement and R&D
intensity will lead to large, consistent, positive effect on q. This implies that a
portion of current period advertisement and R&D carries over to subsequent
periods and suggests that a capitalisation and amortisation rather than current
expense treatment is appropriate in most situations.’ Hirschey and Spencer (1992)
however, observe advertisement expenditures to have a durable effect on market
value only in case of large firms. Viewing advertisement as a form of investment
in intangible assets, Chauvin and Hirschey (1993) observe that advertisement
expenditure has large, positive and consistent influence on the market value of the
firm. Chauvin and Hirschey (1994) find advertisement an important source of
goodwill. They also reveal that the goodwill effects of advertisement are
consistently positive for both manufacturing and non-manufacturing firms. Their
paper opines that spending on advertisement and R&D can be viewed as a form of
investment in intangible assets with predictably positive effects on future cash
flows. Mathur and Mathur (1995) use event study methodology and conclude that
investors react positively to announcements of advertisement changes leading to
higher market value for the firms. Thomadakis (1977), for instance, uses a value-
based analysis of the future-oriented implications of market structure. Thomadakis
(1977) believes that a forward-looking index of profitability is a firm’s market

43
value, which should reflect the ex-ante rate of return on investment. Similarly,
Hirschey and Wichern (1984) argue that neither accounting nor market data
provides an ideal measure of profitability and, hence, believe that a comparison of
accounting and market data can prove highly beneficial. Using both accounting
and market estimates of profitability as indicators of performance characteristics,
Hirschey and Wichern (1984) find a significant role for R&D intensity, television
advertisement, leverage and industry growth as determinants of profitability.
Interestingly, they find no important role for traditional market structure variables
(e.g. market share, concentration etc.) in their analyses. Ben-Zion (1978) was
perhaps the first to use stock market data to measure a longer-term effect of
advertisement and promotion (A&P) spending on the market value of the firm. If
A&P spending is viewed as an investment that enhances future-period cash flows,
A&P spending may serve as a signal to investors that the firm is systematically
investing in future profits, and investors will adjust their valuation of firm stocks
based on levels of firm spending on A&P activities. Alternatively, Erickson and
Jacobson (1992) suggest that increases in firm spending on A&P may serve as a
signal to the market that the firm has the discretionary funds required to undertake
these activities. Srivastava et al. (1998) argue that advertisement can create
market-based assets that may accelerate the timeliness of cash-flow occurrence,
thereby improving over-all shareholder value. Advertisement can add to
shareholder value by creating market-based assets: lower costs of sales and
services to customers; secure price premiums through creation of perceived value
identified with brand equity; and create competitive barriers, thereby enhancing
and stabilizing cash flows and generating synergies among assets within a firm to
improve productivity that may provide further competitive advantages (Srivastava
et al., 1998). Graham and Frankenberger (2000) indicate that the results for the
earnings and valuation regression taken together provide support for the asset
value of advertisement. Cheng and Chen (1997), indicate that scaler selection (i.e.
the choice of deflator) can be one factor which may contribute to the empirical
irregularities in the extant literature. Using US advertisement expenditure data
obtained from COMPUSTAT, Cheng and Chen (1997), show that differences

44
exist among empirical results on the relationship between advertisement spending
and market value due to scaler selection. They suggest that empirical results
should be explained in light of model specification. Similarly, Keller (2002)
indicates that advertisement promotes brand equity, which in turn generates
financial value through enhanced cash flows attributable to customer loyalty,
increased marketing efficiency, brand extensions and higher margins. More
recently, results in Singh et al. (2005) suggest a significant positive relationship
between advertisement expenditure and market value added (MVA), implying
that firms with higher product market advertisement also experience greater
performance in terms of MVA. Joshi and Hanssens (2002) conclude that
advertisement has a positive and persistent impact on market valuation that exists
beyond advertisement’s impact on customer response. Yew, Keh and Ong (2005)
report that intensive investment in advertisement contributes positively to the one-
year stock market performances in case of the non-manufacturing firms.
However, their results are inconclusive whether manufacturing firms benefit from
investment in advertisement as measured by the three-year stock market
performance. An important contribution to the advertisement as an intangible
asset literature came from Hirschey (1982). While earlier studies attempt to relate
advertisement with either sales or profitability, Hirschey (1982) uses a market
valuation model, and regresses deflated market values on contemporaneous
deflated values of a number of relevant variables including profit, advertisement,
R&D, concentration, growth and risk. Hirschey (1982) employs data on national
media advertisement from ‘Leading National Advertisers’ for a sample of 390
firms from 12 major product groups for the year 1977. Data on other accounting
variables is obtained from ‘Fortune’, while the source of data for R&D is
‘Business Week’. Investigating intangible capital, Hirschey (1982) finds that, on
average, advertisement and R&D expenditure has significant market value
(intangible capital) effect. On the basis of the estimation results for the valuation
model, Hirschey (1982) suggests that both advertisement and R&D be treated as
intangible capital assets and comments that ‘we find support for their treatment as
intangible capital since each has a highly significant positive influence on market

45
value ...’According to Hirschey (1982), tax laws which permit an expensing of
capital items result in substantial tax subsidies for affected firms. Hirschey (1982)
thus seems to support early views (e.g. Bloch 1974; Weiss 1969, among others)
regarding treatment of advertisement as an intangible asset in the accounts, as it
will not only improve the equity of the tax system, but will also result in more
accurate accounting records. In addition, Hirschey (1982) also points to a number
of problems in, and limitations of, the previous studies for arriving at ambiguous
results regarding the nature of advertisement. The problems mentioned by
Hirschey (1982) include, for instance, the emphasis of previous studies on
individual items’ sales-related advertisement, while ignoring the importance of a
firm’s aggregate level of both ‘product’ and ‘institutional’ advertisement.
According to this argument, in addition to product advertisement for an individual
product, institutional advertisement is also important in building a unique
corporate image of the firm among its potential customers. According to
Wilmshurst and Mackay (1999), corporate advertisement by major companies
such as Philips, British Petroleum, Sony, ICI, Intel, etc. ‘promote the company
name in such a way that all of their products benefit from the values attached to
their corporate identity ...’. Hirschey (1982) believes that, as both product and
institutional advertisement might have a spillover effect, there might be instances
where a weakening of the sales–product advertisement relationship for an
individual product only is erroneously assumed as an absence of the durability
effects of advertisement expenditure as a whole. Hirschey (1982) also questions
earlier studies for not taking into account the multipurpose goals of advertisement.
He argues that the goal of individual product advertisement might be quite
different from the institutional advertisement. While the former is primarily
intended to increase sales, the later type of advertisement is directed towards both
increasing sales and reducing costs. Based on these observations, Hirschey (1982)
believes that the firm’s overall objective in advertisement is profit and suggests
that, in order to avoid measurement errors, analysis of advertisement
effectiveness must consider the complete body of intended effects.. Studying the

46
UK market, Qureshi (2007) observes that advertisement expenditures are
significantly associated with increases in market value.

Advertisement can play a key role in achieving superior brand equity by

communicating with potential customers (Ailawadi et al., 2003; Srivastava et al.,
1998). However, due to the failure of marketers to show the influence of
marketing activities and costs on firm (shareholder) value, marketers could not
justify its significance to the management. Marketers have rather relied on metrics
such as sales volume and customer awareness (Doyle, 2000). Further,
advertisement plays a bigger role than other forms of marketing efforts in building
and maintaining brand equity (Aaker, 1991; Keller, 1998; Ailawadi et al., 2003).

Srivastava et al. (1998) throw some light on the way in which advertisement can
help enhance the firm value. Their paper argues that firstly, advertisement helps
improve customer relationships thereby influencing relational market-based
assets. Customer relationships are created on the basis of value delivered to
customers. A brand has a higher perceived value by the Customers when it can
provide unique and superior product functionality, features, and quality as well as
wider availability, greater ease of use, and better reputation and image. The major
role of advertisement is to communicate these elements of brand value to
customers, which further contributes to brand equity (Keller, 1998; Srivastava
and Shocker, 1991).

There are also studies that find little impact of advertisement on firm value. The
studies of Bublitz and Ettredge (1989); Erikson and Jacobson (1992); Han and
Manry (2004); Kundu, Kulkarni and Murthy (2010) are prominent amongst those.
Investigating the relationship between abnormal stock returns and the forecast
errors for R&D and advertisement expenditure, Bublitz and Ettredge (1989)
although supporting the earlier findings of Hirschey (1982) and Hirschey and
Weygandt (1985) on R&D being valued as a long-lived asset, differ in the
treatment of advertisement and argue for its treatment as an expense. Erikson and
Jacobson (1992) conclude that once the effects of firm-specific factors and the

47
influence of profitability on discretionary spending are taken into account,
advertisement expenditures do not increase the market value of the firm more than
other types of investments or expenditures. Han and Manry (2004) find that the
economic benefits of advertisement expenditure expire in the current period, as
also is the case with other expenses. Kundu, Kulkarni and Murthy (2010) observe
that increased advertisement has not been able to contribute conclusively in
enhancing the firm value.

Belch and Belch (1998) suggest that advertisement is the most effective way to
build the long-term franchise of a brand and therefore, it is very important to find
the link between marketing communications especially advertisement to
shareholder value. A number of studies have been conducted in order to find out
the relationship between advertisement expenditure and firm value through sales
and profitability. Very few papers study the direct relationship between
advertisement expenditure and firm value (Joshi and Hanssens, 2010). Andras
and Srinivasn (2003) report positive relationship between Advertisement intensity
and R&D intensity to the firm’s performance. Hirschey and Chauvin (1993) find
out that advertisement and R&D expenditure have large positive and consistent
influence on the market value of the firm, which is why it is considered as
investment in intangible assets with predictably positive effects on future cash
flows. Margy & Melvin (2005) observe positive relationship between
advertisement expenditure and promotional spending on market value of firm.
Qureshi (2007) studies the relationship between advertisement expenditures and
the market value of firms by using OLS. The study finds out that advertisement
expenditures are significantly associated with increases in market value,
suggesting that capitalizing advertisement expenditures is appropriate. Using OLS
reports, Siong (2010) observes a statistically significantly positive relationship
between advertisement and firm value. Hlouskova & Tsigaris (2012) observe the
risk taking dynamics under prospect theory. Kundu, Murthy and Kulkarni (2010)
use the data of 172 firms from 2000-2007 and find positive and significant
relationship between advertisement expenditure and Tobin’s Q accounting for
firm size and leverage. Bhattacharya (1994) provides the evidence of positive
48
relationship between advertisement expenditure and consumers and firm
performance, therefore it indicates the advertisement effectiveness have their
impact on consumers and firm performance and offer perspectives for the
firms in planning for more effective advertisement strategies to promote their
products or services. Frankenberger (2004) studies 2662 firms to determine the
economy-wide and industry effects than average advertisement spending has
on earnings and market value recessionary periods and compared those effects of
increased and decreased advertisement during recessionary period and indicated
that advertisement creates a firm asset by contributing and claimed that
increasing spending on advertisement during a recession leads to benefits that
exceed the benefits of increasing advertisement during non-recessionary
periods. concluded that firms should support advertisement budget wherever
possible, as advertisement in general translates to an asset that is valued by
stock market participants. Shah and Stark (2004) investigate the value
relevance of the advertisement expenditure The results of the study showed a
positive influence of advertisement expenditure on the market value of firms.
Shark and Stark (2004) by splitting the sample into sub-sample of manufacturing
and non-manufacturing of Large and small size, find advertisement expenditure to
be relevant for large and non-manufacturing firms. Shah and Shark (2005)
investigate whether advertisement expenditure help in forecasting future
earning and are associated with market value by using valuation model found
that major media advertisement expenditure valuation relevant and useful in
predicting future value of earnings. Using the OLS method, C'onchar, C'rask
and Linkhan (2005) examine the relationship between advertisement
expenditure on firm market value, future cash flows and boost the
shareholder wealth. Merino, Srinivasan and Srivastava (2006) study the
relationship between advertisement and R&D expenditure on variability of
cash flow and intangible cross-sectional to the panel data case to relate a
firm's advertisement and R&D expenditure to the variability of cash flow
and intangible firm value and concluded that advertisement impacts on the
variability of cash flow and intangible value are different, which

49
advertisement expenditure they found that advertisement stabilizes both cash
flow and intangible value in turbulent and competitive environments. Qureshi
(2007) investigates the relationship between advertisement expenditure and the
market value of firms. Advertisement expenses are significantly related with the
increase in market value suggested that investment in advertisement should be
capitalized and then amortized rather than treated as expense item. Gupta
(2008) studies the effect of advertisement on the firm performance 10 year (1997-
98 to 2006-2007) of Automobile, Textile and Food by applying Least square. This
paper notes that results of advertisement certainly affect the firms depending on
their nature. It further claims that it is evident that advertisement has positive
and significant effect on sales of firms while it has significant adverse effect
on profitability. Automobile industry shows positive impact of advertisement on
sales as well as profitability alongwith firm value. Hsu and Jang (2008) study the
relationship between advertisement expenditure, intangible value, and risk in
stock returns of restaurant firms. They suggest that advertisement expenditure
creates intangible benefit to restaurant firms. They also note that advertisement
may affect product introduction, positioning, and differentiation which lead
to a restaurant firm's success. Wang, Zhang and Ouyang (2008) study the
nature and degree of advertisement effect on firm intangible values by
applying Time series approach. They report that advertisement effects on firm's
intangible assets are sustainable and accumulative and support the asset or
investment like characteristic of advertisement expenditure. Using
Cointegration model, Leong et al (1996) reveals that a strong positive relationship
exists between advertisement expenditure and sales. Leach and Reekie (1996)
apply Granger causality test and find that advertisement expenses cause sales but
sales do not simultaneously cause advertisement. Metwally (1997) explains the
variations in the growth rates of advertisement expenditure of consumer goods
and services that the growth in advertisement expenditure is strongly correlated
with the growth in sales and that movement in market shares exerts a significant
effect on the growth in advertisement expenditure.

50
A typical valuation study (also known as ‘levels’ studies) involves regression
analyses of a number of relevant variables. The variable used on the left-hand side
of the regression equation is the dependent or ‘regressed’ variable. Variables to
the right-hand side of the equation are the independent or ‘explanatory’ variables,
which are also called ‘regressors’. The dependent variables often used are either
the market value of the firm, or the market value deflated by some size variable
(e.g. book value, sales etc.), or simply the price–earnings ratio. Scale effect is
believed to exist when large firms exert undue influence on the estimated
regression coefficients. As a consequence, it is normal practice to deflate variables
included in a valuation model by some scale proxy (e.g. sales, book value,
number of shares outstanding or open market value, etc.) in an attempt potentially
to mitigate econometric problems such as heteroscedasticity (see e.g. Akbar and
Stark 2003; Easton 1998). The number and choice of the independent or
explanatory variables varies from study to study, ranging from including
components of earnings and book value to the inclusion of additional market
structure variables (e.g. growth, market share, concentration and risk etc).

Hirschey and Weygandt (1985) also use a market value-based investigation of

advertisement and R&D as intangible capital. Hirschey and Weygandt (1985)
adopt a slightly different approach by regressing Tobin’s q on advertisement
intensity, R&D intensity, industry concentration, growth and risk. According to
the results in Hirschey and Weygandt (1985) – ‘a one-unit increase in
advertisement and R&D intensity will lead to large, consistent, positive effecton
Q. This implies that a portion of current period advertisement and R&D carries
over to subsequent periods and suggests that a capitalisation and amortisation
rather than current expense treatment is appropriate in most situations.’

Barth et al. (1998) use both a market valuation and returns specification to
investigate the value relevance of brand value estimates provided by the
‘Financial World’ for a sample of 183 firms (covering 204 brand value estimates)
over the period 1991–1996. In addition to performing a number of other analyses,
Barth et al. (1998) employ various alternative proxies for brand values (including

51
advertisement) to examine any incremental value relevance of the brand value
estimates. Barth et al. report that the brand value estimates reflect value-relevant
information, not reflected in these alternative proxies.

2.4 Theoretical Framework

The research attempts have been made in the past to study the impact of
advertisement expense on sales, profits and firm value. However, the focused
studies covering a specific industry in a country are not found so commonly.
Moreover, the research efforts in the past have largely concentrated on observing
the impact of advertisement expense on firm value indirectly, i.e., by studying the
impact of advertisement on sales, followed by the impact of sales on profits and
finally by studying the impact of profits on firm value (Dekimpe and Hanssens,
1995; Lee et al, 1996; Leong et al, 1996; Joshi and Hanssens, 2010). In fact,
advertisement expense, sales and profitability also has a direct impact on firm
value. This issue has broadly been ignored by the previous researches. The current
study attempts to bridge this gap by studying both direct and indirect impact of
advertisement expense on firm value.

Usually, manufacturing companies’ advertisement spending are higher than the

service companies (Singh and Asress, 2012). Besides, the sales in currency as
well as sales in units are both visible in case of manufacturing companies, as
against the service companies where only the sales in currency are visible and
sales in units are not. Therefore, choosing a manufacturing industry for the
purpose of such study makes sense. FMCG industry, being one of the most
diverse manufacturing industries forms the scope of the study. One hundred BSE-
listed companies from the FMCG industry selected randomly are used as the
sample for the study.

Table 2.1 presents a brief summary of the literature concerning the relationship
between advertisement expenditure and firm’s performance.

52
 Table 2.1

Summary of related literature

Title Authors Year Objectives Tools Findings

1. Neither accounting nor
Accounting and Mark 1984 1. To learn whether 1. Correlation; market data provides an
Market-Value Hirschey; accounting & 2. Factor ideal measure of
Measures of W. Wichern market data Analysis; profitability;
Profitability: provide consistent 3. Linear 2. A comparison of
Consistency, or independent structural accounting and market data
Determinants, measure of model; can prove highly
and Uses profitability; 4. Q ratio beneficial;
2. To determine if 3. There is a significant
there is a difference role for R&D intensity,
between television advertisement,
accounting and leverage and industry
market value growth as determinants of
3. Are the profit profitability;
measures caused 4. There is no important
by industry related role for traditional market
factors or by firm structure variables (e.g.
specific influences market share,
and/or accounting concentration etc.) in their
conventions; analyses
3. To consider the
determinants of
profitability within
a framework that
allows for
imperfect nature of
profit measures.

Advertisement, Keith W. 1993 1. Impact of Regression Advertisement and R & D

R&D Chauvin and advertisement expenditure have large,
Expenditures Mark expenditure on positive and consistent
and the Market Hh’sciaey market value of the influence on the market
Value of the firm; value of the firm that is
Firm 2. Impact of R & D why it is considered as an
on market value of investment in intangible
the firm assets with predictably
positive effects on future
cash flows

53
Causality Francisco F. 1996 Dynamic causal 1. Johansen's 1. Result Based on VECM
among sales, R. Ramos relationships (in Cointegration reflects each Explanatory
advertisement the Granger Analysis; variable A & P Granger
and prices: new (temporal) sense) 2. Vector Error causes sales in the short
evidence from a among sales and Correction run (F-test) but
multivariate advertisement Model; proportionately by which
cointegrated 3. Variance the sales are adjusted to
system Decomposition long run equilibrium is
Analysis; nevertheless significant (t-
4. Granger's test);
Causality 2. VECM reflects that
Advertisement remain
unexplained by exogenous
variables as proved by (F
& t-test);
3. There exists strong one-
way relationship between
advertisement and sales;
4. There exists feedback
relationship between sales
and prices

The Matthias R 2000 To examine the 1. Correlation; These firms cannot

Competitive Greuner, effects of 2. Regression increase their profits above
Effects of David R advertisement on normal levels by increasing
Advertisement Kamerschen competition in the their advertisement
in the US and Peter G US automobile expenditures.
Automobile Klein industry Advertisement serves
Industry, 1970± primarily to transmit
94 information, not to create
entry barriers

The Roger C. 2000 1. To extend prior 1. Valuation The results provide a

Contribution of Graham, Jr, research by Regression; strong indication of
Changes in Kristina D. establishing a link 2. Tobin Q contribution of
Advertisement Frankenberg between advertisement expenditures
Expenditures to er advertisement to earnings and market
Earnings and expenditures and values
Market Values future earnings.
Connecting
current-year
advertisement
expenditures with
future earnings
provides a
reasonable estimate
of the asset value
of advertisement

54
 expenditures;
2. To examine
whether
advertisement
assets as derived
from the
association
between
advertisement
Expenditure and
future earnings are
associated with
firm value

Effects of Xiao, Hui; 2001 Impact of Rotterdam 1. The hypothesis that

Advertisement Kinnucan advertisement of Model advertisement affects the
on U.S. Non- Henry W; non-alcoholic total demand for non-
Alcoholic Kaiser, beverages on alcoholic beverages is
Beverage Harry M aggregate demand rejected;
Demand: 2. Advertisement affects
Evidence from the distribution of
a Rotterdam expenditures within the
Model non-alcoholic beverage
group, but has no effect on
total expenditures. This
finding is in line with
Duffy's work (1987, 1990,
1991) on alcoholic
beverage advertisement in
the United Kingdom.

Linking Victoria 2003 Impact of 1. Descriptive 1. Advertisement has a

marketing to Louise Advertisement on statistics like significant impact on stock
shareholder Hodgson shareholder value Frequency prices and vis-à-vis on
value in Listed Distribution shareholder value via stock
and Non-listed and Cross prices;
markets tabulations; 2. Advertisement has a
2. Correlation; greater impact on the sales
3. Regression; of larger firms and this is
4. t-test probably related to the
higher brand power of
large firms;
3. Advertisement
expenditure has significant
explanatory power for
sales, but that these effects
will differ in functional
relationship and impact
according to size and

55
 industry decomposition;
4. There is a significant
difference between the
advertisement and sales
ratios for small and large
firms. The results
confirmed that there is a
significant difference,
indicating different
managerial philosophies
with regard to
advertisement expenditure.

The effect of Jooyoung 2003 1 To explore 1. Anova; Investors’ reactions to the

advertisement Kim, Jon D whether investors 2. Event study advertisement is not
on the Morris behave like methodology dependent on the
market value of consumers, likeability of the
firms: and make advertisement or
Empirical investment frequencies of
evidence from decisions advertisement.
the Super Bowl based on their
ads response to
advertisements as
consumers;
2. To understand
whether investors
view advertisement
as an investment,
and therefore use a
restricted approach
to evaluating the
impact of
advertisement on
the market value of
the advertised
product’s
company.

Advertisement Trina Larsen 2003 1. Impact of Regression Advertisement intensity

Intensity and Andras and advertisement and R&D intensity are
R&D Intensity: Srini S intensity on the positively and significantly
Differences Srinivasan profit margin; related to the firm's
across 2. Impact of R & D performance.
industries and intensity on the
their impact on profit margin
Firm's
performance

56
An Confidence 2004 1. To investigate 1. Augmented 1. There is no significant
investigation of W. Amadi, the long-run Dickey-Fuller long-run relationship
the long-run Florida properties of the unit-root test; between the levels of sales
impact of A&M sales-advertisement 2. Johansen's and advertisement
advertisement University expenditure; cointegration; expenditure rather, it is the
expediture on 2. To study the 3. Granger's growth rates that are
sales causal relationship Causality relevant;
between sales and 2. The impact of time on
advertisement the long-run relationship
expenditure is between these variables is
investigated highly significant
(significantly) indicating that time is
relevant variable in
establishing the long term
relationship between sales
growth and growth of
advertisement expenditure;
3. Granger causality test
provides mixed results on
the impact of sales on
advertisement expenditure
and vice versa;
4. The slope of the VECM
equation is mixed for the
firms studied, with eight of
the fifteen firms having a
positive value;
5. There is a a long-run
relationship between sales
and advertisement
expenditure inferring the
use of capital budgeting
procedure to evaluate
advertisement expenditure
rather than the prevailing
percentage of sales
approach

Advertisement C W Amadi 2005 To study the long- 1. Johansen's 1. Johansen's cointegration

expenditure and run relationship Cointegration; provides a mixed insight
firm and causal 2. Vector into the nature of
profitability: an implications Autoregression advertisement expenditure
investigation between Model; for the household products
advertisement and 3. Granger's industry. Of the nineteen
operating income. Causality; firms studied, only ten
4. Vector Error firms exhibited long-run
Correction relationship between
Model advertisement expenditure

57
 and operating income;
2. Time is a relevant
variable in establishing the
long-run relationship
between operating income
and advertisement
expenditure;
3. Granger causality test
provides mixed results on
the impact of operating
income on advertisement
expenditure and vice versa.
The result indicates that,
for all but two of the firms
studied, causality runs
strongly from operating
cash flow to advertisement
expenditure. For the
remaining firms, the tests
indicate and support the
inter-dependence of
operating cash flow and
capital expenditure through
the bi-directional Granger
causality between
operating income and
capital expenditure;
4. The slope of the
operating income in the
capital expenditure VECM
equation is positive for
seven of the firms studied.
The positive slope implies
that increase in operating
income increases
advertisement spending.
The bi-directional causality
implies that the resulting
increase in advertisement
increases operating income
and the cycle continues.
On the other hand, the
three firms with negative
VECM slope indicates that
advertisement expenditure
for these firms is a
prompted by declining
profitability. For the firms

58
 with negative slope on the
operating income VECM,
increase in advertisement
expenditure results in a
decrease in operating
income. For these firms
advertisement has a
negative impact on
shareholder wealth by
decreasing operating
income.

Advertisement, Zoe 2005 To examine the Cross-section 1. Market share greatly

Market Share, Ventoura– relationship analysis influences profitability;
and Profitability Neokosmidi between the gross 2. Advertisement to sales
in the Greek profit, the market ratio seems to affect
Consumer share, as an profitability less than
Industry appropriate market share
strategy, and the
plasmatic
differentiation
(measured by
advertisement
expenses)

The Direct, Amit 2005 1. Interaction 1. Time-series 1. Advertisement can have

Indirect and Madhav Effect of econometrics; long-run direct effect on
feedback effects Joshi Advertisement 2. Event study stock prices, which is
of Marketing effect on movies methodology above and beyond its effect
Actions Profitability; on sales;
2. Advertisement 2. Foreign firms are more
having long run likely to have innovation
direct effect on momentum which gives
stock prices over them a long-term strategic
and above its advantage;
effects on sale; 3. Pre-launch
3. Existence of advertisement helps create
feedback effect in expectations of movie
context of performance, which leads
innovation in to stock price correction
automobile post-launch.
industry

59
Asset value of Maqsood 2007 To study the Multiple Advertisement
UK firms' Iqbal relationship Regression expenditures are
advertisement Qureshi between significantly associated
expenditure advertisement with increases in market
expenditures and value, suggesting that
the market value of capitalizing advertisement
firms expenditures is appropriate

The effect of André 2008 To examine the 1. Regression; Increasing advertisement

competitive Bonfrer, effect of 2. Econometric for the focal brand
advantage Peter J. competitive methodology will increase its sales.
interference on Danaher, advertisement on However, the amount by
sales for Sanjay Dhar sales which its sales increase
packaged goods very much depends
on the competitive clutter,
with high levels resulting
in lower sales lift.

Value relevance Syed 2008 To review the 1. There has been a recent
of Zulfiqar Ali studies that relate shift to the use of valuation
advertisement Shah and advertisement to models in exploring the
expenditure: A Saeed Akbar profitability or nature of advertisement
review of the sales of the firm or expenditure. Valuation is
literature industry to seen as a better alternative
investigate the in exploring the intangible
effects of nature of advertisement
advertisement expenditure;
expenditure 2. Bulk of evidence on
advertisement value
relevance comes from the
US, where there has
historically been greater
disclosure of advertisement
expenditure. There appears
to be little evidence on this
matter in the UK, because
of lack of advertisement
data in UK.

Brand Portfolio Neil A. 2009 To examine the the 1. Regresion; 1. Market concentration
Strategy and Morgan & relationship 2. Tobin's Q (HHI) is associated
Firm Lopo L. between the brand negatively with firms’ cash
Performance Rego portfolio strategy flows and consumer
characteristics and loyalty and positively with
marketing and market share and
financial relative advertisement
performance expenditures;

60
 2. Firms’ marketing
effectiveness and
efficiency
explain significant
additional variance

The Direct and Amit Joshi 2009 To study the long 1. Vector 1. Advertisement spending
Indirect effects & Hannsens run relationship Autoregression has positive and long run
of between ; 2. Impulse impact on own firm's
Advertisement advertisement Response market capitalization and
spending on spending and Function may have negative impact
firm value Market on valuation of competitor
Capitalization / of comparable size;
Firm Value above 2. There are several cases
and beyond its of significant investor
effect on sales response even when there
Revenue and is no consumer response
profits. Long run i.e., there is an increase in
relationship firm value even in the
between absence any impact on
advertisement sales. Thus advertisement
spending and has positive impact even if
Market it no measurable impact on
Captilization / Firm sales
Value above and
beyond its effect on
sales revenue and
profit

An Empirical Gan Kien 2010 1. To determine Ordinary Least 1. Linear regression shows
Analysis: Siong whether there was Square that there was a positive
Advertisement Positive Regression relation between
Effects on Firm relationship Analysis Advertisement and it is
Performance in between statistically significant with
the Malaysian Advertisement both variables of firm
Consumer Expenditure and performance which are
Products sector Profitability; firm Profitability and firm
2. To determine Value;
whether there was 2. Sales Variables are
Positive found only to be significant
relationship with Firm Profitability not
between with Firm Value.
Advertisement
Expenditure and
Firm Value

61
Advertisement Anindita 2010 1. Impact of 1. Q ratio; 1. There is positive
and Firm Value: Kundu, advertisement on 2. Correlation correlation between
Mapping the Anantha profitability of the 3. Multiple Advertisement Spending
relationship Murthy firm; Regression; and PAT and also between
between N.K., 2. Does 4. Anova Advertisement Spending
Advertisement Prashant advertisement add and Net Sales;
,Profitibility Kulkarni value to the firm; 2. Advertisement spending
and Business 3. Differences is positively correlated
Strategy in between the impact with Tobin’s Q accounting
India both in degree and for firm size and leverage
time across the
industry;
4. Implications for
the marketers

The effect of Nana Yaa 2011 To examine Multiple 1. There is strong

marketing Dufie the relationships regression relationships between sales
communication Okyere, existing between analysis promotion, advertisement
s on the sales Gloria G Q marketing budgets
performance of Agyapong, communications and total sales;
Ghana Telecom Kwamena activities and the 2. An inverse relationship
(Vodafone, Minta sales performance between TV
Ghana) Nyarku of Vodafone advertisements and sales;
3. Negative relation
between sponsorship
budget and total sales

The effect off Jesus 2012 To analyze the Vector Error There exists a positive
marketing Crespo- relationship Correction marketing-sales relation
spending on Cuaresma, between marketing Model even after including
sales in the Matthias expenditures and an error term structure
premium car Stoeckl sales in the German including model- xed and
segment: New premium time- xed e ects, as well as
evidence from automobile market product life cycle
Germany specific trends

An Somroop 2012 The study analyzes 1. Augmented Although past sales do not
Econometric Siddhanta, time series data Dickey-Fuller influence current
Measurement of Neelotpaul pertaining to Unit-root test; advertisement,
the Impact of Banerjee advertisement, 2. Vector advertisement and sales
Marketing sales promotion, Autoregression promotion have a
Communication direct marketing ; 3. Impulse significant effect on the
on Sales in the and personal Response sales of cement after one
Indian Cement selling Function; year.
Industry expenditures, 4. Forecasting
collectively Error Variance
referred to as Decomposition
Integrated

62
 Marketing
Communications
(IMC) and its
causal nexus with
Net Sales revenue
of some Indian
firms operating in
India

The optimal Hamid 2012 1. To study the 1. DorfMan There is existence of long
level of ,Nadar and existence of long Steiner Model; term Relationship Between
advertisement Meena run relationship 2. Regression; Advertisement Expenditure
and long run between 3. Johansen's and Profitability
equilibrium Advertisement Cointegration;
relationship Expenditure & 4. Error
between sales; 2. To Correction
advertisement study the long term Method;
and profits. The relationship 5. F-test
case study of between
Iraninan Sepah Advertisement
bank Expenditure and
profits

The impact of Kamran 2012 To study whether 1. Factor The first hypothesis of the
promotional Ahmed, 1. TV Analysis; research study is accepted
tools on sales Nasir Advertisement has 2. Regression as TV advertisement have
growth Mehmood, a positive a positive significant effect
(evidence from Sobia Irum, significant effect on sales Growth. The
Northern rural Afsan on sales growth; second hypothesis of the
areas in Sultana 2. Print media has a research is rejected due to
Pakistan) positive significant positive insignificant
effect on sales impact with sales growth.
growth; The third hypothesis of the
3. Billboards have study is also rejected as
a positive Bill board has a negative
significant effect impact with sales growth
on sales growth; and the impact is
4. LCD has a insignificant. The fourth
positive significant hypothesis is about LCD‟s
effect on sales which is also rejected as
growth the LCD‟s have a negative
insignificant effect on sales
growth.

63
 CHAPTER THREE

RESEARCH DESIGN

The study attempts to explore the impact of advertisement expenditure on firm

performance. For measuring the firm performance, the study uses variables in the
form of sales, profits and firm value. The advertisement spending is higher in
manufacturing companies’ than the service companies. Similarly, for
manufacturing companies, the sales in currency and the sales in units are both
visible, whereas in service companies only the sales in currency are observable,
sales in units are not. Hence, the study focuses on the manufacturing sector.

This chapter presents the research design used for the purpose of the study. The
chapter is divided into three sections including (a) Sampling Design and Data
collection; and (b) Data analysis and reporting.

3.1 Sampling Design and Data Collection

For understanding the impact of advertisement expenditure on firm’s

performance, it is essential to focus on an industry wherein the advertisement
spending is considerably high. It has largely been observed that the advertisement
expenditure for the manufacturing sector is higher when compared with other
sectors of the economy (FICCI, 2013). Further in the manufacturing sector, Fast-
moving consumer goods (FMCG) industry, in particular, reports high
advertisement spending.

On the other hand, the manufacturing sector reports its sales in units as well as in
rupees unlike the services sector, which can only report its sales in rupees. In the
manufacturing sector, FMCG industry witnesses high volatility in sales. The
empirical researches also point out that the sales in FMCG sector are more
sensitive to the advertisement spending as compared with other sectors of the
economy (Balyan, 2011). Therefore, it makes sense for the study to focus on the
FMCG industry.

64
The study uses one hundred Bombay Stock Exchange (BSE)-listed companies
from the FMCG industry. The companies are selected on random basis. The
detailed list of the selected FMCG companies is as under –

Table 3.1

List of the sample companies

S Name of the Company
1 ADF FOODS LIMITED.
2No ADOR MULTIPRODUCTS LTD
3 ADVANCE PETROCHEMICALS LTD.
4 AGRO DUTCH INDUSTRIES LTD.
5 AJANTA SOYA LIMITED
6 ASIAN TEA & EXPORTS LTD.
7 ASSAM COMPANY (INDIA) LIMITED
8 ASSAMBROOK LIMITED
9 ASSOCIATED ALCOHOLS &
10 AVANTI FEEDS LTD.
11 BREWERIES
AVT NATURAL LTD
PRODUCTS LTD.
12 B & A LTD.
13 BAMBINO AGRO INDUSTRIES LTD
14 BEEYU OVERSEAS LTD.
15 BHARTIYA INTERNATIONAL LTD.
16 BHATINDA CHEMICALS LTD
17 BKV INDUSTRIES LTD.
18 BLISS GVS PHARMA LIMITED
19 BRITANNIA INDUSTRIES LTD.
20 CCL PRODUCTS (INDIA) LTD.
21 CERA SANITARYWARE LTD.
22 CHAMAN LAL SETIA EXPORTS LTD.
23 CHOKSI IMAGING LTD.
24 COLGATE-PALMOLIVE (INDIA) LTD
25 CUPID LIMITED
26 DABUR INDIA LTD.
27 DAIRYFIELD LTD.
28 DFM FOODS LTD.
29 DHUNSERI PETROCHEM & TEA
30 DIANA TEA CO.LTD.
31 LIMITED
DIVYA JYOTI INDUSTRIES LTD.
32 EMAMI LTD
33 EMPEE DISTILLERIES LTD
34 EVEREADY INDUSTRIES INDIA LTD.
35 FLEX FOODS LTD.

65
36 FOODS & INNS LTD.
37 G.M. BREWERIES LTD.
38 GAYATRI BIOORGANICS LTD
39 GILLETTE INDIA LTD.
40 GLAXOSMITHKLINE CONSUMER
41 GLOBUS SPIRITS LIMITED
42 HEALTHCARE
GODFREY LTD. INDIA LTD.
PHILLIPS
43 GODREJ CONSUMER PRODUCTS LTD.
44 GOLDEN TOBACCO LTD.
45 GOODRICKE GROUP LTD.
46 GRM OVERSEAS LTD.
47 GUJARAT AMBUJA EXPORTS LTD.
48 HANUMAN TEA CO. LTD.
49 HARYANA LEATHER CHEMICALS
50 HATSUN AGRO PRODUCTS LTD.
51 LTD.
HERITAGE FOODS (INDIA) LTD.
52 HILLOCK AGRO FOODS (INDIA) LTD.
53 HIND INDUSTRIES LTD.
54 HINDUSTAN PHOTO FILMS MFG. CO.
55 HINDUSTAN UNILEVER LTD.
56 LTD.
HIPOLIN LTD.
57 IFB AGRO INDUSTRIES LTD
58 INDAGE VINTNERS LTD
59 INDIAN EXTRACTIONS LTD.
60 INDO BIOTECH FOODS LTD
61 IOL CHEMICALS &
62 ITC LTD
63 PHARMACEUTICALS
IVP LTD. LTD
64 J.L. MORISON (INDIA) LTD.
65 JAGATJIT INDUSTRIES LTD.
66 JAGDAMBA FOODS LTD.
67 JAY SHREE TEA & INDUSTRIES LTD.,
68 JK SUGAR LIMITED
69 JVL AGRO INDUSTRIES LIMITED
70 JYOTHY LABORATORIES LIMITED
71 KHODAY INDIA LTD.,
72 KLRF LTD
73 KOHINOOR FOODS LTD
74 KOTHARI GLOBAL LIMITED
75 KRBL LTD.
76 KWALITY DAIRY (INDIA) LTD.
77 LAKHANI INDIA LTD.
78 LAKSHMI OVERSEAS INDUSTRIES
79 LAWRESHWAR POLYMERS LIMITED
LTD.
66
 80 LEDO TEA CO. LTD.
81 LIBERTY SHOES LTD.
82 LOTUS CHOCOLATE CO. LTD.
83 MADHUSUDAN INDUSTRIES LTD.
84 MAHAAN FOODS LTD.
85 MARICO LIMITED
86 MAYA AGRO PRODUCTS LTD.
87 MAYUR LEATHER PRODUCTS LTD.
88 VIJAY SOLVEX LTD.
89 VIKAS GRANARIES LIMITED
90 VIMAL OIL & FOODS LTD.
91 VIPPY INDUSTRIES LTD.
92 VIRAT CRANE INDUSTRIES LTD
93 VST INDUSTRIES LTD.
94 WADALA COMMODITIES LIMITED
95 WARREN TEA LTD.
96 WATERBASE LIMITED
97 WELTERMAN INTERNATIONAL LTD.
98 WINSOME BREWERIES LTD.
99 WORLDWIDE LEATHER EXPORTS
100 ZYDUS WELLNESS LIMITED
LTD.
The sample period for the study is 10 years ranging from 2001–2002 to 2010–
2011. In a study related to advertisement, a longer period is not suitable as the
advertisement patterns of the industry undergo major transformation in a longer
period. Further, in the light of the competitive environment in the manufacturing
sector of India, every decade witnesses change in the competitive positions of the
market players. Therefore, the study uses a sample period of ten years.

The data for sample companies have been collected from the annual reports of the
respective companies. Wherever necessary, CMIE Prowess database has also
been used for data collection purposes.

3.2 Data analysis and reporting

The study uses descriptive statistics and econometric tools for analyzing the data.
In the case of econometric analysis, all the hundred companies have been grouped
together and the data for all the ten years has been grouped together as well. In
this way, the number of data points rises to 1000 (10 x 100). However, there is a

67
threat while grouping different companies into one group because of the
difference in magnitude of advertisement expenditure and sales revenue of the
companies. The study uses indexing as a means to remove this defect. Data for
all the companies is adjusted with an index of 100 in order to ensure uniformity
across the companies. Afterwards, log of the series has been computed in order to
find out the change in advertisement expenditure, sales revenue and profit across
various data points. Several methodological works in econometric analysis
suggest such direction for grouping together the data points for different cases
[Theil (2008), Anselin (1988), Fair & Shiller (1990), Franses & Van Dijk (1996),
Brooks, Clare and Persand (2000), Arellano (2003), Brooks (2008), Sharma &
Bodla (2011)].

While the data for advertisement expenditure, sales and profits are taken from the
sources as mentioned in the previous section of this chapter, the computations
have been done with regard to the firm value. Ratio Q developed by James Tobin
of Yale University, Nobel laureate in economics, has been extensively used as a
proxy for firm value. Tobin (1969) hypothesizes that the combined market value
of all the companies on the stock market should be about equal to their
replacement costs.

The Tobin q has been employed particularly by manufacturing firms to explain a

number of diverse corporate phenomena. These have entailed (a) cross-sectional
differences in investment and diversification decisions, (b) the relationship
between managerial equity ownership and firm value, (c) the relationship between
managerial performance and tender offer gains, investment opportunities and
tender offer responses, and (d) financing, dividend, and compensating policies
(Chung and Pruitt, 1994). It is a statistic that might serve as a proxy for the
firm's value from an investor's perspective. By definition, it is the ratio between
the market value of the firm's assets and the replacement value of those assets
calculated as follows:

68
A number of improvised models of ‘Q’ have been developed by the researchers
after Tobin giving the ‘Q’ ratio. These include L-R algorithm and many other
improvised methods. To make Q a more useable research construct, Chung and
Pruitt (1994) develop an approximation, Approximate Q, using readily available
accounting data, as given below –

Approximate Q =

where, MVE is the market value of the firm’s equity;

PS is the liquidating value of the preferred stock;

DEBT is the book value of the short-term liabilities minus its

short-term assets plus the book value of long-term debt; and

TA represents the book value of the firm’s total assets.

Tests reported by Chung and Pruitt (1994) show that Approximate Q explains
more than 96% of the variability in Q estimated by the more theoretically correct
Lindenberg and Ross method.

Approximate Q has been widely used in diverse areas of financial study,

including capital structure, firm performance, industrial diversification, earnings
management, pollution reduction, and strategic competition.

The present study uses descriptive analysis and econometric analysis for
conducting the data analysis. In the descriptive statistics, the study presents Mean,
Median, Standard Deviation, Skewness, Kurtosis, Coefficient of variation and
Jarque-bera statistic.

The mean is a particularly informative measure of the "central tendency" of the

69
variable if it is reported along with its confidence intervals. The confidence
intervals for the mean give us a range of values around the mean where we expect
the "true" (population) mean is located (with a given level of certainty).

Mean 
X i
(3.1)
n

A measure of central tendency, the median (the term first used by Galton, 1882)
of a sample is the value for which one-half (50%) of the observations (when
ranked) will lie above that value and one-half will lie below that value. When the
number of values in the sample is even, the median is computed as the average of
the two middle values.

The standard deviation is a commonly used measure of variation. The standard

deviation of a population of values is computed as:

 x   
2

σ= i
(3.2)
N

where

 is the population mean and N is the population size

The sample estimate of the population standard deviation is computed as:

  x  x
2
i
s= (3.3)
(n  1)

where

x is the sample mean and n is the sample size

The coefficient of variation measures the dispersion of data points around the
mean. Calculated as the ratio of the standard deviation divided to the mean, the
coefficient of variation can be used to compare the degree of variation from one
sample to another, even if the means are different.

70
 s
CV = (3.4)
x

where

s is the sample standard deviation and x-bar is the sample mean.

When the standard deviation and mean come from repeated measurements of a
single subject, the resulting coefficient of variation is an important measure of
reliability. The coefficient of variation is sometimes reported as a percentage (i.e.,
CV*100%).

Skewness measures the deviation of the distribution from symmetry. If the

skewness is clearly different from 0, then that distribution is asymmetrical, while
normal distributions are perfectly symmetrical.

nM 3
Skewness = (3.5)
(n  1)(n  2) s 3

where

 x  x
m
M3 is equal to: i
i 1

s3 is the sample standard deviation raised to the third power

n is the valid number of cases.

Kurtosis measures the "peakedness" of a distribution. If the kurtosis is clearly

different than 0, then the distribution is either flatter or more peaked than normal;
the kurtosis of the normal distribution is 0. Kurtosis is computed as:

n(n  1) M 4  3M 2 2 (n  1)
Kurtosis = (3.6)
(n  1)(n  2)(n  3) s 4

where
2

 
m
M 2   yi  y
i 1

71
 4

 
m
M 4   yi  y
i 1

n is the valid number of cases

s4 is the sample standard deviation raised to the fourth bar

The Jarque–Bera test is a goodness-of-fit measure of departure from normality,

based on the sample kurtosis and skewness. The test is named after Carlos
Jarque and Anil K. Bera. The test statistic JB is defined as –

n 2 1 2
JB  S  K 
6 4  (3.7)

where n is the number of observations (or degrees of freedom in general); S is the

sample skewness, and K is the sample kurtosis.

The statistic JB has an asymptotic chi-square distribution with two degrees of

freedom and can be used to test the null hypothesis that the data are from a normal
distribution. The null hypothesis is a joint hypothesis of the skewness being zero
and the excess kurtosis being 0, since samples from a normal distribution have an
expected skewness of 0 and an expected excess kurtosis of 0 (which is the same
as a kurtosis of 3). As the definition of JB shows, any deviation from this
increases the JB statistic.

Data have been analyzed using econometric tools also. In the econometric
analysis, the study performs Johansen’s cointegration, Augmented Dickey-Fuller
unit-root test, Vector Autoregression (VAR), Variance Decomposition Analysis
(VDA), Impulse Response Function (IRF) and Vector Error Correction Model
(VECM). Out of the tools of econometric analysis applied in the study,
Johansen’s cointegration analysis and Vector Error Correction Model has been
applied on the raw series, while the remaining analysis has been conducted on the
dlog of the series under reference.

72
Most of the econometric analysis can only be performed on a series of stationary
nature. In order to check whether or not the series are stationary, we prepare the
line graph for each of the series. In order to further confirm the (stationary) nature
of the series. Further, we perform the Augmented Dickey-Fuller test under the
unit root test to finally confirm whether or not the series are stationary. For the
basic understanding of Unit root testing, we may look at the following equation

yt =  yt–1 + xt + t (3.8)

where, xt are optional exogenous regressors which may consist of constant, or a

constant and trend, and are parameters to be estimated, and the tare assumed to
be white noise. If ||≥ 1 ,y is a nonstationary series and the variance of y increases
with time and approaches infinity. If ||<1 ,y is a (trend-)stationary series. Thus,
we evaluate the hypothesis of (trend-)stationarity by testing whether the absolute
value of || is strictly less than one.

The Standard Dickey-Fuller test is carried out by estimating equation (3.9) after
subtracting yt-1 from both sides of the equation.

yt =  y t-1 + xt + t, (3.9)

where =  - 1. The null and alternative hypotheses may be written as,

H0 : = 0

H1 :< 0

In order to make the series stationary, we take the dlog of the series under
reference.

The vector auto regression (VAR) is commonly used for forecasting systems of
interrelated time series and for analyzing the dynamic impact of random
disturbances on the system of variables. The VAR approach sidesteps the need for
structural modeling by treating every endogenous variable in the system as a

73
function of the lagged values of all of the endogenous variables in the system. The
mathematical representation of a VAR is:

yt = A1 y t-1 + …… + Ap y t-p + Bxt + t (3.10)

where yt is a k vector of endogenous variables, xt is a d vector of exogenous

variables, A1, …… , Ap and B are matrices of coefficients to be estimated, and tis
a vector of innovations that may be contemporaneously correlated but are
uncorrelated with their own lagged values and uncorrelated with all of the right-
hand side variables.

The study further applies the Variance Decomposition Analysis in order to finally
quantify the extent upto which the series are influenced by each other. While
impulse response functions trace the effects of a shock to one endogenous
variable on to the other variables in the VAR, variance decomposition separates
the variation in an endogenous variable into the component shocks to the VAR.
Thus, the variance decomposition provides information about the relative
importance of each random innovation in affecting the variables in the VAR.

A shock to the i-th variable not only directly affects the i-th variable but is also
transmitted to all of the other endogenous variables through the dynamic (lag)
structure of the VAR. An impulse response function traces the effect of a one-
time shock to one of the innovations on current and future values of the
endogenous variables. If the innovations are contemporaneously uncorrelated,
interpretation of the impulse response is straightforward. The i-th innovation is
simply a shock to the i-th endogenous variable. Innovations, however, are usually
correlated, and may be viewed as having a common component which cannot be
associated with a specific variable. In order to interpret the impulses, it is
common to apply a transformation to the innovations so that they become
uncorrelated:

(3.11)

74
where D is a diagonal covariance matrix.

The study performs Cointegration methodology developed in Johansen (1991,

1995) using a group object or an estimated VAR object. Two types of
cointegration tests are available – Engle-Granger’s cointegration and Johansen’s
cointegration. While the Engle-Granger methodology is applicable on two
variables, Johansen’s cointegration can be applied on the series having more than
two variables. Unlike the VAR, VDA and IRF models described above,
Cointegration tests have been applied on the absolute series (which is of non-
stationary nature) rather than the dlog series. We have applied VAR-based
cointegration tests using the methodology developed in Johansen (1991, 1995)
performed using a Group object or an estimated Var object.

Consider a VAR of order p:

yt = A1 yt-1 + ….. + Ap yt-p + Bxt +  t (3.12)

where yt is a k-vector of non-stationary I(1) variables, xt is a d-vector of

deterministic variables, and  t is a vector of innovations. We may rewrite this
VAR as,

p 1
yt   yt 1   i yt i  Bxt  t (3.13)
i 1

where:
p

  A  I
i 1
i , and

p
i    Aj
j i 1

Granger’s representation theorem asserts that if the coefficient matrix  has

reduced rank r  k , then there exist k  r matrices  and  each with rank r such

that     and   yt is I(0). r is the number of cointegrating relations (the

cointegrating rank) and each column of  is the cointegrating vector. As

75
explained below, the elements of  are known as the adjustment parameters in the
VEC model. Johansen’s method is to estimate the matrix from an unrestricted
VAR and to test whether we can reject the restrictions implied by the reduced
rank of  .

The trend assumption in the case of our series applied for cointegration is that the
level data and the cointegrating equations have linear trends:

H * (r ) :  yt 1  Bxt   (  yt 1  0  1t )    0 (3.14)

Johansen (1995) identifies the part that belongs inside the error correction term by
orthogonally projecting the exogenous terms onto the  space so that   is the

null space of     0 . We identify the part inside the error correction term by

regressing the cointegrating relations   yt on a constant (and linear trend).

To determine the number of cointegrating relations r conditional on the

assumptions made about the trend, we can proceed sequentially from r  0 to
r  k  1 until we fail to reject.

The trace statistic for the null hypothesis of r cointegrating relations is computed
as:
k
LRtr (r / k )  T  log(1  i ) k (3.15)
i  r 1

where t is the i -th largest eigenvalue of the  matrix.

The maximum eigenvalue statistic is computed as –

LRmax (r / r  1)  T log(1  r 1 )  LRtr (r / k )  LRtr (r  1/ k ) (3.16)

for r =0,1,….. k -1

A vector error correction (VEC) model is a restricted VAR designed for use with
non-stationary series that are known to be cointegrated. The VEC has
cointegration relations built into the specification so that it restricts the long-run
behavior of the endogenous variables to converge to their cointegrating
relationships while allowing for short-run adjustment dynamics. The cointegration

76
term is known as the error correction term since the deviation from long-run
equilibrium is corrected gradually through a series of partial short-run
adjustments.

To take the simplest possible example, consider a two variable system with one
cointegrating equation and no lagged difference terms. The cointegrating equation
is:

(3.17)

The corresponding VEC model is:

(3.18)

In this simple model, the only right-hand side variable is the error correction term.
In long run equilibrium, this term is zero. However, if and deviate from the

long run equilibrium, the error correction term will be nonzero and each variable
adjusts to partially restore the equilibrium relation. The coefficient measures

the speed of adjustment of the i-th endogenous variable towards the equilibrium.

The following hypothesis are formulated while applying the statistical measures –

A. H0 = dlog of sales, advertisement expenses, profits and firm value are

normally distributed (Tested through Skewness, Kurtosis and Jarque-
Bera).
B. H0 = dlog of sales, advertisement expenses, profits and firm value are not
correlated with each other (Tested through Coefficient of Correlation).

77
 C. H0 = dlog of sales, advertisement expenses, profits and firm value have a
unit root (Tested through Augmented Dickey-Fuller Unit-root test).
D. H0 = dlog of sales, advertisement expenses, profits and firm value are not
impacted by each other (Tested through Vector Auto Regression and
Variance Decomposition Analysis).

E. H0 = There are no cointegrating equations between sales, advertisement

expenses, profits and firm value (Jahensen’s Cointegration Test).

The data is reported through graphical, mathematical and text tools as used in the
various chapters/sections of the thesis.

78
 CHAPTER FOUR

EMPIRICAL ANALYSIS

The chapter focuses on the empirical analysis with regard to the impact of
advertisement expenditure on firm’s performance in case of Indian FMCG
industry. As mentioned in earlier chapters, the study regards sales, profitability
and firm value as the measures of firm’s performance. The empirical analysis is
presented in four sections as under:

1. Impact of advertisement expenditure on sales and profitability;

2. Impact of advertisement expenditure on firm value;
3. Impact of sales and profitability on firm value; and
4. Managerial implications for marketers.

For the above-mentioned four heads, the study presents results obtained by
applying various statistical tools and qualitative analysis.

4.1 Impact of advertisement expenditure on sales and

profitability
The study firstly establishes the impact of advertisement expenditure on sales and
profitability. In order to understand this impact, the study attempts to get insights
into the three series through the descriptive statistics. This is followed by
Johansen’s cointegration analysis, which is performed on the raw series. The
study further performs the Augmented Dickey-Fuller unit-root test on the dlog of
the three series, in order to check stationarity of the series under reference.
Afterwards, Vector Autoregression (VAR), Variance Decomposition Analysis
(VDA) and Impulse Response Function (IRF) are applied on the dlog of the
series. Finally, Vector Error Correction Model (VECM) is applied onto the raw
series.

a) Descriptive statistics

The analysis of data starts with the computation of basic statistics for the three

79
series so as to get insights into the data. In the descriptive statistics, Mean,
median, standard deviation and the variance of the series under reference is
presented. These statistics for the Advertisement expenditure, Sales and
Profitability are presented in table 4.1.

Table 4.1

Descriptive Statistics of Advertisement Expenditure, Sales and Profitability

ADV PAT SALES
Mean 619.2266 591.0172 6662.252
Median 56.7 24.9 1217.4
Std. Dev. 2642.795 3674.305 25466.19
Skewness 9.254446 7.79152 7.610713
Kurtosis 106.0755 77.71447 67.00244
Coefficient of Variation 426.7896 621.6917 382.246
Jarque-Bera 411724.8 218683.3 162480.5
Probability of Jarque-Bera 0 0 0

The values in the above table for mean and median are computed in millions of
dollars. The statistics of Advertisement Expenditure, Sales and Profitability over
the study period reveal that the mean value of the Advertisements is 619.22 while
the median is 56.7 (which is quite far from mean) which depicts that not the
similar numbers of the value is found above and below the mean. A high value of
standard deviation of 2642.795 shows that there was high volatility among the
advertisement expenditure of the companies. This fact is also strengthened by a
high value of Co-efficient of Variation (426.78). The Skewness statistics of 9.25
shows the series is positively skewed. The Kurtosis statistic of 106.07 infers that
the observations of the Advertisement expenditure cluster less and have shorter
tails, showing that the series is lepokurtic. The mean value in case of profit is
591.0172 and the median is 24.9 (which is quite far from mean) which depicts
that not the similar number of values is found above and below the mean. A high
value of standard deviation of 3674.3 shows high volatility among the
Profitability of the companies which is again depicted by high value of coefficient

80
of variation having value of 621.6 .The Skewness of 7.7 shows that the series is
positively skewed and further the results of kurtosis 77.7 shows the series is
leptokurtic. Further moving towards statistics result the mean value of the sales is
666.2 whereas the median is 1217.4 which is quite far from mean shows no
similar values are found are above and below the mean .A high value of standard
deviation 25466.1 which is quite high Skewness of 7.6 and kurtosis of 67.0
showing series to be leptokurtic. The high standard deviation shows the sample
companies are highly different in size. The Skewness of the three series shows the
series to be positively skewed. High kurtosis for the three series implies that the
series are non-normal and are leptokurtic. Coefficient of variation demonstrates
the variation in respect of both the series while also taking the mean into account.
Jarque-Bera statistic being lesser than 0.05 clearly implies that the series is non-
normal.

b) Johansen’s Cointegration

After getting insights into the given data we further move on to perform
econometric analysis on the series. Johansen Cointegration is applied on raw data.
The results are given in table 4.2.

Table 4.2

Unrestricted Cointegration Rank Test (Trace)

Series: ADV PAT SALES

Lags interval (in first differences): 1 to 4
Hypothesized Eigenvalue Trace 0.05 Prob.**
None
No. of*CE(s) 0.124766 256.2667
Statistic 29.79707
Critical Value 0.0001
At most 1 * 0.082581 136.8616 15.49471 0.0001
At most 2 * 0.064390 59.63438 3.841466 0.0000
Trace test indicates 3 cointegrating eqn(s) at the 0.05 level
* denotes rejection of the hypothesis at the 0.05 level
**MacKinnon-Haug-Michelis (1999) p-values
In table 4.2, we compare the Trace statistic with the 0.05 critical value. In the all
three rows that has the Null hypothesis of no cointegrating equation, the Trace
statistic is more than the critical value. This coupled with the probability value of

81
less than 0.05, enables us to reject the Null hypothesis. This implies that there are
three cointegrating equation at the 0.05 level. This conclusion is also confirmed
by the Eigenvalue statistics presented in Table 4.3. Hence, we arrive at the
observation that there are three cointegrating equation in the series.

Table 4.3

Unrestricted Cointegration Rank Test (Maximum Eigenvalue)

Series: ADV PAT SALES

Lags interval (in first differences): 1 to 4
Hypothesized Eigenvalue Trace 0.05 Prob.**
Noneof*CE(s)
No. 0.124766 119.4050
Statistic 21.13162
Critical Value 0.0001
At most 1 * 0.082581 77.22726 14.26460 0.0001
At most 2 * 0.064390 59.63438 3.841466 0.0000
Max-eigenvalue test test indicates 3 cointegrating eqn(s) at the 0.05 level
* denotes rejection of the hypothesis at the 0.05 level
**MacKinnon-Haug-Michelis (1999) p-values

Table 4.4

Unrestricted Cointegrating Coefficients (normalized by b'*S11*b=I)

ADV PAT SALES

-0.000801 -0.001094 0.000210
-0.000364 0.000345 2.25E-05
0.000285 -0.000903 0.000124

Table 4.5

Unrestricted Adjustment Coefficients (alpha)

D(ADV) 438.5640 -134.5490 -185.1390

D(PAT) 462.4514 -478.4995 20.14814
D(SALES) 2674.919 -3089.174 -992.6981

82
Table 4.4 and 4.5 provide estimates of the cointegrating relations β and the
adjustment parameters α. As is well known, the cointegrating vector β is not
identified unless we impose some arbitrary normalization. Table 4.4 reports
estimates of β and table 4.5 reports estimates of α based on the normalization β
'*S11* β =I, where S11 is defined in Johansen (1995). The transpose of β is
reported under Unrestricted Cointegrating Coefficients so that the first row is the
first cointegrating vector, the second row is the second cointegrating vector, and
so on.

The unrestricted coefficient values are the estimated values of coefficients in the
cointegrating vector, and these are presented in Table 4.4. However, it is useful to
normalize the coefficient values to set the coefficient value on one of them to
unity, as would be the case in the cointegrating regression under the Engle--
Granger approach. The normalization has been done with respect to
Advertisement (i.e. ADVERTISEMENT has been given a coefficient of 1 in the
normalized cointegrating vector) in the first two equations and with respect to
profit (i.e. PROFIT has been given a coefficient of 1 in the normalized
cointegrating vector) in the case of third equation.

Table 4.6

Cointegrating Equations

Log
1 Cointegrating Equation(s): likelihood -24132.15
Normalized cointegrating coefficients (standard error in parentheses)
ADV PAT SALES
1.000000 1.365091 -0.261511
(0.15119) (0.02130)
Adjustment coefficients (standard error in parentheses)
D(ADV) -0.351486
(0.03911)
D(PAT) -0.370631
(0.05582)
D(SALES) -2.143809
(0.36312)

83
 Log
2 Cointegrating Equation(s): likelihood -24093.53
Normalized cointegrating coefficients (standard error in parentheses)
ADV PAT SALES
1.000000 0.000000 -0.143623
(0.00876)
0.000000 1.000000 -0.086359
(0.00662)
Adjustment coefficients (standard error in parentheses)
D(ADV) -0.302554 -0.526197
(0.04277) (0.05574)
D(PAT) -0.196612 -0.670910
(0.05964) (0.07773)
D(SALES) -1.020353 -3.991502
(0.38810) (0.50584)

Table 4.6 presents the adjustment coefficients, or loadings in each regression (i.e.
the ‘amount of the cointegrating vector’ in each equation).

From table 4.6, we can construct the following cointegrating equations –

1. 1.00 Advertisement + 1.36509 Profit -0.261511 Sales=0

2. 1.00 Advertisement - 0.143623 Sales = 0
3. 1.00 Profit - -0.086359 Sales =0

c) Augmented Dickey-Fuller unit-root test

The unit-root test is performed on the dlog of advertisement expenditure, sales

and profit series in order to test the null hypothesis that the series have a unit root.
The findings of the unit-root test and the augmented Dickey-Fuller test are shown
in table 4.7, 4.8 and 4.9.

84
 Table 4.7

Augmented Dickey-Fuller unit-root test (dlog of advertisement expenditure)

Null Hypothesis: DADV has a unit root

Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, maxlag=20)
z-Statistic Prob.*
Augmented Dickey-Fuller test statistic -34.61871 0.0000
Test critical values: 1% level -3.437401
5% level -2.864542
10% level -2.568422
*MacKinnon (1996) one-sided p-values.
By the way of unit-root test, the null hypothesis that dlog of advertisement
expenditure, sales and profit has a unit-root is tested. Probability value of less
than 0.05 in table 4.7, 4.8 and 4.9 implies that the Null hypothesis is rejected and
the variable does not have a unit-root, which confirms that the series are
stationary. Hence, all the three dlog series happen to be stationary.

Table 4.8

Augmented Dickey-Fuller unit-root test (dlog of sales)

Null Hypothesis: DSALES has a unit root

Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, maxlag=20)
z-Statistic Prob.*
Augmented Dickey-Fuller test statistic -31.81259 0.0000
Test critical values: 1% level -3.437401
5% level -2.864542
10% level -2.568422
*MacKinnon (1996) one-sided p-values.

85
 Table 4.9

Augmented Dickey-Fuller unit-root test (dlog of profit)

Null Hypothesis: DPAT has a unit root

Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, maxlag=20)
z-Statistic Prob.*
Augmented Dickey-Fuller test statistic -31.55067 0.0000
Test critical values: 1% level -3.437401
5% level -2.864542
10% level -2.568422
*MacKinnon (1996) one-sided p-values.
The study further performs the group unit-root tests for Advertisement, Sales, and
Profit. The group unit root test involves the Levin, Lin & Chu test; Im, Pesaran
and Shin W-stat; ADF-Fisher Chi-square and PP-Fisher Chi Square tests. The
findings of the group unit root tests are presented in table 4.10.

Table 4.10

Group unit-root test

Series: DADV, DPAT, DSALES
Exogenous variables: Individual effects
Newey-West automatic bandwidth selection and Bartlett kernel
Method Statistic Prob.
Null: Unit root (assumes common unit root process)
Levin, Lin & Chu t* -70.6791 0.0000
Null: Unit root (assumes individual unit root process)
Im, Pesaran and Shin W-stat -67.3388 0.0000
ADF - Fisher Chi-square 537.193 0.0000
PP - Fisher Chi-square 425.835 0.0000

d) Vector Autoregression (VAR)

After the Unit Root Test, the study further applies unrestricted Vector
Autoregressive (VAR) models in order to check the relationship between dlog of
advertisement expenditure, sales and profits. The results of VAR model are

86
presented in table 4.11.

By application of the VAR Model, it is observed that the integration of one

variable (i.e. Advertisement) with the other can be established if the t-statistic is
more than 1.96 (irrespective of the sign). The integration of the one variable with
the other is tested at the lag of 1 and 2. The dlog at lag 0 is taken in the columns
while the dlog at all the variables at lag 1 and lag 2 are taken in the rows. For
understanding the analysis produced by the Vector Auto-Regression, one needs to
move column-wise.

Table 4.11

Vector Autoregression (VAR)

Standard errors in ( ) & Z-statistics in [ ]

DADV DPAT DSALES
DADV(-1) -0.268697 -0.263807 -0.090807
(0.04516) (0.06817) (0.02819)
[-5.94995] [-3.86996] [-3.22118]
DADV(-2) -0.073759 0.000248 0.053970
(0.03760) (0.05675) (0.02347)
[-1.96193] [ 0.00437] [2.29967]
DPAT(-1) 0.028202 -0.223539 0.024381
(0.03086) (0.04658) (0.01926)
[ 0.91393] [-4.79907] [ 1.26568]
DPAT(-2) -0.021719 -0.042869 0.024814
(0.02995) (0.04522) (0.01870)
[-0.72506] [-0.94810] [ 1.32703]
DSALES(-1) 0.143899 0.688880 0.169063
(0.09508) (0.14353) (0.05935)
[ 1.51342] [ 4.79970] [ 2.84835]
DSALES(-2) 0.128867 0.169285 -0.018100
(0.09790) (0.14778) (0.06111)
[ 1.31630] [ 1.14552] [-0.29617]
C 0.164940 0.105314 0.117604
(0.02981) (0.04500) (0.01861)
[ 5.53233] [ 2.34014] [ 6.31898]

87
Taking the first column in table 4.11 – dlog of advertisement expenditure is
influenced by the dlog of advertisement at lag 1 and 2. Dlog of profit is influenced
by dlog of advertisement, profit and sales at lag 1. Dlog of sales is influenced by
dlog of advertisement at lag of 1 and 2, and by dlog of sales at lag of 1. These
values have been highlighted in table 4.11.

In this way, application of the VAR model leads us to the conclusion that the
advertisement expenditure, sales and profit impact each other significantly.

e) Variance Decomposition Analysis

The Variance Decomposition Analysis of the dlog of advertisement expenditure,

sales and profit, is presented in the table 4.12 to 4.14. The tables decomposes the
variance in dlog of advertisement expenditure, sales and profit for a period
ranging from 1 to 10.

Table 4.12

Variance Decomposition Analysis of dlog of advertisement expenditure

Period S.E. DADV DPAT DSALES
1 0.538438 100.0000 0.000000 0.000000
2 0.555019 99.00184 0.396549 0.601616
3 0.556647 98.42368 0.459900 1.116415
4 0.557039 98.34818 0.501457 1.150367
5 0.557040 98.34791 0.501727 1.150364
6 0.557049 98.34543 0.502300 1.152274
7 0.557049 98.34535 0.502357 1.152294
8 0.557050 98.34533 0.502366 1.152307
9 0.557050 98.34532 0.502368 1.152312
10 0.557050 98.34532 0.502368 1.152312
Taable 4.12 decomposes the variance of dlog of advertisement expenditure and
reveals that by and large, the dlog of advertisement expenditure is composed by
the dlog of advertisement expenditure for the previous years. However, it is
evident that the dlog of sales leaves an impact on the dlog of advertisement,
particularly at period 3 and beyond. This is in conformity with the results

88
produced by the Vector Auto-Regression (VAR) model, which found that the
Sales influences the Advertisement.

Table 4.13
Variance Decomposition Analysis of dlog of sales
Period S.E. DADV DPAT DSALES
1 0.336118 14.28233 6.497962 79.21971
2 0.342460 14.25851 7.247617 78.49387
3 0.344742 15.10206 7.424660 77.47328
4 0.344786 15.09950 7.431111 77.46939
5 0.344811 15.09750 7.430257 77.47224
6 0.344813 15.09802 7.430767 77.47121
7 0.344813 15.09804 7.430806 77.47115
8 0.344813 15.09804 7.430806 77.47115
9 0.344813 15.09804 7.430807 77.47115
10 0.344813 15.09804 7.430807 77.47115
Table 4.13 decomposes the variance of dlog sales and reveals that the dlog of
advertisement and dlog of profit leaves a visible impact on the dlog of sales at all
the periods. This is in conformity with the results produced by the Vector Auto-
Regression (VAR) model, which found that the sales are influenced by the
advertisement expenditure.

Table 4.14
Variance Decomposition Analysis of dlog of profit
Period S.E. DADV DPAT DSALES
1 0.812765 2.601915 97.39809 0.000000
2 0.851209 3.342436 90.79575 5.861812
3 0.853428 3.674422 90.38610 5.939474
4 0.853924 3.690124 90.34972 5.960152
5 0.853980 3.691258 90.33966 5.969080
6 0.853983 3.691239 90.33901 5.969749
7 0.853985 3.691408 90.33876 5.969830
8 0.853985 3.691409 90.33876 5.969832
9 0.853985 3.691410 90.33875 5.969836
10 0.853985 3.691411 90.33875 5.969836

89
Taable 4.14 decomposes the variance of dlog of profit and reveals that by and
large, the dlog of profit is composed by the previous Year levels/dlog at the same.
However, it is evident that the dlog of advertisement leaves a visible impact on
the dlog of profit, at all the periods. Table 4.14 also depicts that dlog of sales also
impacts the dlog of profit significantly at period 2 and beyond. This is in
conformity with the results produced by the Vector Auto-Regression (VAR)
model, which found that the sales influence advertisement expenditure.

f) Impulse Response Function

Figure 4.1

Impulse Response Function (dlog of advertisement expenditure, sales and

profits)

Response to Cholesky One S.D. Innovations

Response of DADV to DADV Response of DADV to DPAT Response of DADV to DSALES
.6 .6 .6

.4 .4 .4

.2 .2 .2

.0 .0 .0

-.2 -.2 -.2

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Response of DPAT to DADV Response of DPAT to DPAT Response of DPAT to DSALES

1.0 1.0 1.0

0.8 0.8 0.8

0.6 0.6 0.6

0.4 0.4 0.4

0.2 0.2 0.2

0.0 0.0 0.0

-0.2 -0.2 -0.2

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Response of DSALES to DADV Response of DSALES to DPAT Response of DSALES to DSALES

.4 .4 .4

.3 .3 .3

.2 .2 .2

.1 .1 .1

.0 .0 .0

-.1 -.1 -.1

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

90
Figure 4.1 presents the findings of Impulse Response Function with regard to the
dlog series of advertisement expenditure, sales and profits. The figure depicts the
impulse response of the variables (i.e. dlog of advertisement expenditure, sales
and profit) on each other. Figure 4.1 shows the number of years on x-axis and the
shock-response on y-axis. The figure exhibits in about how many years the shock
at the other variable cools down.

g) Vector Error Correction Model (VECM)

In order to further explain the cointegrating equations, the application of Vector

Error Correction Model (VECM) is employed. Restrictions concerning the
cointegrating relationships embodied in β are denoted by B(i,j), where B(i,j)
represents the j th coefficient in the i th cointegrating relationship.

The results of the Vector Error Correction Model are summarized below in Table
4.15. Table 4.15 also presents the VECM estimates of the cointegrating equation.

Table 4.15

Vector Error Correction Estimates

Cointegrating Eq: CointEq1
ADV(-1) 1.000000
PAT(-1) 0.976398
(0.20419)
[ 4.78186]
SALES(-1) -0.169164
(0.02896)
[-5.84159]
C -69.62622
Error Correction: D(ADV) D(PAT) D(SALES)
CointEq1 -0.286769 -0.363773 -2.498913
(0.02848) (0.03978) (0.25677)
[-10.0691] [-9.14441] [-9.73205]
D(ADV(-1)) 0.058812 0.124837 1.020688
(0.06179) (0.08630) (0.55707)
[ 0.95184] [ 1.44647] [ 1.83226]

91
 D(ADV(-2)) 0.023222 0.064841 1.091550
(0.06112) (0.08537) (0.55104)
[ 0.37994] [ 0.75951] [ 1.98088]
D(PAT(-1)) 0.183401 -0.034528 0.973730
(0.07369) (0.10293) (0.66440)
[ 2.48872] [-0.33543] [ 1.46557]
D(PAT(-2)) -0.202137 -0.573221 -1.770737
(0.07307) (0.10206) (0.65875)
[-2.76651] [-5.61661] [-2.68803]
D(SALES(-1)) -0.031483 -0.008036 -0.256422
(0.01423) (0.01988) (0.12833)
[-2.21185] [-0.40418] [-1.99815]
D(SALES(-2)) 0.042659 0.085484 0.230918
(0.01414) (0.01976) (0.12751)
[ 3.01618] [ 4.32713] [ 1.81093]
C 0.121950 0.158175 0.628931
(49.4524) (69.0752) (445.855)
[ 0.00247] [ 0.00229] [ 0.00141]

The purpose of the VECM is to focus on the short run dynamics while making
them consistent with long run solution. If a number of variables are found to be
cointegrated with at least one cointegrating vector, then there always exists a
corresponding error-correction representation which implies that changes in
dependent variable can be formulated as a function of the level disequilibrium in
the cointregration relationship and fluctuations in other explanatory variables. The
table above depicts the long term relationship between advertisement expenditure,
sales and profits at lag 1 and 2, hence depicting cointegration among
advertisement expenditure, sales and profitability.

4.2 Impact of advertisement expenditure on firm value

This section of the attempts to establish the impact of advertisement expenditure
on firm value. The previous section has already presented the descriptive statistics
for the advertisement expenditure. Hence, this section presents the descriptive
statistics of the proxy ‘Q’ for firm value. This is followed by Johansen’s

92
cointegration analysis, which is performed on the two raw series. The study
further performs the Augmented Dickey-Fuller unit-root test on the dlog of firm
value, in order to check stationarity of the same. The stationarity of dlog of
advertisement expenditure has already been checked in the previous section.
Afterwards, Vector Autoregression (VAR), Variance Decomposition Analysis
(VDA) and Impulse Response Function (IRF) are applied on the dlog of the
series. Finally, Vector Error Correction Model (VECM) is applied onto the raw
series.

a) Descriptive statistics

In the descriptive statistics, Mean, median, standard deviation and the variance of
the series under reference is presented. These statistics for the Advertisement
expenditure have already been discussed in section 4.1. Table 4.16 only presents
the descriptive statistics in respect of the proxy ‘Q’ for firm value. It may be
recalled here that for the purpose of the study, the firm value is approximated as
per the simplified version of approximated ‘Q’ as suggested by Chung and Pruitt
(1994), which seems simpler and more objective as compared to the original ‘Q’
as given by Tobin –

Approximated Tobin’s q =

Table 4.16

Descriptive Statistics of Firm Value (Approximated by Tobin’s Q)

Statistic Firm Value (Approximated Tobin’s Q)
Mean 1.827
Median 1.150
Std. Dev. 2.94
Skewness 11.4211
Kurtosis 187.4888
Coefficient of Variation 160.9195
Probability of Jarque-Bera 0.00000

93
The statistics of Firm Value over the study period reveal that the mean value of
the firm value is 1.827 while the median is 1.150 (which is quite far from mean)
which depicts that not the similar numbers of the value is found above and below
the mean. A high value of standard deviation of 2.94 shows that there was high
variability among the firm value of the companies. This fact is also strengthened
by a high value of Co-efficient of Variation (160.92). The Skewness statistics of
11.42 shows the series is positively skewed. The Kurtosis statistic of 187.48 infers
that the observations of the firm value cluster less and have shorter tails, showing
that the series is lepokurtic.

b) Johansen’s Cointegration

The study further performs econometric analysis on the series. Johansen

Cointegration is applied on raw data .The results are given in table 4.17 below:

Table 4.17
Unrestricted Cointegration Rank Test (Trace)
Series: ADV FV Lags interval (in first differences): 1 to 4
Hypothesized Trace 0.05 Critical
No. of CE(s) Eigenvalue Statistic Value Prob.**
None * 0.105042 169.1551 15.49471 0.0001
At most 1 * 0.076038 70.38476 3.841466 0.0000
Trace test indicates 2 cointegrating eqn(s) at the 0.05 level
* denotes rejection of the hypothesis at the 0.05 level
**MacKinnon-Haug-Michelis (1999) p-values

In table 4.17, we compare the Trace statistic with the 0.05 critical value. In the
both rows that has the Null hypothesis of no cointegrating equation, the Trace
statistic is more than the critical value. This coupled with the probability value of
less than 0.05, enables us to reject the Null hypothesis.

94
 Table 4.18

Unrestricted Cointegration Rank Test (Maximum Eigenvalue)

Series: ADV FV Lags interval (in first differences): 1 to 4

Lags interval (in first differences): 1 to 4
Hypothesized Max-Eigen 0.05
No. of CE(s) Eigenvalue Statistic Critical Value Prob.**
None * 0.105042 98.77038 14.26460 0.0000
At most 1 * 0.076038 70.38476 3.841466 0.0000
Max-eigenvalue test test indicates 2 cointegrating eqn(s) at the 0.05 level
* denotes rejection of the hypothesis at the 0.05 level
**MacKinnon-Haug-Michelis (1999) p-values
This implies that there are two cointegrating equation at the 0.05 level. This
conclusion is also confirmed by the Eigenvalue statistics presented in Table 4.18.
Hence, we arrive at the observation that there are two cointegrating equation in
the series.

Table 4.19

Unrestricted Cointegrating Coefficients (normalized by b'*S11*b=I)

ADV FV
-0.000232 0.452290
0.000416 0.085498

Table 4.20

Unrestricted Adjustment Coefficients (alpha)

D(ADV) 152.6446 -411.5120

D(FV) -0.628271 -0.248000

Table 4.19 and 4.20 provide estimates of the cointegrating relations β and the
adjustment parameters α. As is well known, the cointegrating vector β is not
identified unless we impose some arbitrary normalization. Table 4.19 reports
estimates of β and table 4.20 reports estimates of α based on the normalization β

95
'*S11* β =I, where S11 is defined in Johansen (1995). The transpose of β is
reported under Unrestricted Cointegrating Coefficients so that the first row is the
first cointegrating vector, the second row is the second cointegrating vector, and
so on.

The unrestricted coefficient values are the estimated values of coefficients in the
cointegrating vector, and these are presented in Table 4.19. However, it is useful
to normalize the coefficient values to set the coefficient value on one of them to
unity, as would be the case in the cointegrating regression under the Engle--
Granger approach. The normalization has been done with respect to
ADVERTISEMENT (i.e. ADVERTISEMENT has been given a coefficient of 1
in the normalized cointegrating vector).

Table 4.21 presents the adjustment coefficients, or loadings in each regression

(i.e. the ‘amount of the cointegrating vector’ in each equation).

Table 4.21

Cointegrating Equations

1 Cointegrating Equation(s): Log -9691.255

Normalized cointegrating coefficients (standard error in parentheses)
likelihood
ADV FV
1.000000 -1946.133
(184.852)
Adjustment coefficients (standard error in parentheses)
D(ADV) -0.035475
(0.01220)
D(FV) 0.000146
(1.6E-05)

From table 4.21, we can construct the following cointegrating equation –

1.00 Advertisement – 1946.13 Firm Market Value = 0

c) Augmented Dickey-Fuller unit-root test

The unit-root test on dlog of advertisement expenditure has already been applied

96
and discussed in section 4.1. Table 4.22 discusses the findings of the unit-root test
and the augmented Dickey-Fuller test on dlog of firm value.

Table 4.22

Augmented Dickey-Fuller unit-root test (dlog of firm value)

Null Hypothesis: DFV has a unit root

Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, maxlag=20)
z-Statistic Prob.*
Augmented Dickey-Fuller test statistic -23.80219 0.0000
Test critical values: -3.437475 -3.437401
-2.864574 -2.864542
-2.568439 -2.568422
*MacKinnon (1996) one-sided p-values.
By the way of unit-root test, the null hypothesis that dlog of firm value has a unit-
root is tested. Probability value of less than 0.05 in table 4.22 implies that the Null
hypothesis is rejected and the variable does not have a unit-root, which confirms
that the series are stationary. Hence, all the dlog of firm value series happen to be
stationary.

d) Vector Autoregression (VAR)

After the Unit Root Test, the study further applies unrestricted Vector
Autoregressive (VAR) models in order to check the relationship between dlog of
advertisement expenditure and firm value. The results of VAR model are
presented in table 4.23.

Taking the first column in table 4.23 – dlog of Advertisement expenditure is

influenced by the dlog of advertisement expenditure at lag 1 and lag 2.
Conversely, dlog of firm value is influenced by dlog of advertisement expenditure
at lag 1 and by dlog of firm value at lag 1 and 2. In this way, application of the
VAR model leads us to the conclusion that the advertisement expenditure impacts
firm value.

97
 Table 4.23

Vector Autoregression (VAR)

DADV DFV
DADV(-1) -0.157438 0.042053
(0.03354) (0.01623)
[-4.69444] [ 2.59056]
DADV(-2) -0.066257 -0.006790
(0.03364) (0.01628)
[-1.96988] [-0.41705]
DFV(-1) 0.106758 -0.086841
(0.06899) (0.03339)
[ 1.54748] [-2.60058]
DFV(-2) 0.096039 -0.128317
(0.07589) (0.03673)
[ 1.26548] [-3.49310]
C 0.106614 -0.005964
(0.02972) (0.01439)
[ 3.58709] [-0.41454]

e) Variance Decomposition Analysis

Further, the Variance Decomposition Analysis of Advertisement expenditure and

Firm Value is presented in the table 4.24. The table decomposes the variance of
advertisement expenditure and firm value for the period ranging from 1 to 10.
Table 4.24 decomposes the variance of dlog of Advertisement expenditure and
reveals that by and large, dlog of advertisement expenditure is composed by the
previous Year values of the same series. However, it is evident that the dlog of
Firm Value does not have any impact on the advertisement at any period. This is
in conformity with the results produced by the Vector Auto-Regression (VAR)
model, which found that the Firm Value does not influence advertisement
expenditure.

98
 Table 4.24

Variance Decomposition Analysis of dlog of advertisement expenditure

Period S.E. DADV DFV
1 0.876349 100.0000 0.000000
2 0.887971 99.74048 0.259524
3 0.889008 99.62989 0.370110
4 0.889294 99.59588 0.404125
5 0.889302 99.59471 0.405288
6 0.889308 99.59357 0.406431
7 0.889308 99.59357 0.406430
8 0.889308 99.59355 0.406450
9 0.889308 99.59355 0.406450
10 0.889308 99.59355 0.406450

However, the results from table 4.25 are not in conformity with the results from
VAR. Table 4.25 shows that advertisement expenditure has little impact on firm
value.

Table 4.25

Variance Decomposition Analysis of dlog of firm value

Period S.E. DADV DFV
1 0.424187 0.215752 99.78425
2 0.427228 0.889307 99.11069
3 0.430406 1.036740 98.96326
4 0.430534 1.042338 98.95766
5 0.430571 1.048271 98.95173
6 0.430575 1.048257 98.95174
7 0.430575 1.048358 98.95164
8 0.430575 1.048361 98.95164
9 0.430575 1.048361 98.95164
10 0.430575 1.048362 98.95164

99
 f) Impulse Response Function

Figure 4.2 presents the findings of Impulse Response Function with regard to the
dlog series of advertisement expenditure and firm value. The figure depicts the
impulse response of the Variables (i.e. dlog of advertisement expenditure and firm
value) on each other. Figure 4.2 shows the number of years on x-axis and the
shock-response on y-axis. The figure exhibits in about how many years the shock
at the other variable cools down.

Figure 4.2

Impulse Response Function (dlog of advertisement expenditure and firm

value)

Response to Cholesky One S.D. Innovations

Response of DADV to DADV Response of DADV to DFV
1.0 1.0

0.8 0.8

0.6 0.6

0.4 0.4

0.2 0.2

0.0 0.0

-0.2 -0.2
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Response of DFV to DADV Response of DFV to DFV

.5 .5

.4 .4

.3 .3

.2 .2

.1 .1

.0 .0

-.1 -.1
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

g) Vector Error Correction Model (VECM)

In order to further explain the cointegrating equations, the application of Vector

100
Error Correction Model (VECM) is employed. Restrictions concerning the
cointegrating relationships embodied in β are denoted by B(i,j), where B(i,j)
represents the j th coefficient in the i th cointegrating relationship.

The results of the Vector Error Correction Model are summarized below in Table
4.26. Table 4.26 also presents the VECM estimates of the cointegrating equation.

Table 4.26

Vector Error Correction Estimates

Cointegrating Eq: CointEq1
ADV(-1) 1.000000
FV(-1) -914.6234
(103.565)
[-8.83137]
C 1050.257
Error Correction: D(ADV) D(FV)
CointEq1 -0.134599 0.000157
(0.01831) (2.5E-05)
[-7.35091] [ 6.28540]
D(ADV(-1)) -0.022286 -9.60E-05
(0.03422) (4.7E-05)
[-0.65128] [-2.06056]
D(ADV(-2)) 0.109298 1.74E-05
(0.03380) (4.6E-05)
[ 3.23377] [ 0.37795]
D(FV(-1)) -56.91428 -0.053636
(25.4523) (0.03464)
[-2.23611] [-1.54829]
D(FV(-2)) -68.74724 -0.163220
(24.8827) (0.03387)
[-2.76286] [-4.81951]
C 0.065408 -0.002740
(51.6969) (0.07036)
[0.00127] [-0.03894]

101
The purpose of the VECM is to focus on the short run dynamics while making
them consistent with long run solution. If a number of variables are found to be
cointegrated with at least one cointegrating vector, then there always exists a
corresponding error-correction representation, which implies that changes in
dependent variable can be formulated as a function of the level disequilibrium in
the cointregration relationship and fluctuations in other explanatory variables. The
table above depicts the long term relationship between advertisement expenditure
and Firm value at lag 1 and 2 hence depicting cointegration among advertisement
expenditure and Firm Value.

4.3 Impact of sales and profitability on firm value

After analysing the impact of advertisement expenditure on sales and profitability
of firms, and that of advertisement expenditure on firm value; the study proceeds
to study the impact of sales and profitability on firm value. This section does not
present the descriptive statistics of the variables covered in the section, i.e., sales,
profitability and firm value. This is due to the fact that while the descriptive
statistics of sales and profitability have already been presented in section 4.1 of
this chapter, section 4.2 of the chapter has already presented the descriptive
statistics with regard to the firm value. On the similar lines, the Augmented
Dickey-Fuller unit-root test has been applied on dlog of sales and profits in
section 4.1, while the same has been applied onto the dlog of firm value in section
4.2 of the chapter. The application of Augmented Dickey-Fuller unit-root test
shows that the dlog of the three series is stationary in nature. This section applies
Johansen’s cointegration analysis, which is performed on the raw series. The
section further performs the Vector Autoregression (VAR), Variance
Decomposition Analysis (VDA) and Impulse Response Function (IRF) applied on
the dlog of the three series. Finally, Vector Error Correction Model (VECM) is
applied onto the raw series.

a) Johansen’s Cointegration

The results of Johansen’s cointegration are shown in table 4.27 below:

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 Table 4.27

Unrestricted Cointegration Rank Test (Trace)

Series: FV PAT SALES

Lags interval (in first differences): 1 to 4
Hypothesized Trace 0.05
No. of CE(s) Eigenvalue Statistic Critical Value Prob.**
None * 0.109186 248.1546 29.79707 0.0001
At most 1 * 0.092492 145.2533 15.49471 0.0001
At most 2 * 0.064013 58.87664 3.841466 0.0000
Trace test indicates 3 cointegrating eqn(s) at the 0.05 level
* denotes rejection of the hypothesis at the 0.05 level
**MacKinnon-Haug-Michelis (1999) p-values

Table 4.27 compares the Trace statistic with the 0.05 critical value. In all the three
rows that has the Null hypothesis of no cointegrating equation, the Trace statistic
is more than the critical value. This coupled with the probability value of less than
0.05, enables us to reject the Null hypothesis.

Table 4.28

Unrestricted Cointegration Rank Test (Maximum Eigenvalue)

Series: FV PAT SALES

Lags interval (in first differences): 1 to 4
Hypothesized Trace 0.05
No. of CE(s) Eigenvalue Statistic Critical Value Prob.**
None * 0.109186 102.9013 21.13162 0.0001
At most 1 * 0.092492 86.37668 14.26460 0.0000
At most 2 * 0.064013 58.87664 3.841466 0.0000
Max-eigenvalue test test indicates 3 cointegrating eqn(s) at the 0.05 level
* denotes rejection of the hypothesis at the 0.05 level
**MacKinnon-Haug-Michelis (1999) p-values

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This implies that there are three cointegrating equation at the 0.05 level. This
conclusion is also confirmed by the Eigenvalue statistics presented in Table 4.28.
Hence, we arrive at the observation that there are three cointegrating equation in
the series.

Table 4.29 and 4.30 provide estimates of the cointegrating relations β and the
adjustment parameters α. As is well known, the cointegrating vector β is not
identified unless we impose some arbitrary normalization. Table 4.29 reports
estimates of β and table 4.30 reports estimates of α based on the normalization β
'*S11* β =I, where S11 is defined in Johansen (1995). The transpose of β is
reported under Unrestricted Cointegrating Coefficients so that the first row is the
first cointegrating vector, the second row is the second cointegrating vector, and
so on.

Table 4.29

Unrestricted Cointegrating Coefficients (normalized by b'*S11*b=I)

FV PAT SALES
0.385866 0.000718 -9.82E-05
0.224837 -0.000706 5.94E-05
-0.088559 0.000913 -0.000155

Table 4.30

Unrestricted Adjustment Coefficients (alpha)

D(FV) -0.657855 -0.192286 0.085852

D(PAT) -286.4692 595.3687 50.09206
D(SALES) -1433.380 3636.356 1421.404

The unrestricted coefficient values are the estimated values of coefficients in the
cointegrating vector, and these are presented in Table 4.30. However, it is useful
to normalize the coefficient values to set the coefficient value on one of them to
unity, as would be the case in the cointegrating regression under the Engle-

104
Granger approach. The normalization has been done with respect to firm value
(i.e. firm value has been given a coefficient of 1 in the normalized cointegrating
vector) in the first two equations and with respect to profit (i.e. profit has been
given a coefficient of 1 in the normalized cointegrating vector) in the case of third
equation.

Table 4.31 presents the adjustment coefficients, or loadings in each regression

(i.e. the ‘amount of the cointegrating vector’ in each equation), are also given in
this table.

From table 4.31, we can construct the following cointegrating equations –

1. 1.00 Firm value + 0.001861 Profit - 0.000254 Sales=0

2. 1.00 Firm value - 0.00000614 Sales = 0
3. 1.00 Profit - 0.103678 Sales =0

Table 4.31

Cointegrating Equations

Log
1 Cointegrating Equation(s): likelihood -18714.80
Normalized cointegrating coefficients (standard error in parentheses)
ADV PAT SALES
1.000000 1.365091 -0.261511
(0.15119) (0.02130)
Adjustment coefficients (standard error in parentheses)
D(ADV) -0.351486
(0.03911)
D(PAT) -0.370631
(0.05582)
D(SALES) -2.143809
(0.36312)

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 Log
2 Cointegrating Equation(s): likelihood -24093.53
Normalized cointegrating coefficients (standard error in parentheses)
ADV PAT SALES
1.000000 0.000000 -0.143623
(0.00876)
0.000000 1.000000 -0.086359
(0.00662)
Adjustment coefficients (standard error in parentheses)
D(ADV) -0.302554 -0.526197
(0.04277) (0.05574)
D(PAT) -0.196612 -0.670910
(0.05964) (0.07773)
D(SALES) -1.020353 -3.991502
(0.38810) (0.50584)

Vector Autoregression (VAR)

The study further applies unrestricted Vector Autoregressive (VAR) models in

order to check the relationship between dlog of sales, profits and firm value. The
results of VAR model are presented in table 4.32. By application of the VAR
Model, it is observed that the integration of one variable (i.e. Advertisement) with
the other can be established if the t-statistic is more than 1.96 (irrespective of the
sign). The integration of the one variable with the other is tested at the lag of 1
and 2. The dlog at lag 0 is taken in the columns while the dlog at all the variables
at lag 1 and lag 2 are taken in the rows. For understanding the analysis produced
by the Vector Auto-Regression, one needs to move column-wise.

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 Table 4.32

Vector Autoregression (VAR)

Standard errors in ( ) & Z-statistics in [ ]

DFV DPAT DSALES
DFV(-1) -0.102985 -0.010811 0.039012
(0.04511) (0.08240) (0.03400)
[-2.28288] [-0.13121] [ 1.14738]
DFV(-2) -0.064363 -0.039528 -0.002852
(0.05086) (0.09291) (0.03834)
[-1.26538] [-0.42546] [-0.07439]
DPAT(-1) 0.039242 -0.231322 0.011370
(0.02610) (0.04767) (0.01967)
[ 1.50370] [-4.85275] [ 0.57805]
DPAT(-2) 0.026319 -0.036920 0.021561
(0.02542) (0.04643) (0.01916)
[ 1.03538] [-0.79519] [ 1.12540]
DSALES(-1) -0.037898 0.455947 0.074799
(0.07268) (0.13276) (0.05478)
[-0.52142] [ 3.43443] [ 1.36543]
DSALES(-2) -0.073058 0.245697 0.064568
(0.07678) (0.14024) (0.05787)
[-0.95154] [ 1.75196] [ 1.11576]
C 0.006424 0.088519 0.113378
(0.02505) (0.04575) (0.01888)
[ 0.25645] [ 1.93466] [ 6.00521]
Taking the first column in table 4.32 – dlog of firm value is influenced by dlog of
firm value at lag 1. Dlog of profit at lag 1 is influenced by dlog of profit and dlog
of sales at lag 1. Dlog of sales is not found to be influenced by any of the
variables at any lag.

A study of the VAR model leads us to the conclusion that the firm value is not
influenced by sales or profit.

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 b) Variance Decomposition Analysis

The Variance Decomposition Analysis of the dlog of firm value, sales and profit,
is presented in the table 4.33 to 4.35. The tables decomposes the variance in dlog
of firm value, sales and profit for a period ranging from 1 to 10.

Table 4.33

Variance Decomposition Analysis of dlog of firm value

Period S.E. DADV DPAT DSALES
1 0.452527 100.0000 0.000000 0.000000
2 0.455265 99.56607 0.362047 0.071880
3 0.456221 99.41336 0.369204 0.217434
4 0.456313 99.37563 0.389782 0.234588
5 0.456315 99.37563 0.389780 0.234586
6 0.456316 99.37516 0.390007 0.234833
7 0.456316 99.37515 0.390021 0.234834
8 0.456316 99.37514 0.390022 0.234834
9 0.456316 99.37514 0.390022 0.234834
10 0.456316 99.37514 0.390022 0.234834

Table 4.33 decomposes the variance of dlog of firm value and reveals that by and
large, the variance of dlog of firm value is composed by the previous Year levels
at the same. However, it is evident that the return at sales and profit leaves no
impact on the return at the firm value, at any period.

Table 4.34 decomposes the variance of dlog of Profit and reveals that the dlog of
sales and dllog of firm value leaves an impact on the dlog of Profit, though the
impact of sales is seen at Period 2 and beyond.

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 Table 4.34

Variance Decomposition Analysis of dlog of profit

Period S.E. DADV DPAT DSALES
1 0.826567 4.937532 95.06247 0.000000
2 0.851425 4.899760 92.12550 2.974736
3 0.854076 4.870129 91.73935 3.390520
4 0.854213 4.883115 91.72732 3.389569
5 0.854251 4.882766 91.72008 3.397155
6 0.854252 4.882758 91.71988 3.397358
7 0.854252 4.882760 91.71983 3.397410
8 0.854253 4.882760 91.71982 3.397416
9 0.854253 4.882760 91.71982 3.397417
10 0.854253 4.882760 91.71982 3.397417

Table 4.35

Variance Decomposition Analysis of dlog of sales

Period S.E. DADV DPAT DSALES
1 0.341071 0.108436 10.72049 89.17108
2 0.342987 0.467341 10.86184 88.67082
3 0.344762 0.469618 11.29412 88.23626
4 0.344824 0.469481 11.29039 88.24013
5 0.344850 0.469539 11.29329 88.23717
6 0.344851 0.469601 11.29342 88.23698
7 0.344852 0.469600 11.29346 88.23694
8 0.344852 0.469600 11.29346 88.23694
9 0.344852 0.469600 11.29346 88.23694
10 0.344852 0.469600 11.29346 88.23694

Table 4.35 decomposes the variance of dlog of Sales and reveals that dlog of
profit leaves a visible impact on the return at the Sales, at all periods.

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 c) Impulse Response Function

Figure 4.3

Impulse Response Function (dlog of sales, profits and firm value)

Response to Cholesky One S.D. Innovations

Response of DFV to DFV Response of DFV to DPAT Response of DFV to DSALES
.5 .5 .5

.4 .4 .4

.3 .3 .3

.2 .2 .2

.1 .1 .1

.0 .0 .0

-.1 -.1 -.1

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Response of DPAT to DFV Response of DPAT to DPAT Response of DPAT to DSALES

1.0 1.0 1.0

0.8 0.8 0.8

0.6 0.6 0.6

0.4 0.4 0.4

0.2 0.2 0.2

0.0 0.0 0.0

-0.2 -0.2 -0.2

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Response of DSALES to DFV Response of DSALES to DPAT Response of DSALES to DSALES

.4 .4 .4

.3 .3 .3

.2 .2 .2

.1 .1 .1

.0 .0 .0

-.1 -.1 -.1

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Figure 4.3 presents the findings of Impulse Response Function with regard to the
dlog series of sales, profits and firm value.

Figure 4.3 depicts the impulse response of the variables (i.e. dlog of sales, profit
and firm value) on each other. Figure 4.3 shows the number of years on x-axis
and the shock-response on y-axis. The figure exhibits in about how many years
the shock at the other variable cools down.

d) Vector Error Correction Model (VECM)

In order to further explain the cointegrating equations, the application of Vector

110
Error Correction Model (VECM) is employed. Restrictions concerning the
cointegrating relationships embodied in β are denoted by B(i,j), where B(i,j)
represents the j th coefficient in the i th cointegrating relationship.

Table 4.36

Vector Error Correction Estimates

Cointegrating Eq: CointEq1
FV(-1) 1.000000
PAT(-1) 0.001857
(0.00034)
[ 5.53055]
SALES(-1) -0.000286
(4.8E-05)
[-6.00928]
C -1.014481
Error Correction: D(FV) D(PAT) D(SALES)
CointEq1 -0.229306 -43.65129 -48.08349
(0.02394) (25.5606) (165.922)
[-9.57931] [-1.70776] [-0.28980]
D(FV(-1)) -0.015723 48.99449 164.3374
(0.03356) (35.8352) (232.618)
[-0.46851] [ 1.36722] [ 0.70647]
D(FV(-2)) -0.122170 24.59217 1.190588
(0.03284) (35.0703) (227.653)
[-3.71976] [ 0.70122] [ 0.00523]
D(PAT(-1)) 0.000407 -0.192139 -0.474014
(9.7E-05) (0.10405) (0.67544)
[ 4.17201] [-1.84654] [-0.70178]
D(PAT(-2)) -6.73E-05 -0.700130 -3.110973
(9.7E-05) (0.10318) (0.66975)
[-0.69692] [-6.78582] [-4.64501]
D(SALES(-1)) -6.53E-05 0.016326 -0.017237
(1.5E-05) (0.01630) (0.10584)
[-4.27770] [ 1.00133] [-0.16286]

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 D(SALES(-2)) 1.67E-05 0.101945 0.477654
(1.5E-05) (0.01618) (0.10505)
[ 1.09910] [ 6.29932] [ 4.54684]
C -0.002758 0.236739 1.175934
(0.06802) (72.6324) (471.481)
[-0.04055] [ 0.00326] [ 0.00249]

The results of the Vector Error Correction Model are summarized in Table 4.36.
Table 4.36 also presents the VECM estimates of the cointegrating equation.

The purpose of the VECM is to focus on the short run dynamics while making
them consistent with long run solution. If a number of variables are found to be
cointegrated with at least one cointegrating vector, then there always exists a
corresponding error-correction representation, which implies that changes in
dependent variable can be formulated as a function of the level disequilibrium in
the cointregration relationship and fluctuations in other explanatory variables.
Table 4.36 above depicts the long term relationship between sales and
profitability at lag 1, hence depicting cointegration among advertisement
expenditure, sales and profitability.

In a nutshell, the hypothesis developed in Chapter 1 of this report are accepted/

rejected as under –

Hypothesis 1: Advertisement expenditure has positive impact on firm value –

various models as applied in the study indicate at a visible impact of
advertisement expenditure on firm value. Therefore, hypothesis 1 is accepted;

Hypothesis 2: Advertisement expenditure has positive impact on sales revenue

and profitability of the firm – application of the models lead us to infer that
advertisement expenditure impacts sales revenue and profitability leading to
acceptance of the hypothesis 2; and

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 Hypothesis 3: Sales Revenue and Profitability has positive impact on market
value of firm – a long-run relationship is indicated through Johansen’s
Cointegration Analysis and Vector Error Correction Model, which implies
hypothesis 3 to be accepted.

4.4 Managerial implications for marketers

For long, the issue of advertisement expenses being a waste has been debated by
the managers, corporate professionals and researchers. The study addresses this
critical issue. The results as discussed in sections 4.1 through 4.3 above are not
similar across different econometric models. However, most of the models lead to
the conclusion that advertisement expenses leave a visible direct impact on the
firm value. Besides, the study also finds out that the advertisement expenses also
impact firm value indirectly. This indirect impact is observed through the impact
of advertisement expenses on sales and profits, and further the impact of sales and
profits on firm value. In the light of the debate raging over the efficacy of
advertisement expenses, this is a significant indication.

Contradicting the findings of Beckwith (1972), Hamilton (1972), Aaker et al

(1982), Bass and Pilon (1980), Hanssens (1980), Jagpal (1981), Leone (1983),
Baltagi and Levin (1986), Tschoel and Yu (1991), Kwoka (1993), Andras and
Srinivasan (2003), Sharma and Sharma (2009), this research indicates towards a
need for corporates to increase their advertising expenses in order to attain higher
sales, profits and firm value. The findings of the study support the conclusions
drawn by Leong et al (1996), Leach and Reekie (1996), Metwally (1997), Elliot
(2001), Pagan et al (2001), Kamber (2002), Yiannaka et al (2002), Ouyang et al
(2002), Zhou et al (2003), Pauwels et al (2004), Esteve and Requena (2006),
Agyapong et al (2011), Banerjee et al (2012). Hence, the study finds that
advertising is a critical tool with the marketers since it has a significant impact on
firm performance, i.e., sales, profitability and firm value.

These results repudiate the belief of advertisement expenses being a waste. This is
a significant strategic input for the managers since they can bank on the tool of

113
advertisement in order to push their sales, profits and firm value. However, this in
no way conveys that every kind of advertisement will lead to a rise in sales and
profits. The managers need to evaluate various advertisement appeals in order to
zero-in on the most-suitable appeal that addresses the potential consumer group.
The impact of competitive advertisement on own firm valuation is highlighted.
Marketers need to be aware of advertisement campaigns by firms of similar sizes
since those have a potential to effect own firm value via stock price. Marketers
can bank on the tool of advertisement in order to push their sales, profits and firm
value. It also gives an indication to the marketers that advertisement has double
impact on firm value through the direct and indirect routes. This provides strong
justification for investment in advertisement. On the other hand, the study
demonstrates that advertisement may have an investor impact even if there is no
tangible consumer impact. This implies that marketers should be aware of total
impact of advertisement spending, not only the near-term sales and profits impact.
Finally, the study highlights the importance of keeping advertisement expenditure
close to optimum while also observing that the market penalizes firms for
significant deviations (in both directions) from optimal advertisement spending.

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 CHAPTER 5

SUMMARY AND CONCLUSION

The detailed findings of the study have been given wherever the study arrived at
those in the preceding chapters. However, for the purpose of broad understanding
of the findings and in order to arrive at a conclusion regarding those, it is essential
to present the major and more significant findings in this chapter. The chapter also
gives a summary of the implications stemming from the study for the marketers.
The chapter contains five parts. Part one of the chapter presents a summary of the
research methodology followed in the study. The second part summarizes the
major findings of the study. Implications for the marketers are contained in the
third part of the chapter. The fourth part presents the limitations of the study. The
scope for future research is presented in the fifth part of the chapter.

5.1 Summary of the Research methodology

The prime aim of the study was to explore the impact of advertisement
expenditure on firm’s performance. For measuring the firm performance, the
study uses variables in the form of sales, profits and firm value. The study focuses
on the FMCG industry.

The study attempts to carry out the under-mentioned objectives–

 To study the impact of Advertisement on the market value of the firm.

 To observe whether increase in advertisement expenditure leads to

increase in sales revenue and profitability.

 To study the impact of sales revenue and profitability on the market

value of the firm

 To suggest the implications for marketers from the firm value effect of
advertisement.

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The present study attempts to test the following hypotheses for studying the
impact as such.

Hypothesis 1: Advertisement expenditure has a positive impact on firm

value.

Hypothesis 2: Advertisement expenditure has a positive impact on sales

revenue and profitability of the firm.

Hypothesis 3: Sales Revenue and Profitability has a positive impact on

market value of firm.

The research uses one hundred Bombay Stock Exchange (BSE)-listed companies
from the FMCG industry. The companies are selected on random basis. The
sample period for the study is 10 years ranging from 2001–2002 to 2010–2011.

The data for sample companies have been collected from the annual reports of the
respective companies. Wherever necessary, CMIE Prowess database has also
been used for data collection purposes. While the data for advertisement
expenditure, sales and profits are taken from the sources as mentioned above, the
computations have been done with regard to the firm value. Ratio Q developed by
James Tobin of Yale University, Nobel laureate in economics, has been
extensively used as a proxy for firm value. Tobin (1969) hypothesizes that the
combined market value of all the companies on the stock market should be about
equal to their replacement costs.

By definition, Q the ratio between the market value of the firm's assets and the
replacement value of those assets calculated as follows:

A number of improvised models of ‘Q’ have been developed by the researchers

after Tobin giving the ‘Q’ ratio. These include L-R algorithm and many other
116
improvised methods. To make Q a more useable research construct, the study
uses approximate Q as suggested by Chung and Pruitt (1994), using readily
available accounting data, as given below –

Approximate Q =

where, MVE is the market value of the firm’s equity;

PS is the liquidating value of the preferred stock;

DEBT is the book value of the short-term liabilities minus its

short-term assets plus the book value of long-term debt; and

TA represents the book value of the firm’s total assets.

Approximate Q has been widely used in diverse areas of financial study,

including capital structure, firm performance, industrial diversification, earnings
management, pollution reduction, and strategic competition.

The study uses descriptive statistics and econometric tools for analyzing the data.
In the descriptive statistics, the study presents Mean, Median, Standard Deviation,
Skewness, Kurtosis, Coefficient of variation and Jarque-bera statistic.

Most of the econometric analysis can only be performed on a series of stationary

nature. In order to check whether or not the series are stationary, line graphs are
prepared for each of the series. In order to further confirm the (stationary) nature
of the series, the study performs the Augmented Dickey-Fuller test under the unit-
root test to finally confirm whether or not the series are stationary.

The study further performs Vector Autoregression (VAR), Variance

Decomposition Analysis and Impulse Response Function in order to meet the
research objectives. These models are advisable to be applied on the stationary
series. Therefore, the study applies these models on the dlog of the series.

117
The study performs Cointegration methodology developed in Johansen (1991,
1995) using a group object or an estimated VAR object. Two types of
cointegration tests are available – Engle-Granger’s cointegration and Johansen’s
cointegration. While the Engle-Granger methodology is applicable on two
variables, Johansen’s cointegration can be applied on the series having more than
two variables. Unlike the VAR, VDA and IRF models described above,
Cointegration tests have been applied on the absolute series (which is of non-
stationary nature) rather than the dlog series. We have applied VAR-based
cointegration tests using the methodology developed in Johansen (1991, 1995)
performed using a Group object or an estimated Var object.

Finally, the study applies Vector Error Correction Model on the data. A vector
error correction (VEC) model is a restricted VAR designed for use with non-
stationary series that are known to be cointegrated. The VEC has cointegration
relations built into the specification so that it restricts the long-run behavior of the
endogenous variables to converge to their cointegrating relationships while
allowing for short-run adjustment dynamics. The cointegration term is known as
the error correction term since the deviation from long-run equilibrium is
corrected gradually through a series of partial short-run adjustments.

5.2 Summary of the Findings

The statistics of Advertisement Expenditure, Sales and Profitability over the study
period reveal that the mean value of the Advertisements is 619.22 million rupees
while the median is 56.7 million rupees (which is quite far from mean) which
depicts that not the similar numbers of the value is found above and below the
mean. A high value of standard deviation of 2642.795 shows that there was high
volatility among the advertisement expenditure of the companies. This fact is also
strengthened by a high value of Co-efficient of Variation (426.78). The Skewness
statistics of 9.25 shows the series is positively skewed. The Kurtosis statistic of
106.07 infers that the observations of the Advertisement expenditure cluster less
and have shorter tails, showing that the series is lepokurtic. The mean value in
case of profit is 591.0172 million rupees and the median is 24.9 million rupees

118
(which is quite far from mean) which depicts that not the similar number of values
is found above and below the mean. A high value of standard deviation of 3674.3
shows high volatility among the Profitability of the companies which is again
depicted by high value of coefficient of variation having value of 621.6 .The
Skewness of 7.7 shows that the series is positively skewed and further the results
of kurtosis 77.7 shows the series is leptokurtic. Further, the mean value of the
sales is 666.2 million rupees whereas the median is 1217.4 million rupees, which
is quite far from mean shows no similar values are found are above and below the
mean. A high value of standard deviation 25466.1 which is quite high Skewness
of 7.6 and kurtosis of 67.0 showing series to be leptokurtic. The high standard
deviation shows the sample companies are highly different in size. The Skewness
of the three series shows the series to be positively skewed. High kurtosis for the
three series implies that the series are non-normal and are leptokurtic. Coefficient
of variation demonstrates the variation in respect of both the series while also
taking the mean into account. The statistics of Firm Value over the study period
reveal that the mean value of the firm value is 1.827 while the median is 1.150
(which is quite far from mean) which depicts that not the similar numbers of the
value is found above and below the mean. A high value of standard deviation of
2.94 shows that there was high variability among the firm value of the companies.
This fact is also strengthened by a high value of Co-efficient of Variation
(160.92). The Skewness statistics of 11.42 shows the series is positively skewed.
The Kurtosis statistic of 187.48 infers that the observations of the firm value
cluster less and have shorter tails, showing that the series is lepokurtic. Jarque-
Bera statistic being lesser than 0.05 for all the series clearly implies that the series
is non-normal.

Application of Johansen’s cointegration on advertisement expenditure, sales and

profitability shows three cointegrating equations among these three variables.
Two cointegrating equations are found among advertisement expenditure and firm
value. Similarly, Johansen’s cointegration finds three cointegrating equations
among sales, profits and firm value.

Augmented Dickey-fuller unit-root test shows the dlog series in respect of

119
advertisement expenditure, sales, profits and firm value to be stationary in nature.

The application of Vector Autoregression model on advertisement expenditure,

sales and profit shows that the three impact each other significantly. Similarly, the
study also observes that the advertisement expenditure impacts firm value.
Conversely, the study of the VAR model reveals that the firm value is not
influenced by sales or profit.

The results from Variance Decomposition Analysis shows that sales influence
advertisement expenditure. However, the application of VDA on advertisement
expenditure and firm value fails to offer similar results as disclosed by the VAR
model. VDA shows that advertisement expenditure has little impact on firm
value. Similarly, the application of this model observes that the return at sales and
profit leaves no impact on the return at the firm value, at any period. However,
sales and firm value leaves an impact on the profit, though the impact of sales is
seen at Period 2 and beyond. Finally, the model describes that there is a visible
impact of profit on sales in the next periods.

The study finally applies the Vector Error Correction Model (VECM) on the
variables under study. The model depicts the long term relationship between
advertisement expenditure, sales and profits at lag 1 and 2, hence depicting
cointegration among advertisement expenditure, sales and profitability. The
model further observes the long term relationship between advertisement
expenditure and firm value at lag 1 and 2 hence depicting cointegration among
advertisement expenditure and firm Value. Similarly, VECM finds the long term
relationship between sales and profitability at lag 1, hence depicting cointegration
among advertisement expenditure, sales and profitability.

In a nutshell, the hypothesis developed in Section 5.1 above are accepted/ rejected
as under –

Hypothesis 1: Advertisement expenditure has positive impact on firm value –

various models as applied in the study indicate at a visible impact of
advertisement expenditure on firm value. Therefore, hypothesis 1 is accepted;

120
 Hypothesis 2: Advertisement expenditure has positive impact on sales revenue
and profitability of the firm – application of the models lead us to infer that
advertisement expenditure impacts sales revenue and profitability leading to
acceptance of the hypothesis 2; and

Hypothesis 3: Sales Revenue and Profitability has positive impact on market

value of firm – a long-run relationship is indicated through Johansen’s
Cointegration Analysis and Vector Error Correction Model, which implies
hypothesis 3 to be accepted.

5.3 Summary of the implications for marketers

For long, the issue of advertisement expenses being a waste has been debated by
the managers, corporate professionals and researchers. The study addresses this
critical issue. The results as discussed in sections 5.2 above are not similar across
different econometric models. However, most of the models lead to the
conclusion that advertisement expenses leave a visible direct impact on the firm
value. Besides, the study also finds out that the advertisement expenses also
impact firm value indirectly. This indirect impact is observed through the impact
of advertisement expenses on sales and profits, and further the impact of sales and
profits on firm value. In the light of the debate raging over the efficacy of
advertisement expenses, this is a significant indication.

These results repudiate the belief of advertisement expenses being a waste. This is
a significant strategic input for the managers since they can bank on the tool of
advertisement in order to push their sales, profits and firm value. However, this in
no way conveys that every kind of advertisement will lead to a rise in sales and
profits. The managers need to evaluate various advertisement appeals in order to
zero-in on the most-suitable appeal that addresses the potential consumer group.
The impact of competitive advertisement on own firm valuation is highlighted.
Marketers need to be aware of advertisement campaigns by firms of similar sizes
since those have a potential to effect own firm value via stock price. Marketers
can bank on the tool of advertisement in order to push their sales, profits and firm

121
value. It also gives an indication to the marketers that advertisement has double
impact on firm value through the direct and indirect routes. This provides strong
justification for investment in advertisement. On the other hand, the study
demonstrates that advertisement may have an investor impact even if there is no
tangible consumer impact. This implies that marketers should be aware of total
impact of advertisement spending, not only the near-term sales and profits impact.
Finally, the study highlights the importance of keeping advertisement expenditure
close to optimum while also observing that the market penalizes firms for
significant deviations (in both directions) from optimal advertisement spending.

5.4 Limitations of the Study

India remains the focus area of the study. The study could not be extended to
include other countries because of the data availability constraints. While CMIE
Prowess database helped extract the data for Indian companies, the data with
regard to the annual financial statements of the companies across the world could
not be made available for the study.

Moreover, due to the time constraints, the study could not include all the
industries in India. However, the study did choose the industry that best suits its
objectives. FMCG industry is one in which on one hand, the advertisement
expenditure is high; and on the other hand, the data for both sales in volumes and
sales in rupees are available. Besides, the industry has witnessed high growth
rates in the recent past. Choosing FMCG industry as the sample for the study on
the basis of these factors helped minimize the sampling limitations. Having stated
this, there is no denying the fact that focusing only on one industry is a limitation
of the study.

Further, this research studies the impact of advertisement expenditure on firm’s

performance. Not including the other elements of marketing than just
advertisement expenditure may be considered as another limitation of the study.

122
Most of the limitations mentioned above could be done away with, had there been
no resource constraints. However, since the study was not a funded project, there
were resource constraints, which emerged as another limitation of the study.

Having mentioned the limitations of the study as above, it must also be stated that
all the relevant econometric models have been used in the study. This ensures that
there is no analytical limitation in the study.

5.5 Scope for further Research

On the basis of the limitations of this research as mentioned in section 5.4 above,
the scope for further research can be worked out. Further studies may be
conducted in order to remove the limitations of this research as outlined in section
5.4.

Researchers may attempt to expand this study by comparatively analyzing the

impact of advertisement expenditure on firm’s performance across various
industries in India. On the similar lines, researchers may also compare and
analyze such impact across different countries. Besides, scholars may also like to
include more predicting variables than just advertisement expenditure. While
maintaining that the current study uses sales, profits and firm value as the
measures of firm’s performance, it may be advisable to the scholars to include
more measures of firm’s performance in their respective studies.

123
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