Advertising and Firm Risk: A Study of the Restaurant Industry

ABSTRACT

Incorporating recent calls for understanding firm equity risk in relation to a firm's marketing efforts, this study examined the impacts of firm-level advertising spending on firm equity risk with publicly listed firms in the restaurant industry—a key hospitality industry. This study hypothesized and tested the effects of firm-level advertising expenditures on different types of firm equity risk (i.e., total, systematic, and unsystematic risk). Unlike previous empirical findings, we found that an increase in advertising expenditures significantly increased total and unsystematic risk of sampled restaurant firms. The findings provide new insights into the effects of advertising on firm equity risk in the literature, and important theoretical and managerial implications for restaurant firms.

Keywords:

• Restaurant
• hospitality
• advertising
• equity risk
• total risk
• systematic risk
• unsystematic risk

Acknowledgments

The work described in this paper was supported by a grant from the Hong Kong Polytechnic University.

Notes

1. “Value relevance of advertising” means that advertising is associated with stock returns and their variability. That is, if a marketing investment or its resulting marketing intangible is shown to be related to stock returns or their variation, then we consider the investment or the intangible as a “value relevant” investment or a “value relevant” intangible.

2. We will explain the details of CAPM and the way of measuring different types of firm risk later in the Methodology section.

3. Note that the variation of systematic risk (i.e., sensitivity of stock returns to market movement) across firms can be explained by firm-level characteristics such as advertising, R&D, as shown in McAlister et al. (2007). That is, the sensitivity of firm A's stock returns to a specific market event can be different from that of firm B's stock returns to the same market event. The difference can be explained by different characteristics of the firms.

4. The capital asset pricing model (CAPM), proposed by William Sharpe (1964) and John Lintner (1965), describes how to measure risk and the relation between expected return and risk. The CAPM is widely used in applications, such as estimating the cost of capital for firms and evaluating the performance of managed portfolios (Fama & French, 2004). For more details of CAPM, refer to Lintner (1965) and Sharpe (1964).

5. The number of observations to estimate Equation 1 is 252 for a firm in a year (252 trading days in a year).

6. Following an anonymous reviewer's suggestion, we also ran a Koyck model to examine the cumulative effects of historical advertising expenditures (Clarke, 1976). The results of the Koyck model were consistent with our results reported in Table 3.