Advertising, R&D Expenditures and the Market Value of the Firm

Abstract

This article attempts to determine whether investors recognize the long-term, or asset-like, characteristics of advertising and R&D expenditures. In previous studies, it has been conventional to employ Tobin's q ratio, defined as the market value of the firm normalized by the replacement cost of tangible assets, as a measure of capitalized market value. However, the q ratio can be viewed as a market cum accounting-based measure that is subject to measurement error to the extent that flaws persist in accounting replacement cost data. The q data will also be biased if firms capitalize nonproductive assets so as to smooth or hide monopoly profits. To provide an unbiased framework for analysis, our study considers the effects of advertising and R&D on the market value of common equity without any accounting-based adjustments. Therefore, this article focuses on the market value implications of advertising and R&D in a manner that minimizes the potential for accounting error or bias.