Advertising spending disclosure: How does it affect investors and analysts?

In this article, we argue that when companies disclose their advertising spending, they provide more complete information and assuage investor concerns around future performance. For our study, we collected financial data on companies and share prices from various sources: Compustat, the Center for Research in Stock Prices, and Kenneth French’s library. Forecasts from analysts on earnings per share came from the Institutional Brokers’ Estimate System, and institutional ownership information from Thomson Reuters. The timeline we focused on started from fiscal year 1995 (since FRR 44 was implemented in 1994), ending in 2019. To accurately structure our data, we excluded companies in the finance, insurance, and utilities industries because their financial reporting is formatted in a very different way. Ultimately, our final sample was made up of 2,285 firms and 15,297 firm-year observations over the 25-year period in question.  

Our results are essentially two, both noteworthy. 

1. The disclosure of advertising spending in 10-K reports provides invaluable information to both investors and analysts, information that goes well beyond estimates on such spending from other data sources. Specifically, by analyzing our sample over the reference period, we find that advertising spending disclosure reduces idiosyncratic risk by 7%. What’s more, the negative effect of this disclosure on idiosyncratic risk is partially driven by the fact that it lowers uncertainty among analysts about the future financial performance of the company. All this means that CMOs have a critical role to play in investor relations, as they face increasing calls to consider the risk implications of their actions.  
2. Consistent with the reasoning underpinning agency theory, a number of factors moderate the negative effect of advertising spending disclosure on analysts’ uncertainty: the firm’s financial structure, the disclosure’s overall quality, and the intensity of the competition the firm faces.  We find these moderating effects to be statistically and economically significant. In detail, the negative effects of this disclosure on analysts’ uncertainty are 41% greater for companies with high liquidity, and 34% greater for companies that do business in more competitive industries. In addition, the negative effects of disclosure are 28% greater for companies with low quality disclosure, and 20% greater for companies with low leverage.  

This study deepens our understanding of the topic at hand in several imperative ways:  

• Our focus on disclosing advertising spending allows us to examine the impacts of a specific regulation on investors and analysts and provides insights to regulators. 

• Our research reveals a vital mechanism (i.e., disclosure of advertising spending lowers analyst uncertainty about future performance of the firm) by which the disclosure of advertising spending reduces idiosyncratic risk. 

• Tapping into agency theory, we can identify the contingencies underlying the negative impact of advertising spending disclosure on analysts’ uncertainty. 

• By pinpointing criticalities at a company and industry level, our work provides a more nuanced representation of the consequences of disclosing advertising spending. 

Due to the powerful impact of advertising spending disclosure on idiosyncratic risk and analysts’ uncertainty, we find justification for recent calls for greater disclosure of this metric by researchers and by the Marketing Accountability Standards Board. But by the same token, there may be a potential concern that such disclosure could reveal proprietary information. However, our additional analysis shows that the disclosure of advertising spending even helps enhance firm value in certain sectors such as Manufacturing, Business Services, Hi-Tech, and Healthcare. 

All in all, our findings suggest that the SEC and the FASB should rethink the current regulations governing the disclosure of advertising spending.