Accounting for Advertising as a Barrier to Entry

Abstract

Listen

Translate article

The evidence supportive of the barriers to entry hypothesis consists largely of a significant correlation between profit rates and advertising intensity for important segments of manufacturing industry. The studies most frequently referred to are those done by Comanor and Wilson (1967) for 41 consumer goods industries and earlier work by Bain (1956) and Mann (1966). The Comanor and Wilson study yielded a significant positive regression coefficient linking profit rates to variations in advertising expenditure-sales ratios. Telser (1969) pointed to a possible spurious source of this relationship in the accounting treatment of advertising expenditures. Accountants treat such expenditures as current expenses rather than as investments in long-lived assets. Telser argued that this understates the asset base used to calculate profit rates for those firms that advertise intensely and that proper treatment of this expenditure as an investment would eliminate the correlation found by Comanor and Wilson. The issue was joined empirically by Weiss (1969), Ayanian (1974), Bloch (1974), and Comanor and Wilson (1974). These writers attempted This paper examines two questions. (1) Is the correlation between advertising intensity and profit rates explainable in terms of accounting practices? (2) Does advertising create barriers to entry? It might be thought that the answer to 1 determines the answer to 2, but this is not so because accounting practices can be distortive of the investmentlike quality of advertising whether or not advertising gives rise to entry barriers. The answer to question 1 is provided by taking note of the fact that accounting practices should not be equally distortive in all situations, or even that they should be distortive in the same direction. The answer to 2 is obtained through study of intertemporal price stability. The evidence indicates a yes answer to 1 and a no answer to 2. The Research Program on Competition and Public Policy at UCLA generously provided access to data and computing facilities. The talents of Edward Rice provided an essential bridge to these data.