Firm Efficiency, Advertising and Profitability: Theory and Evidence

Abstract

This paper presents a linear-city model where firms compete on price and levels of advertising, which affects the perceived utility of products. More cost efficient firms extend their advantage with more advertising, which leads to higher profits, if advertising is sufficiently effective. We test this relationship using a unique S&P sample. Our empirical results indicate a positive relationship between profits and levels of advertising for all model specifications.