The Value-Relevance of Advertising: Evidence from Pharmaceutical Industry

Abstract

This study examines whether advertising by pharmaceutical firms is value relevant. The large amount of pharmaceutical advertising spending and its rapid growth in recent years raise important questions about the contribution of advertising to pharmaceutical firm value. Our evidence indicates that stock investors view advertising by pharmaceutical firms as a source of future economic benefits, consistent with the value-enhancing role of pharmaceutical advertising. Advertising expenditures of pharmaceutical firms have a greater association with the firm's stock prices and returns than those of nonpharmaceutical firms. We also find that advertising expenditures of pharmaceutical firms, similar to capitalized intangible assets but unlike fully expensed research and development (R&D) expenditures, are not significantly related to future earnings variability and uncertainty. This evidence suggests high reliability of future benefits associated with advertising in pharmaceutical industry. The high value relevance and reliability of pharmaceutical advertising have implications for the accounting treatment of this intangible expenditure (i.e., expensing vs. capitalization).