Advertising, Attention, and Stock Returns

This paper studies the effect of advertising on stock returns both in the short run and in the long run. We find that a greater amount of advertising is associated with a larger stock return in the advertising year but a smaller stock return in the year subsequent to the advertising year, even after we control for other price predictors, such as size, book-to-market, and momentum. We conjecture that this advertising effect on stock returns is due to the effect of advertising on investor attention. Advertising could help a firm attract investors' attention. Stock price increases in the adverting year due to the attracted attention, but decreases in the subsequent year as the attracted attention wears out over time in the long run. We test this "investor attention hypothesis" using trading volume and the number of financial analysts covering to proxy for investors' attention on the firm's stock. We document five consistent findings. First, advertising increases a firm's visibility among investors in the advertising year. Second, an increased level of investor attention is associated with a larger contemporary stock return and a smaller future stock return. Third, the effect of advertising on stock returns is stronger in firms with more visibility in the advertising year. In particular, when a high advertising firm attracts more investor attention in the stock market, the stock return of the high advertising firm increases to a larger degree in the contemporary adverting year and decreases to a larger degree in the subsequent years. However, the stock return of such a high advertising firm decreases to a smaller degree if the attention attracted in the advertising year persists subsequent to the advertising year. Fourth, the effect of advertising on future stock returns is stronger if investors face a larger cost of arbitrage. Finally, we also find that the advertising effect is stronger for small firms, value firms, and firms with poor ex-ante stock performance or poor ex-ante operating performance.