Advertising, Attention, and Stock Returns

This paper studies the effect of advertising on stock returns both in the short 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 advertising affects stock returns by attracting investors’ attention to the firm’s stock. Stock price increases in the advertising year due to the attracted attention, but decreases in the subsequent year as the attracted attention wears out over time. We test this investor attention hypothesis and document consistent findings. We find that advertising increases a firm’s visibility among investors in the advertising year. We further find that the negative effect of advertising on the long-run reversal in stock returns is more pronounced if a firm attracts greater investor attention in the advertising year, or if investors face a larger cost of short selling the firm’s stock. It is also more pronounced for small firms, value firms, and firms with poor ex-ante stock or operating performance. Finally, we find that the effect of advertising on future stock returns is stronger when advertising increases compared to the case when advertising decreases.