MARKETING STRATEGY AFTER MEETING WALL STREET: THE ROLE OF INFORMATION ASYMMETRY

• Published date: 01 September 2017
• Author: Jian Huang,Michaël Dewally,Minghui Ma
• Date: 01 September 2017
• DOI: http://doi.org/10.1111/jfir.12128

MARKETING STRATEGY AFTER MEETING WALL STREET: THE ROLE OF

INFORMATION ASYMMETRY

Minghui Ma

SUNY New Paltz

Michaël Dewally and Jian Huang

Towson University

Abstract

We relate marketing strategy to the initial public offering (IPO) process during 1980–

2010. Pre-IPO marketing intensity provides information to the market, which reduces

underpricing and the magnitude of price revisions during the filing period. Firms that

experience upward (downward) price revisions spend more (less) on marketing in the

five years post-IPO. We confirm that marketing spending is related to a firm’s

informational environment by finding a positive relation between marketing intensity

and firm information transparency post-IPO. This finding indicates that marketing

spending is one channel through which a firm affects its perception by the public equity

market at issuance and later.

JEL Classification: G14, M30

I. Introduction

The literature investigating the interface of marketing and finance is ever expanding and

confirms that marketing activities do influence the market behavior of firms. Joshi and

Hanssens (2010) hypothesize that marketing spending affects firm value not only

indirectly by increasing profits via increased sales but also by directly increasing the

intangible value of the firm, an increase reflected in the firm’s valuation. L

evesque,

Joklegar, and Davies (2012) show that marketing spending, especially in recently public

firms, is a substitute for cost of goods sold and increases future profitability. To

crystallize the impact of marketing spending on market reaction, the literature has

focused on major firm events ranging from the market reaction to product recalls (Chen,

Ganesan, and Liu 2009) to the process of going public, the initial public offering (IPO)

(Kurt and Hulland 2013; Luo 2008). In general, the studies have revealed that marketing

intensity is related to firm perception and valuation. Luo (2008) finds that an increase in

marketing intensity in the pre-IPO period helps reduce information asymmetry and

results in lower underpricing. Kurt and Hulland (2013) find that after the IPO, an increase

in marketing intensity is positively related to the market value of the firm.

The authors thank the anonymous reviewer and participants at the 2017 American Marketing Association

annual meeting for helpful comments.

The Journal of Financial Research Vol. XL, No. 3 Pages 369–400 Fall 2017

369

© 2017 The Southern Finance Association and the Southwestern Finance Association

RAWLS COLLEGE OF BUSINESS, TEXAS TECH UNIVERSITY

PUBLISHED FOR THE SOUTHERN AND SOUTHWESTERN

FINANCE ASSOCIATIONS BY WILEY-BLACKWELL PUBLISHING

This study investigates whet her the result of the IPO process ha s a bearing on

afirm’s strategic decision making for mar keting intensity. Whereas Luo (20 08) finds

evidence pre-IPO and Kurt and Hull and (2013) find evidence post-IPO, we focus on

the outcome of the IPO process a nd how it informs subsequent firm po licies. The

literature has not linked the two periods’actions and has ignored the interaction

between firm behavior and market response. In a first step, we investigate the impa ct of

marketing intensity leading to the I PO not only on underpricing but also on pr ice

revision. We hypothesize tha t, similar to its effect of redu cing underpricing, market ing

intensity reduces price re vision. In a second step, we r elate the sign of the price

revision experienced by the firm at IPO to its future policy. Indeed, al though the

magnitude of the price revis ion is appropriately reduced b y the communication of

information through marketing spending, the firm cannot ignore the direction of the

price revision as a signal of market attitude to the firm’s efforts and a sign of the

perceived value of the firm. We hypot hesize that firms experiencing upward

(downward) price revisions, an indication of positive (negative) market view, continue

(hesitate) to spend on marketing as it inc reases (does not increase) firm value. F inally,

we confirm that marketing intensity is also directly related to the informational

environment of a firm post-IPO. T o that end, we test the impact of marke ting intensity

on firm information transparenc y.

We use a sample of U.S. IPOs spanning 1980–2010. We define underpricing as

the first day of trading return, price revision as the change in IPO price from the initial to

the final filing, and use Jin and Myers’s (2006) definition of information transparency.

We relate these variables to marketing intensity, defined as the ratio of selling, general,

and administrative (SG&A) expenses net of research and deveopment (R&D) expenses

to total assets.

1

We find that an increase in marketing intensity pre-IPO leads not only to

smaller underpricing but also to smaller absolute price revisions. This finding reinforces

the findings of Luo (2008) that marketing intensity is a proxy for information revelation

to market participants and, as such, helps resolve information asymmetry. We also find

that post-IPO, firms with upward price revisions outspend firms with downward price

revisions. This suggests that firms strategically respond to the interaction with the market

resulting from the IPO process. Although it is optimal for all firms to invest in marketing

activity pre-IPO, with the dual goal of increasing firms’market-based assets and

information revelation, post-IPO firms should strategically only spend on marketing

intensity to the degree that it supports firm’s growth and that the market rewards the firm

with a higher valuation due to the investment. A firm that experiences an upward

(downward) price revision at IPO will have an incentive (disincentive) to continue

spending. Finally, we find a positive relation between marketing intensity and firm

information transparency. This confirms that (1) pre-IPO marketing intensity spending

does increase information transparency and this should therefore be reflected in lower

underpricing and (2) post-IPO, for a firm having experienced an upward price revision, a

1

We follow the literature (see, e.g., Mizik and Jacobson 2007; Luo 2008) in defining marketing intensity as

the ratio of SG&A expenses net of R&D expenses to total assets. We also use SG&A expenses net of R&D

expenses scaled by total sales, as well as advertising expenses (Compustat item XAD) as robustness, and the results

remain qualitatively consistent.

370 The Journal of Financial Research

strategy of continued marketing spending not only creates more valuable market-based

assets (Luo and Donthu 2006; Srivastava, Shervani, and Fahey 1998) that improve

customer and brand equity (Keller and Lehmann 2006), but it also concurrently reduces

information asymmetry and promotes information transparency.

By documenting the links between the result of the IPO process and a firm’s

marketing decision, this study contributes to the literature of the marketing–finance

interface in several ways. First, it adds to our knowledge that marketing spending is a

critical way in which a firm communicates information to the equity market. Not only do

we find such evidence in the pre-IPO period, but we also document that marketing

spending influences the information asymmetry present once the firms are public.

Second, this research complements studies of firm behavior post-IPO by stressing that

firms react strategically to the initial market reaction to the firm’s public listing.

II. Literature Review and Hypotheses

IPO Process

The IPO process is a critical time in the history of a firm. This significant funding

event has a profound impact on al l stakeholders. Early funde rs receive liquidity for

their investment, current m anagement benefits from the injection of funds to allow for

firm expansion, and the investment community is allowed access to ownership of the

firm. All parties therefor e benefit if the significantly uneven informational field is

leveled. To this end, the firm is expected to release informat ion to potential investor s.

This information release facilitates the firm’s access to the public capital market (Tang

2009), helps create a liquid m arket for the firm’s shares (Cao, Fi eld, and Hanka 2004),

and helps owners maximize the ir wealth gains during the go ing public process (Habib

and Ljungqvist 2001). To ex pedite and ease this proces s, a firm typically hires an

investment bank to act not only as advi sor but also as an intermediary with investors. It

is the dual duty of the issuer an d the investment bank to co mmunicate clearly the

potential cash-flow prospects of the firm to ascertain equi ty value. The necessary

information is primarily released in the pr ospectus and associated regulatory filings.

This information is compleme nted with the book-building pr ocess, during which

information is exchanged between firms and investors. Ritter and Welch (2002)

provide a comprehensive review of the i ssues surrounding informat ion asymmetry and

underpricing. Figure I dep icts the IPO process.

The range of information incorpor ated into the final price is vast. Not only i s

the formal information laid out in the filings accounted for in the valuation but also the

informal information garner ed through the historical behavior of t he firm. Luo (2008)

finds that the extent of the marketing spend ing of the firm pre-IPO influences

underpricing. By expanding resources to bu ild market-based assets o r by promoting

brand equity, the firm can increa se the information set avai lable to investors. Indeed,

the forecast of the level, timi ng, and risk of the cash flows that inve stors can expect

from this new investment is intim ately tied to the amount and the quali ty of the

information revealed dur ing this process. Loughran and McDonald (2013) and Hanley

Marketing Strategy after Meeting Wall Street 371