Capital Structure Is an Important essay
- Length: 15 pages
- Sources: 15
- Subject: Business - Advertising
- Type: essay
- Paper: #45674903
Excerpt from essay :
Although advertising costs can be substantial, it is essential that companies place significant amounts of funding into advertising. Such funding is necessary because it provides companies with a competitive advantage. According to Doraszelski & Markovich, (2007)
"Practitioners know very well the value of advertising to achieving their long-term market share and profitability goals. A survey of senior executives in 1999 reveals that 82.9% somewhat or strongly agree that good advertising can provide their company with an edge over the competition in the marketplace. Furthermore, 86.8% somewhat or strongly agree that advertising is a long-term investment that contributes to the financial growth and stability of their company (American Advertising Federation, 1999; Doraszelski & Markovich, 2007)."
The authors also explain that firms believe that advertising has the capacity to give them a sustainable competitive advantage over other firms (Doraszelski & Markovich, 2007). Nevertheless, dynamic models of advertising competition, assert that the opposite is true. these models suggests there is a "globally stable symmetric steady state (Doraszelski & Markovich, 2007). " Accordingly, differences among firms are bound to fade away over the long-term (Doraszelski & Markovich, 2007). Additionally, little room exists for a lasting competitive advantage (Doraszelski & Markovich, 2007). Competitive advantage is not lasting even if firms were to come into the market individual and as such differ in their strategic positions from the very beginning (Doraszelski & Markovich, 2007).
Advertising is an important part of any firm because it makes the public aware of the products and services available to them. As such capital spent on advertising is a vital aspect of a company's overall business strategy. In addition, advertising expenses have an influence upon capital structure because it requires capital and without it marketing strategies will fail.
Lastly brand value is defined as "the amount that a brand is worth in terms of income, potential income, reputation, prestige, and market value. Brands with a high value are regarded as considerable assets to a company, so that when a company is sold a brand with a high value may be worth more than any other consideration ("Brand Value")." According to Madden et al. (2006), in recent years a great deal of attention has been given to the importance of branding. The authors explain that the work of Aaker (1991) concerning the power of branding has greatly increased interest in this particular facet of marketing (Madden et al., 2006). The article also asserts that even though many executives now have a greater understanding of brand value, marketing executive sill face challenges associate with defining brand value from a financial standpoint (Doyle 2000; Lehmann 2004; Madden et al., 2006). The authors assert that "The lack of financial accountability "has undermined marketing's credibility, threatened marketing's standing in the firm, and even threatened marketing's existence as a distinct capability within the firm" (Rust, Ambler, Carpenter, Kumar, and Srivastava 2004; Madden et al., 2006)."
The research also suggests that there is a substantial link between brand value and the financial performance of a company. For instance, in a study evaluating the most valued brands conducted in 1995 and 1996, researchers found a positive relationship between financial brand values and market to book ratios. Additional studies found that the "Interbrand values are significantly and positively related to stock prices and returns. Using their own metric for measuring brand equity, Simon and Sullivan (1993) demonstrated that brand equity comprises a large percentage (more than 151%) of the replacement value of many firms. As they noted, Conchar, Crask, and Zinkhan's (2005) comprehensive meta-analysis provides evidence of a significant positive relationship between a firm's advertising and promotion spending and the market value of the firm, thus supporting the linkage between a firm's brand-building activities and the financial performance of the firm (Madden et al., 2006)."
There are two extremely important levels associated with brand value; the micro level and the macro level. As it pertains to the macro level (also known as the enterprise level) brand value influences the perception of investors and financial analysts, and subsequently plays a role in determining the stock prices of firms (Chu & Keh, 2006). On the other hand, at the micro level (also known as the consumer level) brand value has a positive influence on behavioral outcomes, such as purchase intent (Chu & Keh, 2006).
Since this is the case, the development of a brand has garnered a great deal of attention within many companies. Brand development has also necessitated a significant amount of corporate resources (Keller, 2003; (Chu & Keh, 2006)). The article asserts that brand management strategies are vital and are usually inclusive of a firm placing some assets in advertising and different promotional activities. Investments are also made in the area of research and development (Chu & Keh, 2006). The authors explain, "In leveraging brand equity, it is critical to understand the determinants that contribute to its creation (Chu & Keh, 2006)."
Chu & Keh, (2006) also explains that the "individual contributions of advertising, other promotional (e.g., consumer and trade promotions, event marketing, and sponsorships) and R&D expenses to brand value remain unclear. If firms spend too little, the returns should be positive. In contrast, if they spend too much, the returns should be negative. As such, the link between these expenses and brand value should not be linear. Rather, any deviation (positive or negative) from optimal spending should affect performance (Chu & Keh, 2006)."
Obviously, capital structure, advertising expenses and brand value are critically important issues confronting firms throughout the world. This is particularly true of multinational corporations that operate in several different regions of the world. Whatever the case may be for a firm, the type of capital structure that is adopted is essential to the current and future success of a firm. The capital structure must be designed in a manner that is conducive to meeting the overall goals of a firm and to the development of capital flows that are consistent with other companies in the industry.
Capital structure is also influenced by the source of the capital. According to Falukner & Peterson (2006) the tradeoff theory of capital structure assert that firms choose a leverage ratio by "calculating the tax advantages, costs of financial distress, mispricing, and incentive effects of debt vs. equity (Falukner & Peterson, 2006)." The literature has revealed that firms choose their capital structure using this theory predicts the structure by approximating firm leverage as a utility of a company's attributes. Additionally, companies "for whom the tax shields of debt are more significant, and the costs of financial distress is less significant, and the mispricing of debt relative to equity more favorable are expected to be more highly levered (Falukner & Peterson, 2006)."
When these companies understand that the end benefit of acquiring debt is constructive, they tend to embrace their favored capital structure by issuing further debt and/or decreasing their equity (Falukner & Peterson, 2006). The author further explains that the understood supposition has been that the leverage of a company is completely a function of the firm's demand for debt (Falukner & Peterson, 2006). That is, the provision of capital is considerably resilient when the price is correct and the cost of capital is dependent on the risk associated with the projects that the company takes on (Falukner & Peterson, 2006).
Even though the empirical literature concerning the aforementioned issue has been accurate, as it pertains to the proposed alternatives linked with firms' actual capital structure choices, other authors have posited that certain companies seem to be significantly under-levered (Falukner & Peterson, 2006). For instance,
"based on estimated tax benefits of debt, Graham (2000) argues that firms appear to be missing the opportunity to create significant value by increasing their leverage and thus reducing their tax payments, assuming that the other costs of debt have been measured correctly.1 This interpretation assumes that firms have the opportunity to increase their leverage and are choosing to leave money on the table. An alternative explanation is that firms may not be able to issue additional debt (Falukner & Peterson, 2006)."
The author further explains that the same type of market tensions that make capital structure choices pertinent such as, information asymmetry and investment distortions also mean that companies are controlled by their lenders (Falukner & Peterson, 2006). As such, when determining a firm's leverage, the variables that measure the constraints on a firm's ability to increase its leverage and the determinants of its preferred leverage it is important to must be taken into consideration (Falukner & Peterson, 2006).
Now that we have garnered a greater understanding of capital structure, advertising expenses and brand value, let us discuss in greater detail the influence of advertising expenses and brand value on Capital structure.
Influence of advertising expenses and brand value on Capital structure
The research already provided some evidence to suggest that both advertising expenses and brand value have an effect upon capital structure. The research suggests that advertising expenses can be substantial for a…