Are Advertising and R&D Complements?

Abstract

Escalation of advertising or R&D expenditure can give rise to endogenous barriers to entry. This paper investigates whether escalation of investments in R&D raises the return to investments in advertising or vice versa. We provide three empirical tests using a dataset which combines stock market and balance sheet data with information on patents, patent citations, trade marks and trade mark citations from the Internet. Results from Tobin’s q regressions show that advertising is a complement to R&D for companies that rely mainly on R&D. R&D is not a complement to advertising for companies relying mainly on advertising. The same results hold in regressions of the gross-profits ratio on R&D to sales and advertising to sales ratios. These results are derived using two stage GMM regressions in which we instrument the ratios using information on patents and trade marks. Finally, quantile regression is used to exclude the possibility that R&D and advertising are complements to a common unobserved variable. We confirm that advertising is a direct complement to R&D for companies relying mainly on R&D.

Keywords: Advertising, R&D, Tobin’s q, Complementarity, Escalation Mechanism, Quantile Regression

JEL Classification: L11, L13, O34