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Does advertising stimulate sales

or mainly deliver signals?
A multivariate analysis
Maxwell K. Hsu
University of Wisconsin, USA
Ali F. Darrat
Louisiana Tech University, USA
Maosen Zhong
Kansas State University, USA
Salah S. Abosedra
University of Qatar, Doha

The main purpose of this article is to empirically examine the Galbraithian hypothesis that
advertising adjusts aggregate demand to the changing industrial development and
consequently stimulates sales. The causal relations between sales and advertising are tested
in the context of a vector autoregressive system using the US aggregate data over the
post-Second World War period. Our empirical results fail to support the Galbraithian
thesis, and suggest instead the presence of a potent reverse causality running from
aggregate sales to advertising. We use the signalling theory to interpret our results.

INTRODUCTION

Advertising expenditures in the USA have dramatically increased from

about $31 billion in 1950 (or less than 2% of the nation’s Gross
Domestic Product) to more than $168 billion in 1999 (approximately
2.5% of the GDP).1 While several factors may account for such a
phenomenal growth in advertising, a major culprit is likely to be the

1 Real figures are expressed in 1990 prices.

International Journal of Advertising, 21, pp. 175–195

© 2002 Advertising Association
Published by the World Advertising Research Center, Farm Road, Henley-on-Thames,
Oxon RG9 1EJ, UK

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common belief, espoused by Galbraith (1967) and others, that

advertising stimulates sales by altering consumers’ behaviour (see
Balasubramanian & Kumar 1990).
Galbraith (1967) contends that advertising is primarily a societal
response to the needs of highly specialised technologies that require
heavy investment which cannot be converted easily to other uses.
Once such technology is in place, its maintenance depends on
consumers’ demand. Advertising helps manage aggregate demand to
fit the needs of industrialised economies. Since the development of
the industrial system is rather slow and takes an extended period of
time, the Galbraithian hypothesis predicts that the relationship
between advertising and aggregate sales is of a long-term nature.
Another related issue is that disposable income might intervene
between advertising and personal consumption expenditures
(Jacobson & Nicosia 1981). When disposable income rises, firms/
advertisers will attempt to attract more household consumption and
hence intensify their advertising campaign. Thus, the role of
disposable income should be accounted for when studying the
dynamic relationship between advertising and aggregate sales
(consumption). Hence, Galbraith’s (1967) hypothesis implies that
higher personal income from the industrial development yields more
advertising, which in turn leads to increased aggregate consumption.
However, empirical research does not provide unequivocal support for
this proposition (e.g. Solow 1967; Schmalensee 1972; Ashley et al.
1980; Sturgess 1982; Duffy 1991; Chowdhury 1994).
Besides the advertising-to-sales nexus, another plausible presump-
tion contends that sales drive advertising rather than vice versa.
Researchers who ascribe to this sales-to-advertising linkage include
Nelson (1975), Kihlstrom & Riordan (1984), Milgrom & Roberts
(1986), Tellis & Fornell (1988), and Abe (1995). Indeed, such a chain
of causation is consistent with an advertising–sales ratio rule whereby
the advertising budget is decided as a percentage of sales (see Shimp
1997).
In this article, we use recent econometric techniques to investigate
the aggregate relationship between advertising and sales in the USA
over the period 1948 to 1995. We investigate the long-term nature of
this relationship using the Johansen (1991) cointegration test.
Contrary to the Galbraithian hypothesis, we do not find any long-term
relationship binding advertising, aggregate sales and disposable
income. Results from the Granger-causality tests identify a

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unidirectional causal relationship running from aggregate sales to

advertising, but no feedback is found. This finding appears inconsis-
tent with the Galbraithian argument, and we provide a plausible
explanation – signalling theory – to interpret the results.
The rest of the article is structured as follows. The second section
reviews the literature on the relationship between advertising and
sales; the third section introduces the data and illustrates the
methodology; the fourth section presents the empirical results; the
fifth section attempts to provide a logical interpretation in linking the
findings to the signalling theory; and the sixth section concludes the
study.

LITERATURE REVIEW

The relationship between advertising and sales (consumption) has

received considerable attention in the marketing literature. Zanias
(1994) observes that a large number of studies on the advertising–
sales nexus may be categorised into two groups. The first group uses
the regression approach to model advertising expenditure as an
explanatory variable with appropriate dynamics, while the second
group of studies employs a Box–Jenkins time-series model. In terms
of the levels of aggregation, researchers use different data ranging
from the firm level (e.g. Leone 1983) to the national level (e.g.
Jacobson & Nicosia 1981; Chowdhury 1994). Alhough disaggregated
data at the firm or industry level may be better suited for studying the
advertising–sales relationship for specific brands and/or product
categories, we believe that aggregate data used in this article have the
advantage of providing more stable results.2
Using Australia’s data, Metwally & Tamaschke (1981) find evidence
to support the Galbraithian hypothesis, and conclude that advertising
intensity has a positive and significant effect on the propensity to
consume. Peel (1975) also reports similar evidence for the UK, but
Sturgess (1982) derives contradictory results from similar data. As for
the US data, Schmalensee (1972) reports evidence in support of the

2 For example, a McGraw-Hill (1969) study shows that, in terms of the advertising-
to-sales ratios, the variation among firms in the same industry is almost as much as
between different industries. Note, however, that aggregate data do not provide
information on advertising and sales at different stages of the product life cycle.

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notion that sales influence advertising expenditures. Ashley et al.

(1980) employ the causality approach and confirm Schmalensee’s
earlier evidence for the US data. Reference should also be made to
Chowdhury (1994) who applies cointegration and causality tests to the
British data to investigate the relationship between advertising and six
other macroeconomic variables, including sales. He fails to support
any reliable relationship between advertising and sales. Unlike
Chowdhury, we examine in this article the relationship between
advertising and sales in the context of trivariate (as opposed to
bivariate) models against the US (not the UK) data.

DATA AND METHODOLOGY

Our data are annual for three US aggregate variables covering the
period 1948 to 1995. Specifically, the variables are aggregate
advertising expenditures (A) obtained from the Direct Marketing
Association’s Statistical Fact Book; aggregate sales (S) measured by
personal consumption expenditures and obtained from the S&P/DRI
Database; and personal disposable income (I ) culled from various
issues of the Statistical Abstracts of the United States. All three variables
are measured by per capita figures since the hypothesised relationships
have a clear microeconomic foundation. The variables are also
expressed in natural logarithms to mitigate any heteroscedasticity
problems, and expressed in real terms (deflated by the consumer price
index) to eliminate possible inflation noise. Necessary data on
population and prices are also obtained from the S&P/DRI Database.
Given the long-term nature of the advertising–sales relationship as
predicted by Galbraith’s hypothesis, cointegration is well-suited for
this type of research. Recently, Grewal et al. (2001) urged the
application of the cointegration approach on marketing issues and
suggest that this relatively new technique is ‘an intriguing development
for analyzing marketing interactions in dynamic environments’
(p. 127). Details of the cointegration approach and all other empirical
procedures used in this article are given in the appendix.
Galbraith postulates that increased advertising leads to increased
sales, and also that personal disposable income stimulates advertising.
The opposing hypothesis states that sales propagate advertising
expenditures. We test these two competing hypotheses simultaneously
using a three-variable vector autoregressive (VAR) modelling
1 Footnote.

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procedure. Thus, we examine the following VAR model consisting of

real advertising per capita (At ), real sales per capita (St ), and per-capita
real disposable income (It ):3

 At  φ1  γ 11 ( L ) γ 12 ( L ) γ 13 ( L )  At  ε 1t 
 S  = φ  + γ ( L ) γ ( L ) γ ( L )  S  + ε  (1)
 t   2   21 22 23
 t   2t 
 I t  φ3  γ 31 ( L ) γ 32 ( L ) γ 33 ( L )  I t  ε 3 t 

where φi and γij are the coefficients to be estimated (i, j = 1, 2, 3); (L)
are lag polynomials, γ(L) = γ1L + γ2L2 + … + γnLn; and εit denotes
white-noise residuals.
The two competing hypotheses can be tested using the well-known
Granger-causality concept. The null hypothesis that sales unidirection-
ally Granger-cause advertising is consistent with the parameter
restrictions: γ12 (L) ≠ 0 and γ21 (L) = 0. On the other hand, the
Galbraithian argument postulates instead that causality runs from
advertising to sales, and also from personal disposable income to
advertising. The implied restrictions are: γ21 (L) ≠ 0, and γ13 (L) ≠ 0.

EMPIRICAL RESULTS

A necessary prelude to any careful time-series estimation is to check

the stationarity of the variables in the model. To that end, we use the
Augmented Dickey–Fuller (ADF), the Phillips–Perron (PP) and the
Weighted Symmetric (WS) procedures to test for non-stationarity and
determine the lag structure in the tests by the Akaike Information
Criterion (AIC). We employ several testing procedures to ensure the
robustness of our stationarity inferences. The test results, given in
Table 1, suggest the absence of a unit root for all three variables but
only if expressed in first-differences. Since all three variables prove
first-difference stationary, it is possible that they are also co-integrated.
We use the Johansen (1991) multivariate procedure, along with

3 If there exists cointegration among the three variables in the VAR, one should
construct a vector error-correction model by adding the lagged residuals from the
cointegration vector(s) in the VAR model, equation (1). However, as discussed
below, we find no cointegration among the three variables of the model.

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TABLE 1 STATIONARITY TEST RESULTS

ADF (L) PP (L) WS (L)
A. Variables in levels
At –1.61 (3) –1.93 (3) 0.81 (3)
St –1.33 (3) –0.47 (3) 0.40 (3)
It –0.92 (2) –0.73 (2) 0.31 (2)

B. Variables in first-differences
∆At –4.25 (2)* –44.45 (2)* –4.34 (2)*
∆St –5.23 (3)* –44.66 (3)* –5.40 (3)*
∆It –3.43 (2)* –29.61 (3)* –4.03 (2)*
Notes:
At is log advertising expenditure per capita, St is log sales per capita, and It is the log personal disposal income, ∆
denotes the first-difference operator, ADF is the Augmented Dickey–Fuller test, PP is the Phillips–Perron test,
WS is the Weighted Symmetric test, and L denotes the proper lag structure based on the AIC criterion. An
asterisk (*) indicates rejection of the null hypothesis of non-stationarity at the 5% level of significance. A time
trend was included in the testing equations whenever it proved statistically significant.

Reimers’ (1992) correction for possible finite-sample bias, to test for

cointegration among the three variables in the model. Results
displayed in Table 2 indicate that there exists no significant
cointegration relationship among advertising, sales and disposable
income even at the weak 90% level. This evidence against
cointegration persists when using different lags. Since cointegration
reflects long-term relations, the Johansen test results against
cointegration imply that the three variables can only be related over
the short term.
Given the importance of lag structures when estimating VARs, lags
should not be imposed arbitrarily, nor should they be common across

TABLE 2 THE JOHANSEN COINTEGRATION TESTS

Trace statistics:
Maximal eigenvalue: p
λ-max = –(T – pk) ln(1 – λ^ r +1)
(r = 0, 1, …, p)
Trace = –(T – pk) ∑
i =r0 +1
ln(1 – λ^ i )

Null λ-max CV 90% Null Trace CV 90%

H0: r = 0 11.54 19.77 H0: r = 0 25.87 32.00
H0: r = 1 8.48 13.75 H0: r ≤ 1 14.34 17.85
H0: r = 2 5.84 7.52 H0: r ≤ 2 5.84 7.52
Notes:
Both the maximal eigenvalues and trace statistics are adjusted for small sample bias using the Reimers (1992)
method. T is the sample size, p is the number of variables (= 3 in our case), k is the number lags (= 3) determined
by AIC at which there is no autocorrelation in the VAR model, r is the hypothesised cointegrating vectors.

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all variables to avoid possible biases (Ahking & Miller 1985). In this
article, we follow recent literature and select the lag structure for every
variable in each of the three equations by means of Akaike’s final
prediction error (FPE), in conjunction with the specific-gravity
criterion of Caines et al. (1981). Specifically, we search for the ‘optimal’
lag length for each explanatory variable in our VAR system, allowing
up to three annual lags. Higher initial lags could quickly consume
available degrees of freedom. We subject the final model to various
diagnostic tests to ensure appropriate model specifications (e.g.
Durbin-m and Bruesch–Godfrey tests for serial correlation; the
Lagrange-multiplier test for heteroscedasticity; the Ramsey RESET
test for omission-of-variables bias; and the Chow test for structural
instability). Results from all these diagnostic tests (available upon
request) evince no serious model misspecifications.
Observe also that the VAR model can be estimated ‘equation by
equation’ using ordinary least square (OLS). However, if the error
terms across equations are significantly correlated, we can enhance the
statistical efficiency of the estimates through using the Zellner
Seemingly Unrelated Regression (SUR) technique. Applying the
preceding steps, the final model takes the following form:

 ∆At  φ1   γ 11 ( 1) γ 12 ( 3 ) γ 13 ( 1)   ∆At  ε 1t 

 ∆S  = φ  + γ ( 2 ) γ ( 3 ) γ ( 3 )  ∆S  + ε  (2)
 t   2   21 22 23
 t   2t 
 ∆I t  φ3  γ 31 ( 3 ) γ 32 (1) γ 33 (1)   ∆I t  ε 3 t 

The Granger-causality test results from the SUR estimation are shown
in Table 3.
The empirical results given in Table 3 provide support for the
hypothesis that ‘sales cause advertising’ over the Galbraithian
alternative of ‘advertising causes sales’. Specifically, the null hypothesis
that advertising does not Granger-cause sales is not rejected at the 5%
level of significance (χ2 = 5.28 with 3 df). However, the reverse
hypothesis that sales do not Granger-cause advertising is soundly
rejected at the same level of significance (χ2 = 12.60 with 3 df). Also
inconsistent with the Galbraithian hypothesis is the finding that
personal income does not Granger-cause advertising (χ2 = 2.05 with
1 df). To check for the robustness of these inferences, we impose
different lag structures and re-estimate the VAR system, but the results
1persist qualitatively.
Footnote.

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TABLE 3 LIKELIHOOD RATIO (LR) TESTS OF HYPOTHESIS

RESTRICTIONS (SUR SYSTEM ESTIMATION)
Null hypotheses LR statistics df p-values
1 Sales do not Granger-cause advertising: γ12(L) = 0 12.60* 3 0.006
2 Advertising does not Granger-cause sales: γ21(L) = 0 5.28 3 0.15
3 Disposable income does not Granger-cause advertising:
γ13(L) = 0 2.05 1 0.15
4 Advertising does not Granger-cause disposable income:
γ31(L) = 0 0.59 1 0.44
Notes:
The lag profile of the VAR is determined by Akaike’s method in conjunction with specification gravity criterion.
Each equation of the VAR has passed various model diagnostic tests (for autocorrelation, heteroscedasticity,
omission-of-variables bias and structural instability). The VAR system is estimated by Zellner’s seemingly
unrelated regression method. Degrees of freedom (df) correspond to the number of FPE-minimising lags.
An asterisk (*) denotes rejection of the null hypothesis of no-causality at the 5% level of significance.

TABLE 4 FORECAST ERROR VARIANCE DECOMPOSITION

By innovations in

% of FEVD
of the variable Horizon Disposable
explained (in years) income Sales Advertising

FEVD SE FEVD SE FEVD SE

Disposable 1 100.00* 7.07 0.00 3.83 0.00 4.30
income 3 97.22* 7.24 1.80 4.01 0.98 4.35
6 97.04* 7.33 1.93 4.19 1.03 4.36
12 97.03* 5.49 1.92 3.66 1.05 4.25
Sales 1 34.71* 13.97 65.30* 13.88 0.00 3.88
3 35.71* 13.93 63.22* 13.84 1.07 3.92
6 35.72* 13.92 62.85* 13.83 1.43 3.93
12 35.71* 13.97 62.77* 13.73 1.52 3.76
Advertising 1 15.56 12.37 55.56* 12.23 28.88* 7.89
3 20.48 12.35 50.10* 12.20 29.42* 7.88
6 21.36 13.35 49.05* 12.20 29.59* 7.88
12 21.39 12.39 48.85* 12.08 29.76* 7.80
Notes:
The SE is the standard error for the point estimate of forecast error variance decomposition (FEVD) computed
by a Monte-Carlo simulation procedure with 500 random draws. An asterisk (*) indicates the case where the
estimated FEVD is at least twice as much as its standard error. A rule of thumb is that the estimated FEVD is
deemed significant when it is at least twice as much as its standard error.

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Of course, Granger-causality tests are not the only metric for

judging the impact of advertising on sales (or vice versa). Another
useful approach is to check for the ability of one variable to account
for the forecast error variance of the other (see the appendix for
details). Using different forecasting horizons over one year, three
years, six years, and twelve years, Table 4 reports the estimated forecast
error variance decompositions (FEVDs) of each variable (in columns)
decomposed into fractions that are accounted for by innovations of
the three variables (in rows). We also perform a Monte-Carlo
simulation with 500 random draws to compute the standard errors for
the estimated FEVDs. Generally, an estimated FEVD is deemed
statistically significant when it is at least twice its standard error. Using
a second-order VAR, sales explain a significant portion (about 50%) of
the forecast error variance of advertising across all alternative forecast
horizons. In contrast, advertising fails to account for any substantial
portion of the error variance of sales (ranging only from 0 to 1.5%).4
These findings from the FEVD analysis offer additional evidence in
support of the notion that sales drive advertising.
An additional insight into the dynamic interrelations among
advertising, sales and disposable income may be obtained by
examining the impulse responses to innovations of each variable in
the VAR system. To conserve space, we focus on the responses of
sales (advertising) to a one-standard-deviation shock in advertising
(sales). Figures 1 and 2 plot the time paths of the impulse response
functions of sales (advertising) reacting to a one-standard-deviation
shock in advertising (sales), along with the 95% confidence interval
computed by Monte-Carlo simulations with 500 random draws. As is
clear from the two figures, advertising reacts strongly to innovations in
sales. The significant effect of a shock in sales on advertising lasts for
about one year before it converges to zero. In contrast, shocks in
advertising do not have any significant effect on sales. These impulse
response results provide further support for our earlier finding that
sales have a considerable impact on advertising expenditures, but not
vice versa.

4 The orthogonalisation order for results in Table 4 is personal disposable income,

sales, and then advertising. Such an order allows for the exogenous impacts of
personal disposable income and sales on advertising.

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0.008

0.006

0.004

0.002

–0.002

–0.004

–0.006

–0.008

–0.010
1 2 3 4 5 6 7 8 9 10 11 12

Horizons (in years)

Notes
The dark lines represent the time path of impulse response functions to a one-standard-deviation shock. The
dotted lines characterise the 95% confidence intervals of the impulse response functions computed by Monte-
Carlo simulations with 500 random draws.

FIGURE 1 IMPULSE RESPONSES OF SALES TO AN INNOVATION IN

ADVERTISING

AN INTERPRETATION

Recent marketing research does not support the Galbraithian

hypothesis that advertising shapes consumers’ behaviour and
promotes sales. Some researchers explain the alternative ‘sales drive
advertising’ hypothesis on the basis of an advertising budget method
(i.e. advertising-to-sales ratio). The apparent advertising–sales puzzle
may be explained by the signalling theory of advertising (see Prabhu &
Stewart (2001) for a recent account).
Akerlof (1970) and Spence (1973) pioneered the signalling theory
whose central message is that consumers cannot perfectly determine
product quality and attributes. The theory contends that

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0.05

0.04

0.03

0.02

0.01

–0.01

–0.02
1 2 3 4 5 6 7 8 9 10 11 12

Horizons (in years)

Notes
The dark lines represent the time path of impulse response functions to a one-standard-deviation shock. The
dotted lines characterise the 95% confidence intervals of the impulse response functions computed by Monte-
Carlo simulations with 500 random draws.

FIGURE 2 IMPULSE RESPONSES OF ADVERTISING TO AN

INNOVATION IN SALES

manufacturers of high-quality products have an incentive to advertise

more heavily to attract new customers and/or induce repeated
purchases (Nelson 1975). The manufacturers of high-quality (popular)
brands may be considered as ‘strong’ manufacturers, and the
manufacturers of low-quality (less-favoured) products as ‘weak’
manufacturers. Typically, strong manufacturers are able to generate
more revenues and profits because of their superior products, while
weak manufacturers do not realise as much revenue due to their lower
quality and less popular products. For industrial and consumer
products, it has been found that an index of ‘quality’ and ‘uniqueness’
is positively related to higher advertising-to-sales ratios (Lilien 1978;
Farris & Buzzell 1979). This implies that marketers increase
advertising expenditures to promote products of higher quality. In
addition, it is commonly assumed that manufacturers compete with

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each other and attempt to maximise market shares. Under these

circumstances, manufacturers tend to ‘boast’ about their products, and
small manufacturers mimic, and perhaps even challenge, major
competitors through comparative advertising. Consumers typically
experience some difficulty in differentiating strong manufacturers
from weak manufacturers. This problem could cause consumers to
partially discount information contained in public advertisements.
Accordingly, all manufacturers might be simply pooled in consumers’
psyche into one general ‘average quality’ class. This situation is
referred to as ‘pooling equilibrium’ in the signalling literature.5
In order to overcome this market deficiency and more effectively
convey information about product characteristics, a strong
manufacturer tends to employ a series of costly signals that would be
prohibitively expensive to mimic by weaker manufacturers.
Advertising is costly and must generate sufficient sales to cover it. As
Kirmani & Rao (2000) suggest, from the perspective of weak
manufacturers, costly advertisements induce consumers’ trial which
probably exposes the low quality of the weak manufacturer’s products.
These heavy advertisements of strong manufacturers will then deter
weak manufacturers since they jeopardise future sales and the recovery
of advertising costs. Moreover, significant advertising expenditures
also deplete funds that would otherwise be available for product
improvements and/or innovations. Therefore, weak manufacturers
typically find the opportunity cost under these circumstances
prohibitively high.
The net outcome is a ‘separating equilibrium’ in which stronger
manufacturers employ signals to deliver asymmetric information of
their product quality and popularity to consumers, hoping for the
market’s rewards in the form of higher sales. This equilibrium is not
only stable – no party can generate excessive profit by inappropriate
signalling behaviour – but it is also efficient, in the sense that the
amount of advertising expenditure correctly reflects the true
prospects of the various products. Consumers are therefore able to
differentiate strong from weak manufacturers, and consequently have
the opportunity to purchase truly high-quality products.

5 Pooling equilibrium could explain the phenomenon that the effect of interpersonal
communication such as ‘word of mouth’ tends to be more effective than that of
mass media, as the diffusion of innovations research seems to suggest (Sultan et al.
1990).

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It is in this sense that manufacturers tend to increase their

advertising budgets to convey asymmetric information that is
otherwise not perceived by consumers. Whenever manufacturers
realise more revenues from sales, they tend to spend more on adver-
tising. Of course, a considerable portion of advertising expenditure
will be reflected ultimately in higher consumer prices. Indeed, as some
studies suggest, advertising expenditure may be quite wasteful and
akin to ‘burning money to signal’ (see, for example, Abraham &
Lodish (1990) and Lodish et al. (1995)). Yet the underlying justification
for more advertising remains. Strong manufacturers look forward to
recouping advertising costs in the future through creating barriers of
entry and driving out weaker manufacturers from the market.
Consumers too might benefit from advertising signals since such
signals could improve information regarding the characteristics of the
products, and therefore reduce their costs of improper purchases
(Ehrlich & Fisher 1982).
Under this scenario, firms spend on advertising in a direct reaction
to sales increases, and they are motivated to continue with advertising
from their conviction of the high quality of their products and from
their eventual success in the market. In the case of products in which
consumers cannot verify the crucial aspects of their quality except
through the adoption experience, advertisements can credibly convey
little direct information beyond the simple fact that the product is
available in the market. Yet such ‘reminding ads’ may still be useful,
both for consumers to identify high-quality products, and for the
manufacturers to make themselves known. Therefore, even when
consumers discount advertising messages, advertising can still help
consumers gauge the product quality and ascertain the company’s
conviction. As a result, marketers generally spend a considerable
portion of sales revenue on advertising.
Before concluding, we should caution that our analysis in this
article does not directly test the signalling theory, but only uses this
increasingly popular framework to interpret the results we obtained
for the advertising–sales nexus at the macro level.

CONCLUSION

The Galbraithian hypothesis contends that advertising increases with

disposable personal income and promotes sales. We re-examine this

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hypothesis using several empirical procedures (multivariate Granger-

causality tests, forecast error variance decompositions, and impulse-
response functions) against US annual data over the period 1948 to
1995. Consistent with Chowdhury’s (1994) evidence for the UK, our
results for the USA also reject the Galbraithian hypothesis. However,
unlike Chowdhury’s bivariate results, our results from a broader model
consistently suggest that there is a reliable relationship between
advertising and sales, but one in which sales lead advertising rather
than vice versa.
We use the signalling theory to interpret the results. Advertising is
clearly costly, and may even be wasteful. Yet advertising is helpful for
consumers to differentiate high-quality from low-quality manufactu-
rers, thus avoiding regret from purchasing low-quality products.
Consumers view advertising as the company’s way to convey
confidence in its product.

APPENDIX

When considering long-term marketing interactions, it is necessary to

consider the possibility of cointegration among the variables under
investigation. One main advantage of the cointegration analysis is that
it enables researchers to analyse non-stationary variables and thus
avoids the loss of information due to the process of transforming
non-stationary variables to become stationary through differencing.
We summarise below the empirical procedures used.

Non-stationarity (unit root) tests

A variable is said to be stationary (has no unit root) if its stochastic
properties (e.g. mean, variance) do not vary over time. In other words,
‘a stationary series tends to return to its mean value and fluctuate
around it within a more-or-less constant range while a non-stationary
series has a different mean at different points in time and its variance
increases with the sample size’ (Harris 1995, p. 15). Non-stationarity
could result in the spurious regressions phenomenon involving invalid
test statistics (Granger & Newbold 1974; Phillips 1986). Stock &
Watson (1989) also argue that the usual test statistics (such as t, F, DW
and R2 ) will not exhibit standard distributions if some of the variables
in the model are non-stationary. It is not surprising, then, that testing
1for unit roots has gained popularity in the recent literature.
Footnote.

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ADVERTISING: A MULTIVARIATE ANALYSIS

There are several ways to test for unit roots. The procedure
proposed by Dickey & Fuller (1979), dubbed DF, is perhaps the most
familiar unit root test. However, the DF test is biased under serially
correlated errors. The augmented Dickey–Fuller (ADF) test is
superior in this case since it adds lagged values of the dependent
variables to minimise the serial correlation problem. The Weighted-
Symmetric (WS) and the Phillips–Perron (PP) tests have also gained
acceptance in the literature. Pantula et al. (1994) argue that the WS test
is more powerful than several alternative unit root tests, including the
ADF test. On the other hand, the PP test is robust to a wide range of
serial correlations and time-dependent heteroscedasticity (Enders
1995). Typically, a non-stationary time series variable can achieve
stationarity by being differenced appropriately. A non-stationary time-
series variable is said to be integrated of order d if it becomes
stationary after differencing it d times (Engle & Granger 1987).

The cointegration test and error-correction models

Cointegration refers to the presence of a long-term (equilibrium)
relationship among non-stationary variables. Under cointegration,
standard regressions become seriously misspecified due to the
omission of important variables (the error-correction term).
The Johansen (1988) method is widely considered to be more
efficient than the two-step Engle & Granger (1987) procedure. If the
number of variables in the system is n, there can be up to n – 1
cointegrating vectors. Both the trace and the maximal eigenvalue
statistics are computed in order to determine the rank (or number) of
cointegrating vectors, denoted r. The null hypothesis r = 0 is tested
against the alternative r = 1; r ≤ 1 against the alternative r = 2, etc. The
cointegration test is sensitive to the choice of lag length, and hence we
use the Schwartz criterion and the likelihood ratio test to select the lag
order.
Grewal et al. (2001) suggest the use of Vector Autoregressive (VAR)
models and Vector Error Correction Models (VECMs) to access the
relationship among time-series variables. If cointegration among the
variables under study is rejected, then the VAR model is constructed
without incorporating the error-correction term. Under cointegration,
however, VECM becomes appropriate and it includes the error-
correction term(s) to represent the linear combination(s) of the
cointegrating variables. VECMs incorporate the variables in their
stationary
1 forms to avoid the spurious regression problems. In this
Footnote.

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INTERNATIONAL JOURNAL OF ADVERTISING, 2002, 21(2)

regard, one main feature of the VAR and VECM is that all the terms
in the model are stationary so the usual statistical inference is valid.
Since lag structures are unlikely to be similar for different variables,
a reasonable approach is to determine the appropriate lag lengths by
Akaike’s final prediction error (FPE) criterion, in conjunction with the
specific-gravity criterion of Caines et al. (1981). Thornton & Batten
(1985) report that the FPE criterion is superior to many other
alternative lag-selection procedures for determining the VAR lags. The
FPE procedure minimises a function of the one-step-ahead forecast
error. The specific-gravity criterion aids in ranking the various
explanatory variables for inclusion in the equations; see Darrat &
Brocato (1994) for details.
Having specified the equations and determined their proper lag
structures, we then pool them together as a system. Next, we test
various restrictions in the maintained VAR (or VECM) using over- and
under-fitting tests conducted by system estimations (e.g. using
Zellner’s seemingly unrelated regressions, SUR). The purpose of such
system tests is to ensure that the specifications of the various
equations reached on the basis of single-equation estimations are
robust. In addition, we also apply a battery of diagnostic tests to check
the adequacy of the final model. In particular, we test for
autocorrelation by the Durbin-m and Bruesch–Godfrey procedures;
heteroscedasticity by the Lagrange-multiplier test; for a possible
omission-of-variables bias by the Ramsey RESET test; and for
structural instability by the Chow test.

The Granger-causality test

Testing for Granger-causality is a recurrent theme in applied business
research. A covariance stationary time series (Y ) is said to Granger-
cause another stationary time series (X ) if the prediction error from
regressing X on its own lagged values significantly declines when
lagged values of Y are also added to the model. Since this Granger
definition of causality remains controversial and may not correspond
exactly to the concept of causality in the philosophical sense, we
attach ‘Granger’ to ‘cause’. As Schwert (1981) points out, much of this
controversy can be resolved by viewing the Granger-causality
approach as tests of ‘incremental predictive content’.
The Granger-causality is typically examined in a vector system
where each variable under study has an opportunity to be considered
as
1 anFootnote.
endogenous variable at one time. In our case, for example,

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ADVERTISING: A MULTIVARIATE ANALYSIS

Granger-causality can shed light in terms of whether advertising is

determining sales, or sales are determining advertising, or both are
determining each other in a trivariate system.

Forecast error variance decompositions

The forecast error variance decomposition (FEVD) assesses how
much of the forecast error variance of a given variable is explained by
other variables. Variance decompositions are useful since they provide
additional insights into the direction of Granger-causality; for
example, our empirical results suggest that approximately 50% of
forecast error variance of advertising is explained by sales. In contrast,
less than 2% of forecast error variance of sales is explained by
advertising. These results are consistent with the notion that sales
Granger-cause advertising rather than vice versa.
Let vector Zt contain advertising, sales and personal income variables,
and rewrite system equations (2) in a moving-average representation.
The moving-average vector representation of ∆Zt is given by:
∞
∆ Z t = ∑ Bs e t − s (3)
s =0

where the ith and the jth element of Bs measures the impulse response
of the ith variable after s periods to a one standard deviation random
shock in the jth variable.
Although the et variables are serially uncorrelated, they may still be
contemporaneously correlated. If these correlations are high, the
interpretation of the impulse response function, as capturing the
effect of a shock in the jth variable while all other variables are held
constant, could be misleading. Thus, we use an orthogonalising
transformation of et and rewrite system equations (3) in a recursive
form as follows:
∞
∆Z t = ∑ C s u t − s (4)
s =0

where Cs = V–1Bs, and V is a lower triangular matrix so that orthogo-

nalised innovations ut can be obtained from ut = V–1et . The orthogo-
nality of the ut allows the error variance of the h + f step ahead
forecast of the returns in the ith variable to be decomposed into
components accounted for by these shocks. In particular, the
1 Footnote.

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INTERNATIONAL JOURNAL OF ADVERTISING, 2002, 21(2)

components of this forecast error variance of the ith variable

accounted for by shocks in the jth variable are given by ∑h=0
h+f
C 2i, j,h.
This variance decomposition permits the isolation of the relative
contributions of the ith variable.

Impulse response functions

Impulse response functions (IRFs) gauge the response of one variable
to a change in another variable in the system. For instance, if a 10%
shock is assigned to advertising (i.e. increasing or decreasing
advertising expenditure by 10%), the IRFs can be used to enquire
whether such a shock has a delayed effect on sales, and for how many
periods.
The elements in the matrix C1i in equation (4) are called impact
multipliers. These multipliers and their time paths resulting from a
one-standard-deviation shock in a given variable may be plotted along
with the 95% confidence interval derived from Monte-Carlo simulations.

ACKNOWLEDGEMENTS

The authors are indebted to Shahid Bhuian, Sean Dwyer, the Editor
and two reviewers for their many helpful comments and suggestions.

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ABOUT THE AUTHORS

Maxwell K. Hsu is an Assistant Professor of Marketing at the

University of Wisconsin, Whitewater. He received his DBA in
Marketing from Louisiana Tech University in 1999. His articles have
appeared in Applied Economics Letters, International Journal of Business and
Economics, Studies in Economics & Finance, Human System Management, and
other journals. He is currently working on research projects related to
advertising, international diffusion of innovations, service quality and
information technology management.
Ali F. Darrat is The Premier Bank Endowed Professor of Finance
and Professor of Economics at Louisiana Tech University. He has
published more than 130 articles in refereed national and international
journals in the fields of economics and finance, including Review of
Economics & Statistics, Journal of Money, Credit and Banking, Journal of
Financial and Quantitative Analysis, Journal of Banking and Finance, and
Journal of Financial Research. His work has been widely cited (almost 250
citations by other authors in the literature), and several of his articles
have also been abstracted in The Journal of Economic Literature, Monetary
Economics Abstract, CFA Digest and ISFA Digest. His research interests
include applied macroeconomics, monetary theory and policy, money
and banking, capital markets, international money and finance,
economic development, and business cycles and forecasting.
Maosen Zhong is an Assistant Professor of Finance at The
University of Texas, Brownsville. Since joining UTB in 1999, he has
published more than ten refereed articles in Decision Sciences Journal, The
Financial Review, Journal of Banking and Finance, Journal of Financial
Research and Applied Economics Letters, among others. His research
interests include asset pricing, international finance, futures markets
and applied econometrics.
Salah S. Abosedra is Professor of Economics at the University of
Qatar, with a PhD degree from the University of Colorado in 1984.
His articles have appeared in The Journal of Energy and Development and
OPEC Review, among others. His current research interests include
natural gas pricing and financing, and stochastic behaviour of oil
prices.

1 Footnote.

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