The Impact of Brand Value on Stock Return:

The Impact of Brand Value on Stock Return:

A brand-new perspective

Noor van den Assem

Master’s Thesis MSc BA – Finance

Faculty of Economics and Business – University of Groningen

December 15

, 2010

Supervision:

Dr. A. Plantinga

Drs. M.M. Kramer

ABSTRACT

This research examines the relationship between year-to-year changes in brand value estimates and annual stock returns, controlling for firm size and the market-to-book ratio.

Brand value estimates are collected from the Best Global Brands ranking, published by the brand consultancy firm Interbrand during the time span 2000-2010. A fixed effects panel model is used to carry out the regressions. A significant positive relationship between brand value and stock returns is estimated. However, when the brand name is not equal to the stock name, the effect becomes negative. This is in line with theories of behavioral finance. Results show that brand value changes of direct competitive brands, and the ‘new’ appearance of a brand in the ranking, do not have a statistically significant effect on stock returns.

Journal of Economic Literature Codes C23, G12, G14, M31

Keywords: brand value, stock return, panel analysis, investor sentiment, familiarity

Author: N.A.M. van den Assem

Student number: 1451936

E-mail address: noortjevd@hotmail.com

PREFACE

There are a number of people I would like to thank for supporting me during the process of writing this thesis. First of all, I would not have enjoyed writing this paper so much without the inspiring lectures of Prof. F. Tempelaar and Marc Kramer, who triggered my interest and affinity for behavioral finance. Second, I want to thank my colleagues at the Decision Support department of Nestlé Nederland for their encouragement. During my internship at Nestlé, I discovered that some of their products did not carry the Nestlé brand name. This made me think about the possible consequences of a brand name on a firm’s value, and provided me inspiration for writing this thesis. Most of all, I want to express gratitude to my supervisor Dr.

A. Plantinga for his supervision and guidance during this research process. Finally, I would

like to thank my parents, closest friends, and family, for their unlimited support.

TABLE OF CONTENTS

1. INTRODUCTION... 1

2. LITERATURE REVIEW... 4

2.1 Brand value ... 4

2.2 The marketing principle of brand value... 6

2.3 The financial principle of brand value... 8

2.4 Investor sentiment ... 10

2.5 Hypotheses ... 13

3. DATA COLLECTION... 16

3.1 Data collection ... 16

3.2 The Interbrand methodology for estimating brand values... 19

3.3 Criteria for inclusion... 20

4. METHODOLOGY... 24

4.1 Research methodology ... 24

4.2 Regression equation – Balanced panel ... 27

4.3 Regression equations – Unbalanced panels... 28

4.4 Testing hypotheses... 28

4.5 Diagnostic tests ... 30

5. RESULTS... 31

5.1 Regression results – Balanced panel ... 31

5.1.1 Fixed effects panel model... 31

5.1.2 Diagnostic test results ... 33

5.1.3 Familiarity hypothesis ... 33

5.1.4 Rival brand value hypothesis... 36

5.2 Regression results – Unbalanced panels ... 37

5.2.1 Sample pool B ... 37

5.2.2 Sample pool C ... 38

5.3 Outliers... 40

5.4 Empirical analysis... 42

5.5 Summary... 44

6. CONCLUSION ... 45

REFERENCES... 48

APPENDICES... 51

Appendix A ... 51

Appendix B ... 52

Appendix C ... 55

Appendix D... 57

Appendix E ... 59

Appendix F ... 60

1. INTRODUCTION

“In 1983, when 16 Beardstown ladies, average age 70, started the Beardstown Business and Professional Women’s Investment Club, they did so partly because they were sick of being told by men that they shouldn’t worry their pretty heads about stock-buying and finance and such. They weren’t the world’s first women’s investment club. But they were arguably the most famous – not that you could have predicted that by watching them from the start. They invested in companies they knew…and they were successful.”

Wall Street Journal, May 1, 2006

“Our future will depend on our brand equity.”

Yun Jong Yong, CEO of Samsung, 2004

Brands are everywhere. Human beings are so accustomed to brands that they name a specific product similar to the brand name that is attached to it. This leads to situations in which a child asks his mother for a Mars or a Pepsi; to dry his tears with a Kleenex; to play Nintendo games; or to use the Apple to Google the location of the nearest McDonalds. As brands play an increasingly significant role in people’s daily lives, it may be expected that brand names induce investor sentiment, and eventually affect stock market returns.

The practice of brand building has spread far beyond the traditional consumer-goods marketers who initiated the discipline. A brand can be defined not only as a bundle of trademark and associated intellectual property rights, but also includes the visual and marketing intangibles, and the associated goodwill deployed by an organization (Aaker, 1991). This provides the basis for a firm’s differentiation and value creation. The importance of brands has been rising over the years for corporations in almost every industry. One key reason is that consumers have an increasing number of products or services to choose from.

Due to globalization, corporations must reach customers in markets outside their home country. The Internet enables buyers to easily compare products and services offered by multiple sellers from all over the world, neglecting geographic boundaries. A strong brand name acts as an ambassador when companies enter new markets or offer new products or services.

In addition, the current general loss of confidence in financial markets makes people

turn to established strong brands: brands they can trust in uncertain times. Trusted brands

offer consumer perceptions of quality, exclusivity, comfort, and familiarity; they give

consumers something to hold on to in this complex world. This notion is already discussed in

the research of Keller (1993), who states that customer brand equity exists “when the

consumer is familiar with the brand and holds some favorable, strong and unique brand associations in memory”.

A strong brand also shapes corporate strategy, helping to define which initiatives fit within the brand concept and which do not. Brands have become valuable business assets;

they have the power to boost sales and company earnings, and mitigate cyclical drops. Over recent years, intangible assets have increasingly become acknowledged as relevant generators for a sustainable financial performance of businesses across a variety of industries. For this reason, multinational companies that once measured their firm value strictly in terms of tangibles like factories, inventory, and cash have increased their focus on intangible assets like brand value, with the ultimate goal of creating shareholder value. There is a shift noticeable in the sources of value creation, which is reflected in the growing divergences between the net asset book value of companies and their market capitalization.

The acceptance of brands as value creators has accelerated the aim of studies to come up with credible ways to value brands. The study of Srinivasan et al. (2005) outlines several approaches used in the past to value brands. These brand valuation methods largely focus on marketing performance results, like sales, market share and compliance; metrics that do not explicitly quantify the financial outcomes of brand marketing. This thesis, however, will focus on quantified brand values, generated by the specialized brand consultancy firm Interbrand, during the time span 2000-2010. The Interbrand Corporation, a unit of Omnicom Group Inc., annually publicizes a ‘Best Global Brands’ ranking. This ranking provides the brand values of the top 100 most valuable global brands. Brand values are determined by a calculation of the net present value of the cash flows that a brand is expected to generate and retain in the future.

This paper aims to estimate the effect of year-to-year changes in brand value on stock returns, that is, a reflection of aggregate investor expectations of the change in long-term future cash flows. It seeks to assess the market reaction after a publication of the annual Best Global Brands ranking. How do investors react to news about changes in brand value? Is it possible to earn higher returns with investment decisions based on growing brand value estimates? Do brand value estimates have incremental information content? Additional issues discussed in this paper involve the familiarity heuristic; the effect of rival brands; and the impact of a first appearance of a brand in the ranking. According to theories of limited rationality, brand familiarity may represent the investor’s illusion that he has superior information. This form of investor sentiment could eventually lead to higher stock returns.

Beside the behavioral aspects of finance, the neoclassical finance model is taken into

account. The modern theory of financial markets states that the stock market rapidly absorbs

new information as it becomes available. If brand value estimates reveal relevant market valuation information to investors, efficient market theory (Fama, 1970) requires the new information to be instantly reflected in the stock prices. In that case, brand value estimates will not have any impact on stock returns.

A better understanding of the relationship between brand value and stock returns can provide an insight for finance and marketing managers, in terms of guiding their decisions associated with resource allocation. It will lead to a more balanced view of the costs and benefits of brand-building expenditures. Key financial indicators, like return on investment (ROI) in brand marketing activities, can be more accurately understood when an intangible asset has a quantitative value that can be tracked. Knowing a brand’s value also enables investors and other stakeholders to make better-informed decisions. This paper is a contribution to the research area, as it will be the first relating changes in brand value estimates between 2000-2010 to stock returns. Prior studies concerning the brand value-stock market relationship consisted of cross-sectional analyses. This paper will use panel data for a longitudinal analysis, which tracks accumulated brand values and associated characteristics of the brand-owning companies over time.

The remainder of this thesis is organized as follows. The following section discusses theoretical and empirical literature, including an elaboration on the arguments for brand management in the marketing-finance interface area. Additionally, it will focus on the link between brand value and stock return, taking the decision-making process of investors into account. The section ends with an extensive formulation of the hypotheses that will be tested.

Section three elaborates on the data collected for the research and describes the calculation

methodology implemented by the Interbrand Corporation to produce brand values. Section

four discusses the research methodology. The results of the regression analyses are

demonstrated in section five. Finally, section six presents the conclusions and provides

recommendations for further research.

2. LITERATURE REVIEW

This section starts with the definition and characteristics of the concept named ‘brand value’.

Prior theories and literature about brand value in relation to the financial market are discussed.

Although marketing and finance seem separate areas of expertise, their underlying paradigms are mutually reinforcing (Kerin and Sethuraman, 1998; Srivastava et al., 1998; Srinivasan et al., 2005). The concept of brand value lies in the middle of the marketing-finance interface.

This will be explained in the second and third subsection, which elaborates on the marketing principle, and the financial principle of brand value respectively. In the fourth subsection, the impact of brand value estimates on investor sentiment is discussed. Last, the research objectives and hypotheses will be formulated.

2.1 Brand Value

Brand value can be described as the financial intangible value of a brand. Firms have started to realize that off-balance sheet intangible properties embedded in a company’s brand names are a source of tangible wealth (Kerin and Sethuraman, 1998). The tangible wealth is the result of incremental capitalized earnings and cash flows achieved by linking a successful, established brand name to a product or service. These incremental earnings and cash flows can be referred to as ‘brand value’. According to Keller (2003), brand value represents the added value a product or service gathers as a result of past investments in the marketing activity for a brand. The key criteria for brand valuation include that the title to the brand has to be clear and separately disposable from the rest of the business. Additionally, the value has to be substantial and long term, based on separately identifiable earnings that have to be in excess of those achieved by unbranded products (Doole and Lowe, 2004).

Asserting that popular brand names are economically valuable assets that create shareholder wealth is easier than actually assigning a financial value to brand names and proving an empirical relationship between brand value and shareholder value (Kerin and Sethuraman, 1998). Companies have always found it difficult to identify, measure, and communicate the financial value created by intangible marketing activities (Srivastava et al.

1998). This is because brand-building activities are primarily external in their focus and (until

recently) not recorded on the balance sheet. Asset valuation methods make use of book values

or replacement values of the firm’s assets. Replacement costs are difficult to estimate for

intangible assets, which results in the fact that the value of intangibles is mostly ignored on

the balance sheet. Nowadays there is a growing recognition that a significant proportion of the market value of corporations lies in intangible, off-balance sheet assets, rather than in tangible book assets. Using brand assets for financial valuation purposes used to be unappealing since they do not translate into dollar values (Mizik and Jacobson, 2008). However, the Interbrand rankings are based on a valuation method that calculates the brand’s value in US dollars.

Srivastava et al. (1998) designed the first conceptual framework of the marketing- finance interface and discuss the concept of market-based assets, defined as “assets that arise from the commingling of the firm with entities in its external environment”. Market-based assets are primarily external to the firm, generally do not appear on the balance sheet, and are largely intangible. As brand value is specified by the impact of a brand on its external environment, it can be established that brand value is a relational market-based asset. Once determined as being an asset, it should be tested whether brand value contributes to shareholder value. If market-based assets are to contribute to customer and financial value, they must satisfy four tests according to the resource-based perspective on what accounts for competitive success (Srivastava et al. 1998).

1. Convertibility: Brand value must have the ability to exploit an opportunity and/or neutralize a threat in the external environment. Previous studies (Moore et al., 2000) show that brands strongly support the process of vertical integration and expansion. A strong brand value exploits opportunities for international retailers like IKEA, Hennes

& Mauritz, and Zara; all brands listed in the Best Global Brands ranking.

2. Rarity: If multiple rivals possess the asset, its potential to be a source of sustained value is diminished. According to research of Keller (2003), brands offer exclusivity.

Brand names have sustainable value because of their ability to create and maintain earnings by tangible assets (Lane and Jacobson, 1995).

3. Imitation: It must be difficult for rivals to imitate the asset. Mizik and Jacobson (2003) state than brands create a comparative advantage for firms through its ability to differentiate the firm’s product. Findings of Eng and Keh (2007) confirm that brand equity is difficult for competitors to copy, making the brand an effective entry deterrence strategy.

4. Substitution: Rivals do not possess strategically equivalent perfect substitutes. Brands are difficult substitutes due to their installed base of loyal customers. Bolton et al.

(2004) state that the punishing power of consumers decreases due to financial switching thresholds and uncertainty regarding competitors’ products and services.

Brands are a tool for creating a switching threshold, as they offer reliability, quality,

and uniqueness towards the buyer. Once the consumer gets attached to the brand, he will be less likely to switch to a similar (unbranded) product or service. Hence, the brand leads to a diminishing competitive power of substitute products, which creates value for the firm.

As brand value passes these tests, it must contribute to firm value generation. The study of Barth et al. (1998) show that brand values estimated and published by a well-respected financial magazine reflect valuation relevant information and are sufficiently reliable and timely to be reflected in share returns. Not only can brand equity be used for the same purposes as tangible, balance sheet assets, but also are they more likely to serve as a basis for long run, sustained customer value (Srivastava et al. 1998). Doole and Lowe (2004) show that brands can also decline in value due to a failure to understand customer expectations, to inappropriate brand extensions, failures to reposition in response to market decline, or failure to respond to new competition.

2.2 The marketing principle of brand value

In the marketing literature intangible brand properties are known as brand equity. Brand equity arises from customer brand name awareness, brand loyalty, perceived brand quality, and favorable brand symbolism and associations that provide a platform for a competitive advantage and future earnings streams (Kerin and Sethuraman, 1998).

In the first half of last century, there was a manufacturing oriented, industrial economy. Limited consumer choice – due to geographic boundaries – resulted into mass production being the key to economic growth. Times have changed, and now consumer utility rather than productivity can be considered as the real standard for economic growth. Hicks (1939) states that ‘utility’ – as a quantitative measure – can be replaced with ‘satisfaction’.

Consumer satisfaction refers to the size, loyalty and quality of the customer base of a firm (Fornell et al. 2006). The reason customer satisfaction is discussed is because it has a similar revenue enhancing effect as brand strength. Brand strength is an important input for the brand valuation methodology used by Interbrand, elaborated in the following section of this thesis.

Satisfaction with a brand makes customers less sensitive to pricing – more price inelastic –

and therefore more likely to buy products with a brand that they are satisfied with. Satisfied

consumers are willing to pay premium prices, which is exactly the target group for branded

products. Studies of Fornell et al. (1996) show causal evidence that high customer satisfaction

leads to high usage levels in future periods, which positively affects shareholder value.

Investigations by Interbrand (2001) show that brands cannot be profitable without customer satisfaction. Consumers rely on trusted brands to spare time and costs to search for alternatives. When a brand is tarnished, its power to attract customers and command price premiums decreases, which leads to a downturn in brand value.

The marketing principle of brand value states that brands generate product awareness, and lead to customer loyalty. Brands are designed to signal consistency, reliability, and quality to consumers in order to create a long-term relationship with the consumer. It is established that customer loyalty can be considered a major indicator for future firm performance (Fornell et al., 2006). According to their research, customers are the ultimate scarce resource. Brands are a way to attract and retain customers, which is considered an important long-term strategy for company growth. A positive brand attitude increases the likelihood that consumers will buy the product again. Anderson, Fornell and Rust (1997) state that when a customer is satisfied with a firm’s product or service – and experiences a positive association with the brand attached to the product – it is more willing to purchase additional products or services labeled under the same brand. Brands make people aware that products and services that might seem unrelated are indeed produced by the same firm. This stimulates cross buying and positively affects brand value.

According to Lane and Jacobson (1995), highly familiar brand names may be more accessible, so extensions of familiar brands are likely to be chosen more often than those of unfamiliar brands. By attaching established brand names to new products, which is called brand leveraging, a firm taps into consumers’ favorable associations with the brand name in an effort to create financial value (Lane and Jacobson, 1995). According to their research, marketing new products with existing brand names is a profitable strategy as it generates savings in brand development costs over time, and enhances the brand’s image. However, brand leveraging can also have negative consequences like cannibalization, brand image dilution, and brand franchise destruction. This could lead to confusion about the brand image – as perceived exclusivity or status appeal of the brand is reduced – causing diminishing returns in the brand’s original markets. Lane and Jacobson (1995) state that the positive cash flow effects caused by brand familiarity and awareness are greater for firms with a relatively high brand value compared to firms with a low brand value that are, consequently, not listed in the ranking. However, it must be noted that highly familiar and highly regarded brands can also suffer greater losses in case of a negative event, because more brand equity is at risk.

Thus, the potential downside losses for companies owning brands listed in the Best Global

Brands ranking are greater than for firms owning less known, less highly regarded brands.

Hence, familiarity could also have negative consequences for a firm.

Additionally, it can be expected that brands that are fairly well liked but disproportionately less familiar will probably experience a relatively larger positive impact in stock returns when they appear ‘new’ in the Best Global Brands ranking, than brands that are already familiar and listed.

Merely knowing the impact of brand value on consumer purchase intent is inadequate;

the financial consequences of brand value for the stock market need to be understood.

Consumer behavior in any product market depends on consumer perceptions of the brand, which suggests that brand equity components, like familiarity with the brand and attitude toward the brand, should influence investor expectations of future cash flows and therefore stock prices (Lane and Jacobson, 1995). Empirical evidence of Fornell et al. (2006) suggests that consumer perceptions of superior quality are associated with higher economic returns.

Recent empirical studies show that marketing expenditures may not only affect own and competitive sales but also the value of the firm (Srinivasan et al., 2009). Research of Joshi and Hanssens (2010) focuses on the long-term investor response to marketing actions, and document a positive relationship between advertising expenses and market capitalization.

The brand equity components mentioned in this section represent only a fraction of a firm’s activities and therefore its potential profits; this limits the ability to detect the effect of brands on stock market return (Lane and Jacobson, 1995). Therefore, overall brand value published by Interbrand – which already incorporates these brand equity components in the calculation process – will be used as an input to explain possible abnormal stock returns.

Separate sources of brand value will not be taken into account in the remaining part of this thesis.

2.3 The financial principle of brand value

The financial principle of brand value looks at the expected future cash flows that are directly associated with the brand. Findings of Eng and Keh (2007) confirm that increased brand value leads to higher brand sales and brand-operating income. On the contrary, Barth et al. (1998) show evidence that brand value estimates are not significantly positively related to sales growth.

By definition, a firm’s stock returns are mainly driven by changes in cash flow

expectations (Vuolteenaho, 2002). Cash flow – cash inflow versus cash outflow – has a

central role in determining the financial market value of a company and ultimately shareholder value. Kerin and Sethuraman (1998) emphasize that brand names are a corporate asset with an economic value that creates wealth for a firm’s shareholders. They found a significant and positive relationship between a firm’s accumulated brand value and market-to- book ratio. This confirms that brands are an intangible company asset, and have an economic value in the sense that a firm is worth more if it is in possession of a strong brand. Based on the substantial difference between the book value and market value of firms, Fornell et al.

(2006) state that most economic value creation does not get recorded on corporate balance sheets. Even though brand values can change markedly from period to period, changes in brand values largely are unaccounted for, even for brands recognized as assets (Barth et al., 1998). Due to more and innovative research specified on the relevancy of brand values, measures of brand value are increasingly required to be included on corporate balance sheets.

Although market-based assets like brand value can be expected to enhance stock performance and lower risks, there is much to learn about how the stock market values the capability of market-based assets to enhance current and potential market performance (Srivastava et al., 1998). It is important to understand the causal relationship between brand value and stock returns. Research of Barth et al. (1998) shows estimates from a system of simultaneous equations that provide evidence that the primary findings are not attributable to estimates of brand values being based on share prices. This eliminates the bias that the brand value estimates might be influenced by share prices, which would have undermined the validity of this research. It can be assumed that brand value estimates are a factor for explaining stock returns, not the other way around.

Common financial theory states that stock prices should reflect all expected future

discounted cash flows to the investor. Srivastava et al. (1998) find that shareholders’ value

consists of the present value of cash flows during the value growth period and the long-term

residual value. It is the future, based on current information, not the past that drives current

stock return (Lane and Jacobson, 1995). Investors update their expectations about long-term

future cash flows, reacting immediately by buying or selling stock as new information

becomes public. Hence, a publication of newly quantified brand value estimates should

trigger investors. Simon and Sullivan (1993) confirm that the financial market valuation of a

firm incorporates the expected value of future cash flows and returns, including market

expectations of the firm’s brand value. Each investor selects his portfolio so as to maximize

the expected utility of the portfolio’s payoff (Huberman, 2001). Assuming the stock market

assimilates brand value information, a firm’s portfolio of successful, established brand names

and their accumulated brand value – as with all intangible assets – should manifest itself in shareholder value (Kerin and Sethuraman, 1998). In addition, studies of Barth et al. (1998) show that brand value estimates – published in the Financial World magazine by Interbrand – capture information that is relevant to investors and are sufficiently reliable to be reflected in stock returns. They find a positive relationship between brand value and shareholder value. In other words, if new information – like the Best Global Brands ranking – results in a positive (negative) revision in expected future cash flows, a positive (negative) effect on stock return may be assumed. Kerin and Sethuraman (1998) emphasize that if company brand names represent both an asset and a source of future earnings and cash flow, it is reasonable to conjecture that their worth would manifest itself in the financial market value of a firm and, ultimately, shareholder value. However, findings of Eng and Keh (2007) show that brand value improves future accounting returns at the firm level but that the impact of brand value on future stock returns is minimal.

According to the neoclassical finance model, brand value estimates have no significant impact on stock returns. Neoclassical economists assume that investors have rational preferences; they maximize their utility; and they act independently on the basis of full and relevant information. In an efficient market, prices instantly reflect all available information possessed by the market at any time (Fama, 1970). No investor can earn abnormal return by exploiting that set of information. As a consequence, trading schemes using publicly available information, provided by the Best Global Brands ranking, to beat the market are doomed to fail (Ross, 2002). Why should brand value estimates have incremental information value?

Investors are also consumers, and are aware of the impact of brands. If information can be extracted from the way consumers react to brands in the market, there would be no reason for them to wait until the Best Global Brands ranking is published to decide whether to invest in the brand or not. According to the efficient market theory, prices would have already incorporated the expected value of brands, so there would be no effect on stock returns after a Best Global Brands ranking publication.

2.4 Investor sentiment

The standard finance model is a model in which unemotional investors always force capital

market prices to equal the rational present value of expected future cash flows. However,

Baker and Wurgler (2007) give examples of different events that occurred in the history of the

stock market that are difficult to comply with the patterns of the standard finance model. A

reason for this is that investors are subject to sentiment, which is defined as a belief about future cash flows and investment risks that cannot be justified by rational risk-and-return expectations. Investor sentiment can be viewed as optimism, or pessimism about stocks in general. Investors may try to resist the pull of affect through a systematic examination of relevant information, but affect still exerts its power (Statman et al., 2008). If investors are indeed influenced by an irrational stock-purchasing behavior, it is compelling to explain which shares associated with the brands listed in the Best Global Brands ranking are likely to be most affected by sentiment. It could be interesting to test whether the influence of the ranking is similar across firms in the same or different industries. This would suggest that market participants appear to apply a similar positive price premium across all companies with an improved brand value (Cooper et al., 2001).

Baker and Wurgler (2006) state that stocks of low capitalization, younger, unprofitable, growth companies or stocks of firms in financial distress are likely to be disproportionately sensitive to investor sentiment. However, these shares tend to be more costly to buy and to sell short. A high degree of idiosyncratic variation can be found in their returns, which makes betting on them riskier. By contrast, the value of a corporation with a long earnings history, tangible assets, and stable dividends – like Coca Cola Company – is much less subjective, and so its stock is likely to be less sensitive to investor sentiment. It can be assumed that firms in financial distress will not own brands that are included on the Best Global Brands ranking, but it is relevant to take control variables like size – market capitalization – and market-to-book value into account in order to test if these characteristics are determinants for stock returns. Findings of Fama and French (1992) confirm that market value and market-to-book value are both variables needed to explain the cross-section of average stock returns.

It could also be discussed whether an increase in stock returns is rational, due to investor expectations of large future cash flows to the firm, or whether it is driven by a degree of investor mania to invest in popular brands (Cooper et al., 2001). Investor behavior may be affected by the fact that the brands that appear on the Best Global Brands listing could be interpreted as “glamorous”. Investors may even be frantic to buy shares in companies that are related to the glamorous brand. However, findings of Lakonishok et al. (1994) show that value stocks outperform glamour stocks, with a return of 18.7% rather than 11.4% return the following year. This implies that good brands do not always make good investments.

DeBondt and Thaler (1987) show that stocks that experienced poor performance over

the past three to five year period tend to outperform winners over the following three to five

years. Clare and Thomas (1995) find further evidence that losers outperform previous winners over a two-year period by a statistically significant 1.7% per annum. This important aspect of long-term mean reversion in stock returns is known as the ‘overreaction hypothesis’: a theory stating that people overreact to both good and bad news. This paper will test whether there is mean reversal observable in stock returns after significantly good or bad news about the brand value estimates in the ranking.

Other research shows that individual investors prefer to invest in firms with easily recognizable products, which refers to the marketing spillover effects to investors (Frieder and Subrahmanyam, 2005). Less valuable brands might benefit from the positive aspects of familiarity, like inclusion in consideration sets and “buy the familiar” decision heuristics (Lane and Jacobson, 1995). Investors may use brand familiarity as a heuristic to guide purchasing decisions (Kahneman and Tversky, 1974). If investors apply a premium to a company’s stock just because they have affinity with its brands, it would imply that markets are not semi-strong efficient (Cooper et al., 2001). Experiments conducted by Heath and Tversky (1991) show that people prefer to invest in stocks where they consider themselves knowledgeable or competent than in shares where they feel ignorant or uninformed.

Familiarity may represent the investor’s illusion that he has superior information; investors get overconfident (Nofsinger, 2008). According to Huberman (2001), people feel comfortable investing their money in a business that is visible to them. His findings demonstrate the strong and pervasive influence familiarity exerts on investment decisions, affecting investors’

perception of risk and return. Evidence is provided for the familiarity heuristic showing that people invest in the familiar while often ignoring the principles of portfolio theory. It seems that people look favorably upon stocks with which they are familiar and think of them as more likely to deliver higher returns, at lower stock-specific risks. Huberman (2001) concludes that this leads investors to concentrate their portfolios on stocks they know, for instance, stocks of firms that are visible in the investors’ lives, and stocks that are discussed favorably in the media. This view is consistent with the statement that a brand listed on the Best Global Brands ranking positively influences investors’ purchasing behavior, and therefore leads to higher stock returns in case the stock name is equal to the brand name.

In summary, previous studies indicate that advertising expenses, measures of

perceived quality, brand satisfaction, brand familiarity, and brand uniqueness contribute in a

certain extent to the market-based asset called brand value. It can be expected that investors

are positively influenced by changes in brand value, resulting in higher stock returns of the

firms holding the brands. In addition, findings of Barth et al. (1998) show that there is

considerable variation in the sign and magnitude of brand value changes over time. This variation is expected given the diverse factors that can affect brand values, including factors beyond the control of the firm owning the brand, like actions by competitors. Therefore, it is interesting to test whether a brand is negatively affected by positive brand value changes of rival brands.

Comparable research analyzing the effect of brand value on stock returns is carried out by Barth et al. (1998), using data of the last decade of the 20

century. In addition, Kerin and Sethuraman (1998) explore the brand value-shareholder value relationship for publicly held consumer goods companies in the United States. This work will be a contribution to the existing literature as it implements global brand values across all industries, calculated by Interbrand, with a focus on the time-span 2000-2010. The effect on stock returns rather than shareholder value will be estimated. Additionally, Kerin and Sethuraman (1998) carry out a cross-sectional analysis, thereby ignoring a possible linkage between change in a firm’s brand value over time and change in its market-to-book ratio. This paper incorporates the time- effects by using panel data, and will therefore be an extension to prior investigations done in this field of research.

2.5 Hypotheses

The Best Global Brands ranking gives information to the market concerning the brand value developments of firms. Investors will instantly buy or sell stock on the basis of their expectations of how the announced change in brand value will affect the discounted value of future cash flows. The cash flows depend in turn on investors’ expectations about future consumer choice after the brand value ranking is published (Lane and Jacobson, 1995). Are investors positively affected by an increase in brand value? Do investors increase their shareholdings of a firm when they become aware that the brand value of that particular firm has significantly augmented? This leads to the first hypothesis:

H1: An increase in brand value leads to a positive change in stock return of the brand-owning firm.

Following the literature on behavioral finance, a listing in the world’s most valuable

brand ranking may induce investor sentiment. Many of the brand names in the table are also

the name of the parent company. The assigned value, however, is strictly for the brand. Coca

Cola’s value is based on products carrying the Coke name, not on Sprite or Fanta. Investors might get influenced by the ‘buy-the-familiar’ heuristic, which makes them pay a higher price for stocks that are named according to the brand. This leads to the expectation that companies with names not directly associated with the brand name experience a lower effect on stock returns after the Best Global Brands ranking announcement than companies with names equal to the brand name. For instance, the stock return of the company Diageo Plc. will be less affected by a change in the brand value of Smirnoff, since many investors are not aware that Smirnoff is a brand that belongs to the firm Diageo Plc. The second hypothesis states that the sensitivity of investors reacting on a positive change in brand value is less when the stock name is not equal to the brand name.

H2: Stock returns will respond less to brand value fluctuations when the stock name is not equal to the brand name.

According to Lane and Jacobson (1995), the stock return for a corporation reflects not only a given brand’s newly released information but also new information about other brands that comprise the corporation. Many of the firms that own the brands listed in the ranking are multibrand companies: they own more than one brand, and these multiple brands have names deviating from the company stock name. Therefore, it can be expected that companies owning multiple brands experience a lower sensitivity of their stock return to a brand value announcement.

Assuming brand value has a positive effect on stock returns, it is interesting to test whether the brand value of direct competitors can influence stock returns. A brand that is simply familiar but not preferred may be evoked only to remind the consumer of other more preferred but less accessible competitive brands (Nedungadi, 1990). The business dictionary defines direct competition as the “market situation where two or more firms offer essentially the same good or service”. It can be expected that when the brand value of Coca Cola rises significantly, it will affect the market value of Pepsico in a negative way. Similar to consumers, investors might choose a side and invest in either one of these firms as they are in the same industry, in order to have some form of diversification in their portfolios. The third hypothesis posits that the stock return of a firm is negatively influenced by a change in the brand value of direct brand competitors.

H3: Stock returns are negatively correlated to brand value changes of competing brands.

It must be noted that there is not necessarily a mutual effect between direct competitive brands. A firm may have two direct rivals, but may have no competitive impact on those firms in return. For instance, the main direct rival of Cisco Inc. is Hewlett-Packard, but Cisco Inc. is not a main direct competitor to Hewlett-Packard as well. Rather, the main direct competitors of Hewlett-Packard are IBM and Dell.

Last, it must be taken into consideration that an increase in brand value of a direct competitor might have a complementary effect on a firm’s brand value as well. A positive correlation exists when competitive brands have a reinforcing effect on one another. If a brand accelerates in value, it may raise awareness for the products and services that are labeled under the brand, and consequently trigger popularity and interest in similar products in the industry. Hence, a rise in the brand value of direct competition may also have a positive impact on stock return.

Following the literature of Lane and Jacobson (1995), the publication of the Best Global Brands ranking on the Internet must have a greater accelerating effect on the familiarity of the newly entered brand relative to the brands that were already listed in the ranking. This means that the stock return of a newly listed brand is expected to react more heavily on the Best Global Brands publication in comparison with other stock returns.

Additionally, it is likely that stock returns of brands that exit the ranking are more negatively affected than brands that simply decrease in value but are still assured of a place in the top 100 listing. This leads to the fourth hypothesis:

H4: Stock returns are more heavily affected when the brand appears new in the ranking or exits the ranking.

1 Official company websites are used as a secondary source.

3. DATA COLLECTION

This section is divided in three main subsections. First, the data collected for this research are described. In the second subsection, the calculation methodology used by Interbrand to estimate the global brand values is elaborated. Third, the criteria used to determine whether a brand is included in the regression analysis or not are explained.

3.1 Data Collection

To empirically analyze the relationship between brand value and stock market returns after a Best Global Brands ranking publication, the following data are collected:

(1) Brand characteristics;

The brand name, its rank, the country of origin, and the brand sector are gathered from the specialized brand consultancy firm Interbrand. A fragment of the most recently published Interbrand ranking can be found in Appendix A.

(2) Absolute brand value (BV

);

Key data for the research analysis concerns the top 100 brand values listed in the annual Interbrand ranking during the time span 2000-2010. The rankings are based on the brand’s US dollar value. The methodology used by the Interbrand Corporation for calculating the brand values is elaborated in the following subsection. It can be expected that the increase in a firm’s stock return may be relatively modest if a firm already has a high accumulated brand value, like Coca Cola and Microsoft. A given increase in a firm’s brand value probably relates to a larger increase in a firm’s stock return when a firm’s accumulated brand value is small.

Therefore, relative brand value changes will be used as the explanatory variable in the regression equation.

(3) Relative brand value (ΔBV

);

This refers to the change in terms of percentage of the brand value in comparison to the brand value published in the ranking in the previous year. The relative brand value ΔBV

will be used in the regression analysis to indicate whether a brand value has improved or declined over the year. This is an important factor for measuring the effect on stock returns. The lagged brand value change variable (ΔBV

) will also be included in the regression to control for a lag in the reaction of the stock market to the brand value ranking announcement, and to test for serial correlation of the variables.

(4) Name of the parent company;

The brand name is connected to the parent company that owns the brand. A dummy variable D

will code 1 if a brand name is not equal to the company name listed on the stock market exchange. The dummy will code 0 (D

=0) if the brand name corresponds with the stock name.

(5) The relative brand value of direct competitive brands (ΔBV

);

This variable is required in order to test the third hypothesis. A dummy variable D

will indicate whether a brand has a direct competitive brand in the same sector (D

=1 if there is a rival brand listed in the ranking). If there is more than one rival included in the sample, the relative brand value of rival brands (ΔBV

) will be the weighted average of the change in brand value of the competing brands.

(6) D

;

A binary variable coded 1 if a brand appears new in the ranking, compared to the ranking of the previous year.

(7) D

;

A binary variable coded 1 if a brand has dropped out of the ranking, while it was still included the year before.

(8) Publication dates of the annual ranking;

Interbrand’s Best Global Brands ranking is published once a year on the Internet (Table 3.1).

Information indicating the annual publication date of the ranking is required to determine a consistent date on which the annual financial data of all parameters in the regression model should be collected.

(9) The total return index (RI

);

This concerns the total stock return index (RI

) of the companies that own the brands listed in the ranking. For statistical reasons, series of returns rather than raw price series are collected.

Returns have the benefit that they are unit-free. The total return of a stock is the sum of the capital gain and any dividends paid during the holding period. The total return index can be defined as the stock price time series adjusted so that the dividends are added back. For the brands listed in the ranking, the total return index numbers of the corresponding stocks are extracted on a daily, weekly and monthly basis from Datastream (Thomson Reuters, 2010).

To remain consistent, the RI variables on the 1

of October during the time-span 2000-2010 are collected. This date is chosen deliberately in order to control for a lag in investor behavior after each annual publication of the Interbrand ranking. The natural logarithm of the annual change in the return index will be used as the dependent variable in the regression (R

). As an extra control variable, a lagged dependent variable will be included in the regression (R

).

(10) The market value (MV

);

Data concerning the market value of a firm, or market capitalization, are collected from Datastream. It refers to the share price multiplied by the number of common shares in issue.

The amount in issue is updated whenever new tranches of stock are issued, or after a capital change. The market value recorded on every 1

day of October during the time-span 2000- 2010 is collected. Fama and French (1992) show evidence of consistent power of size and book-to-market equity in explaining average stock returns. So market value data are collected in order to control for the size effect, which suggests that smaller firms have relatively higher returns. Market value is displayed in millions of units of local currency. To make sure the variable is normally distributed, the natural logarithm of the market value (lnMV

) will be used as a control variable in the regression analysis.

(11) The market value-to-book value (MTBV

);

The market-to-book value is defined as the market value of the common equity divided by the

balance sheet value of the common equity in the company. This variable is collected at the

security level from Datastream. The MTBV

values are gathered for the companies that own

the brands listed in the Interbrand ranking. The market value-to-book value (MTBV

) is used

as a control variable to eliminate the book-to-market effect bias, which states that stocks with

low market-to-book ratios tend to have higher returns than stocks with high market-to-book

ratios (Grinblatt and Titman, 2004). The natural logarithm can be defined for all positive real

numbers. Since the market-to-book value can take on negative numbers and refers to a ratio,

the absolute change in market value-to-book value (ΔMTBV

) rather than the natural

logarithm of the MTBV

will be implemented in the regression.

3.2 The Interbrand methodology for estimating brand values

Before this paper continues analyzing the relationship between brand values and stock return, it is essential to understand how these brand values are calculated. A brand value represents the net present value (NPV) of the cash flows that a brand is expected to generate and retain in the future. More than 2500 global brand values have been measured since the introduction of Interbrand’s calculation formula in 1988.

The basic theory is that strong brands have the ability to increase sales and earnings. It is calculated by using the economic use approach, discounting the sum of all future earnings that the brand is forecasted to generate to a present day value. The calculation methodology takes into account all of the ways in which a brand might affect an organization, elaborated in the literature review. Three key aspects contribute to the assessment of quantifying brand values: the financial performance of the branded products or services, the role of brand in the purchase decision process, and the brand strength. Financial performance measures a company’s raw financial return to the investors, also known as economic profit, or Economic Value Added (EVA). Taxes are removed from net operating profit to calculate net operating profit less adjusted taxes (NOPLAT). Then a capital charge is subtracted to account for the capital used to generate the brand’s revenues. For purposes of the Best Global Brands rankings, the capital charge rate is set by the industry weighted average cost of capital (WACC).

The role of brand measures the extent by which the brand itself affects the decision to purchase a product or service – this is exclusive of other aspects like price or feature. In other words, the role of brand reflects the additional demand for a branded product or service over the demand that would exist for the same product or service if it were unbranded. Primary research, a review of historical roles of brand for companies in the same industry, and expert panel assessment are carried out by Interbrand to derive the role of brand.

The last key aspect that contributes to the Interbrand assessment is brand strength, which measures the ability of the brand to secure the delivery of expected future earnings.

Brand strength is reported on a 0 to 100 scale, where 100 is the best possible score, based on

an evaluation across ten dimensions of brand value determinants. Performance in these

dimensions is judged relative to other brands in the industry, and in the case of exceptional

brands, relative to other global brands of the same standard. The brand strength score

inversely determines a discount rate by means of a proprietary algorithm. The calculated

economic profit is multiplied against the role of brand to determine the branded earnings that

contribute to the final brand value. The discount rate is used to calculate the present value of the branded earnings, based on the likelihood that the brand will be able to withstand challenges and deliver the expected cash flows. The financial performance is analyzed for a five-year forecast and for a terminal value.

The final brand value is determined by the brand’s expected performance beyond the forecast period and represents the NPV of the expected future cash flows that are directly attributable to the brand.

Each annual Interbrand ranking contains 100 global brands, which results in a data set of 100 global brands over a time span of ten years – 2001-2010 in specific. In case data is available from year 2000 these observations are included as well, because when one-period lags or first differences of a variable are constructed, the first observation is lost. The rankings are updated once a year. Some popular brands will not show up in the ranking. Brands that qualify for a possible listing in the Best Global Brands ranking must have brand values greater than $1 billion. The companies must derive at least a third of their sales from outside their home country or region. In addition, each brand must have enough publicly available data for Interbrand to make a reliable assessment. That leaves out private companies like Mars Inc., and even some publicly traded brands that do not provide enough transparent data. In some cases it is too difficult to separate the strength of the brand from other factors. Airline brands will not be included in the brand ranking as schedules and hubs often leave travelers with little choice in their purchasing decision for tickets, which makes consumers less sensitive to the brand-building activities of airline companies.

3.3 Criteria for inclusion

In order to be included in the regression analysis, brand value data have to submit to strict selection criteria. Table 3.2 outlines the actions undertaken to connect the brand value estimates published in the Interbrand rankings to the associated stock returns. Brand values are measured on brand level whereas stock returns are collected on company level.

2 Interbrand, Best Global Brands Methodology 2010, http://www.interbrand.com

The rankings comprise 1,000 brands with value estimates during the ten-year period 2001-2010. Additionally, 67 previous year’s brand value estimates are reported by Interbrand in the ranking of 2001. Brand values for the sample firms ranged from $ 1,002 billion to $ 72,540 billion. Data availability narrows the sample of firms used in the regression analysis considerably. Since privately held companies are removed from the sample, 990 brand value observations and 917 sample firm-year observations remain left. Table 3.3 provides summary statistics for the number of panel observations involved in the research analysis. In the ten- year time span, 149 different individual brands are at least once listed in the ranking.

Consequently, a sample of 137 different brands is created for which there are reliable stock

return estimates and brand value estimates available. These brands belong to 123 companies

that pass the criteria for inclusion. Financial characteristics and stock data of these firms are

implemented in the regression analysis. Since the relative change in brand value is used as an

explanatory variable, only brands with brand value estimates available in two consecutive

years can be incorporated in the regression analysis, which further narrows down the number

of panel observations (see Table 3.3).

In order to increase the robustness of this research, five different sample pools are

initially created to perform the regressions on. These individual data sets employ different

criteria for inclusion, and therefore vary in sample size and data characteristics. Table 3.4

describes the sample pools used to carry out the regression analyses.

Eventually, the five samples narrowed down to three main data sets, known as sample pools A, B, and C. This is due to the software program EViews 6.0, used to carry out the regressions, and which automatically removes the missing observations in an unbalanced panel. Sample pool 2 consists of 56 brands per year; brands that are listed in the ranking and remain listed during the largest part of the estimation period, from 2001 to 2009. However, due to data unavailability, 473 observations rather than the initial 616 observations were used in the regression model. This results in regression models including 43 cross-sections per annum, which is equal to sample pool 1. Therefore, sample pool A is created, referring to a balanced panel, to minimize unnecessary complexity. Sample pool B is also created by a merger of two initially separate sample pools. Since the explanatory variables in the regression consist of first differences and lagged variables, the first observation is mainly lost, which minimizes the annual cross-sectional observations of the third and fourth sample pool, to 111. Hence, sample 3 and 4 merge to form sample pool B.

Summary statistics for the variables collected for this research can be found in Tables B.1-3 in Appendix B. These tables present descriptive statistics about the brand values, market values, market-to-book values, and stock returns included in sample pools A, B, and C. Figures C.1-2 in Appendix C show that the average change in brand value is much higher than the median change in brand value estimates. This is due to the fact that brands listed in the upper places in the ranking have relatively much higher brand value estimates, which gives upward pressure to the sample average (Figure 3.1). The bar graphs in Figure C.3 in the Appendix show the average changes in estimated brand values per annum for brands for which brand value estimates are available in two consecutive years.

All brand values (x $ 1 million).

4. METHODOLOGY 4.1 Research methodology

In order to test the relationship between brand value and stock return, three sample pools are formed based on the stocks of companies that own the brands listed in the Best Global Brands ranking. If the brand satisfies the selection criteria that determine whether to be or not to be included in the sample, which differ across the sample pools, the corresponding stock is incorporated in the appropriate sample pool(s) in the year(s) the brand is listed in the ranking.

The selection criteria are described in the previous section. Each year, new brands enter the ranking and replace brands that no longer belong in the Best Global Brands listing. The pool of annual panel observations will be adjusted accordingly, including new stocks and removing data associated with stocks that have exited the ranking.

All stock returns are continuously compounded, where the expected R

is the return of stock i at year t, RI

is the return index on year t and RI

is the return index on year t-1.

(1) Exp. R

= ln

This research will employ a panel data approach. The reason for this methodology is that it is of interest to examine how the variables and the relationships between them change dynamically over time. Time-series data would require a long run of data to get a sufficient number of observations to be able to conduct any meaningful hypothesis tests (Brooks, 2008).

By combining cross-sectional and time series data, the number of degrees of freedom, and therefore the power of the test is increased. The fixed effects model is employed as the panel estimator approach as it allows for company heterogeneity. It proposes different intercept terms for each company, but assumes that these effects are constant over time, with the relationships between the explanatory and explained variables assumed to be the same both cross-sectionally and temporally. Mathematically, the main relationship between brand value and stock returns can be expressed as follows:

(2) Exp. R

= α

+ β

ΔBV

+ ε

where the dependent variable, Exp. R

, is the expected change in stock return of company i in year t; ΔBV

is the change in brand value of company i in year t in relation to the brand value estimate in the previous year’s ranking; and ε

is the error term for stock i in year t.

This main regression is carried out on all sample pools in order to increase robustness.

In standard portfolio theory, risk is an important factor to consider, as riskier portfolios require higher returns. Therefore, abnormal returns are analyzed by controlling for the validated risk factors by using the extended capital asset pricing model (CAPM), a model relating risk to expected returns (Sharpe and Lintner, 1964, 1965). Empirical studies show that the CAPM does not properly describe the relation between risk and expected return.

Research of Fama and French (1992) show that there is no reliable relation between average returns and the market beta, and confirm the importance of size and book-to-market equity in explaining the cross-section of average stock returns for the 1963-1990 period. Both time- series and cross-sectional tests find evidence that smaller capitalization stocks tend to have higher annualized mean returns. Stocks with low market-to-book ratios tend to have higher returns than stocks with high market-to-book ratios (Grinblatt and Titman, 2004).

This thesis considers brand value to be a potential risk factor as it might significantly affect stock returns. Fama and French (1992) formulate an equation extended with two additional systematic risk factors: the size of a firm – market capitalization or market value (SMB) – and the market-to-book value (HML) of a firm. The market value parameter controls for the additional returns that might result from investing in small stocks; this involves higher risk. The market-to-book value controls for the historic excess returns of value stocks over growth stocks. These control variables (CV

) are added to the main equation to test the hypotheses. Fama and MacBeth (1973) estimate the second stage cross-sectional regression separately for each time period, and then take the average of the parameter estimates to conduct hypothesis tests (Grinblatt and Titman, 2004). A similar objective can be achieved using a panel approach. Since panel data are employed, no cross-sectional variables provided by Fama (1992) will be used in this analysis. Rather the logarithm of the market value variable (MV) and the first difference of the market value-to-book value variable (ΔMTBV) collected from the Datastream database will be implemented in the regression equation to control for the firm size effect and the book-to-market effect. The three-factor model to test for the influence of control variables is adjusted as follows:

(3) R

- R

= α

+ β

(R

–R

) + β

(lnMV

) + β

(ΔMTBV

) + ε