The Information content of Disclosures on Promotional ...



The Information content of Disclosures on Promotional Spending required by EITF 01-09

William R. Baber

The George Washington University

Mary W. Sullivan

U.S. Department of Justice – Antitrust Division

Gnanakumar Visvanathan

George Mason University

Accounting issues associated with EITF 01-09

.Focus on Revenue Recognition

.SAB 101 (1999)

.SEC’s letter to FASB (Oct 1999) on accounting issues pertaining to “Internet Activities”

.EITFs 00-14, 00-22, and 00-25 were issued in response to SEC’s letter

.EITF 01-09 combines the three EITFs

.EITF 01-09:

.Cash consideration (including sales incentives) given by vendor to customer is presumed to be a reduction in selling price and not an expense

Includes Discounts, Coupons, Rebates, Slotting Fees, Co-op Advertising, and Buydowns

.Exceptions

An Illustration

General Mills, year ending in May 26, 2002

Restated Prior to Restatement**

($ in millions)

Net Sales 7,949 10,195

Cost of Sales 4,767 4,767

SG & A expenses 1,909 4,155

Interest expense 416 416

Unusual Items 190 190

Earnings Before Taxes 667 667

Total Assets 16,540 16,540

“Both Sales and SG&A expenses are reduced by $2,246 million”

Gross Margin % 40.03 53.24

Profit Margin % 8.39 6.54

(before taxes)

Asset Turnover 0.48 0.62

ROA, ROCE remain the same

**Imputed values based on Notes

Questions of Interest

1. What is the extent of Promotional activities?

.Industries where these are prevalent

.Firms that engage in Promotional activities

.Magnitude of Promotions

Such issues are of interest to Regulators

.This is a one-time disclosure

2. Role of Promotions and Advertising

.How do firms balance these 2 strategies?

.The Proctor and Gamble strategy

.Characteristics of firms that engage in different combinations of Promotions and Advertising

.How do Promotions relate to Financial performance?

3. How do investors value Promotions and Advertising?

.Do promotions reduce brand equity?

Prior Literature

Role and Value of Promotions

.Dodd, Tybout, and Sternthal (1978), Winer (JCR, 1986)

.Jedidi, Mela, and Gupta (MS, 1999)

In the long run, Advertising has positive effect on Brand equity while promotions have a negative effect

.Product Differentiation

Slotting Allowances

.Incentive effects, Signal of quality (Lariviere & Padmanabahn MS, 1997, Chu MS 1992)

.Anti-competitive (Kelly, JPPM 1991 & 2003?)

.Evidence in: Bloom, Gundlach, & Cannon (Journal of Marketing, Apr 2000), Sullivan (1992, JLE 1997)

P&G’s strategy

.Ailawadi, Lehmann, and Neslin (Journal of Marketing, 2001)

Valuation literature in Accounting/Economics – primarily Advertising

.Hirschey & Weygandt (JAR 1985), Chauvin & Hirschey (FM 1993)

.Bublitz & Ettridge (AR 1989), Barth et al. (RAS 1998)

.Simon and Sullivan (MS 1993)

.Does Gross-up Vs. Net Revenue make a difference?: Davis (JAR 2002)

Limitations

1. One time disclosure

.No time-series

.Firm-specific rather than product-specific

2. Firms that were “expensing” do not disclose magnitudes

3. Shortcomings of the search procedure

TABLE 1A

Distribution of sample firms across two-digit industries

sample as firms per sample proportion

SIC Description COMPUSTAT firms of total firms

07 Agricultural Services 5 1 0.200

20 Food and Kindred Products 136 46 0.338

21 Tobacco Products 8 3 0.375

25 Furniture and fixtures 36 1 0.027

26 Paper products 58 4 0.069

27 Printing & Publishing 90 5 0.055

28 Chemicals and allied products 562 21 0.037

30 Rubber and plastic products 90 4 0.044

32 Stone, clay, glass, concrete 38 1 0.026

34 Fabricated Metal, Ex Machinery 99 3 0.030

35 Industrial, computer equipment 429 6 0.014

36 Electrical equipment 526 6 0.011

37 Transportation equipment 140 3 0.021

38 Measuring Instruments; photo 435 4 0.010

39 Misc. Manufacturing 74 3 0.041

48 Communications 292 4 0.014

51 Nondurables – Wholsale 108 4 0.037

54 Food stores 32 1 0.031

58 Eating and drinking places 119 1 0.008

59 Retail 160 1 0.006

64 Insurance Agents & Brokers 42 1 0.024

70 Hotels and other lodging 38 1 0.026

73 Business services 1141 10 0.009

78 Motion pictures 60 1 0.017

79 Amusements and recreation 104 1 0.010

Total 136

Sample is collected by examining 10K Notes disclosures and press releases from the WIRES section of LEXIS-NEXIS over the period January 2000 to July 2003. The years 2000 to 2003 were selected as the accounting rules and the adoption periods fell within this period.

Firms that report a dollar value as the impact on adoption of accounting rules and firms that note the adoption impact as immaterial are both included in the sample.

“Sample as proportion of total firms” is computed as the ratio of number of firms in the sample over number of firms in COMPUSTAT in that 2 digit SIC code in 2001. Foreign firms are excluded.

For sample distribution by date of adoption and by disclosure periods, see table 1B.

TABLE 1B

Distribution of sample firms by year that new accounting for promotion costs

is adopted and by year for which disclosures are provided

| |Year of Adoption |

|Years for which disclosures | |

|are provided | |

| |2000 |2001 |2002 |Total |

|2002 only |0 |0 |6 |6 |

|2001 only |0 |14 |9 |23 |

|2002 and 2001 |0 |0 |6 |6 |

|2002, 2001, and 2000 |0 |1 |22 |23 |

|2001 and 2000 |0 |7 |48 |55 |

|2001, 2000, and 1999 |0 |8 |6 |14 |

|2000 only |2 |6 |0 |8 |

|1999 and 2000 |0 |1 |0 |1 |

|Total |2 |37 |97* |136 |

*Of the 97 2002 adopters, 32 firms disclosed the likely impact of adoption in notes to 2001 10K reports, although the restatements took place in 2002.

121 firms disclose data for 2001 and 101 firms disclose data for 2000.

TABLE 1C

Summary of disclosure according to the EITF Consensus and assessment of materiality

EITF mentioned in Disclosure No. of firm-years

01-09 only 98

01-09 only, but impact is “immaterial” 3

00-14, 00-25, 00-22, and 01-09 9

00-14, 00-25, and 01-09 39

00-14 and 01-09 8

00-25 and 01-09 30

total disclosures citing EITF 01-09 187

00-14 only 15

00-22 only 3

00-25 only 21

00-14 and 00-22 2

00-14 and 00-25 31

One or more EITF cited, but impact is “immaterial” 13

Total disclosures (firm-years) 272

Mentions in financial statement disclosures of any of the following EITF Consensuses are included in this compilation. Firm-years, rather than firms, are used as many firms refer to more than one EITF.

EITF 00-14: addresses bill-backs from invoice allowances, buy-downs, free-product deals, rebate and coupon costs, and price reductions.

EITF 00-22: addresses point based loyalty programs and volume based incentives.

EITF 00-25: addresses slotting fees, co-op advertising, and price reimbursements.

EITF 01-09: combines elements of all the above three EITF into a Consensus.

TABLE 2

Firm characteristics delineated by high or low advertising and promotion: Sample of 107 Food and Consumer Products for 2001 – excluding firms with no advertisement or promotions

Number of firms

| |Low advertising to sales |High advertising to sales |

| | | |

| | | |

|Low promotion to sales |44 |32 |

| | | |

|High promotion to sales | | |

| |10 |21 |

Sales ($ millions) – Medians

| |Low advertising to sales |High advertising to sales |

| | | |

|Low promotion to sales | | |

| |205 |160 |

| | | |

|High promotion to sales | | |

| |111 |2,607 |

Market to Book ratios - Medians

| |Low advertising to sales |High advertising to sales |

| | | |

|Low promotion to sales | | |

| |2.52 |3.00 |

| | | |

|High promotion to sales | | |

| |1.87 |5.54 |

Return on assets (ROA) - Medians

| |Low advertising to sales |High advertising to sales |

| | | |

|Low promotion to sales | | |

| |8.97 |8.82 |

| | | |

|High promotion to sales | | |

| |8.92 |14.40 |

Number of registered trademarks

| |Low advertising to sales |High advertising to sales |

| | | |

|Low promotion to sales | | |

| |94.0 |55.4 |

| | | |

|High promotion to sales | | |

| |57.4 |337.6 |

New trademarks per business segment

| |Low advertising to sales |High advertising to sales |

| | | |

|Low promotion to sales | | |

| |1.2 |5.0 |

| | | |

|High promotion to sales | | |

| |1.9 |8.0 |

TABLE 3

Fiscal year 2001 consequences of accounting method changes

for 118 firms that disclose the effects of the change

Panel A: Impact of the accounting change

| | | |25th percentile |75th percentile | |

| |Mean |Median | | |Maximum |

|Impact of the accounting change | | | | | |

|($ millions) |317.25 |26.77 |4.00 |116.00 |9000.00 |

| | | | | | |

|Impact as a fraction of sales | | | | | |

| |0.060 |0.035 |0.012 |0.080 |0.366 |

|Advertising expense as a fraction | | | | | |

|of sales | | | | | |

| |0.048 |0.029 |0.005 |0.070 |0.326 |

Panel B: Comparisons of financial ratios under old and new methods

| | | |t-statistic |

| |pre-EITF |post-EITF |hypothesis: |

| |method |method |diff = 0 |

|Gross profit / sales |0. 472 |0.441 |10.45 |

|(n=118) |(0.479) |(0.440) |(p < 0.001) |

|Operating income/sales |0.011 |0.014 |-1.76 |

|(n=118) |(0.086) |(0.096) |(p = 0.06) |

|Sales/assets |1.296 |1.231 |9.83 |

|(n = 118) |(1.132) |(1.047) |(p < 0.001) |

|Sales growth |7.83 |7.91 |-0.14 |

|(n=92) |(3.55) |(3.36) |(p = 0.89) |

TABLE 4

Comparisons of sample firms in the Food Products (2 digit SIC code 20) Industry with firms in the same four-digit SIC code that disclose no adjustment

Entries are medians for fiscal 2001

| | | | |

| |Firms with |Firms with no adjustment | |

| |adjustments |N= 722 |Wilcoxon |

| |N= 421 | |Z-statistic |

| | | | |

|Firm characteristics | | | |

| | | | |

|Log of market vale ($ million) |6.752 |3.738 |4.78*** |

| | | | |

|Sales ($ million) |1234.700 |161.968 |4.46*** |

| | | | |

|ROA (op. income/total assets) |0.106 |0.059 |3.66*** |

| | | | |

|Advertisement expense / sales |0.022 |0.000 |4.61*** |

| |pre-EITF |post-EITF | |pre-EITF |post-EITF |

|Financial ratios |method |method | |method |method |

| | | | | | |

|Gross Profit / Sales |0.447 |0.388 |0.307 |2.98*** |1.96** |

| | | | | | |

|Operating Income / Sales |0.072 |0.076 |0.050 |3.34*** |3.63*** |

| | | | | | |

|Sales / Total Assets |1.382 |1.279 |1.424 |-0.15 |-0.71 |

Notes:

The mean (median) impact of the accounting change as a fraction of sales for the sample firms is 7.63% (5.94%).

1 42 firms are in sample in 2001 (of the total 46 – see table 1)

2 data available only for 72 firms

*,**,*** represent significances at the 10%, 5%, and 1% levels.

Table 5

Regressions of year-end 2001 market values

for firms that report promotion expense adjustments

Market Value = β0 + β1 (income before extraordinary items) + β2 (book value) + β3 (advertising expense)

+ β4 (promotion adjustment) + β5 Adjustment for Self-selection + ε

Variable

intercept

Income before extraordinary items

Book value

Advertising expense

Adjustment for promotion expense

Adjustment for self-selection bias [Inverse Mills Ratio]

Adj. R2

Sample size

Food industry

-0.13

(-0.61)

10.52

(3.81***)

0.82

(2.06**)

12.69

(2.92***)

-0.31

(-0.20)

0.22

(1.83**)

0.74

41

Food and household products industries

-0.31

(1.04)

12.09

(5.02***)

0.30

(1.00)

2.56

(1.79*)

-0.46

(-0.31)

1.05

(2.61**)

0.63

62

All disclosing firms

0.73

(3.98***)

3.11

(4.47***)

1.26

(4.52***)

3.51

(1.93**)

-1.58

(-1.04)

na

0.28

110

Notes:

1. All variables are scaled by Net Sales

2. Other control variables used but not shown: Growth, Concentration ratio

3. Other specifications: M/B ratio and Tobin’s Q (using approximation in Chung & Pruitt, FM 1994) as dependent variables. The former is a variation of Ohlson’s model (See Amir, AR Oct 1993) and the latter is based on Hirschey and Weygandt (JAR Spring 1985) and Simon and Sullivan (MS, Winter 1993)

Three outliers excluded based on the Belsley, Kuh, and Welsch procedure (1980)

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