We provide a theoretical and empirical analysis of the link between advertising expenditures, brand capital, and asset returns in the cross-section of U.S. publicly traded firms. Interpreting advertising expenditures as firms' investment in brand capital, we document that: (i) firms with high brand capital investment rates underperform firms with low brand capital investment rates by 7% per annum; and (ii) brand capital intensive firms outperform low brand capital intensive firms by 4.1% per annum. Based on standard Q-theory of investment, we develop a structural dynamic investment-based model in which advertising expenditures and firm's risk are both jointly and endogenously determined. The model replicates the empirical asset pricing facts reasonably well. In addition, the model is consistent with the time-series properties of brand capital and physical capital investment rates, as well as with the unusually high advertising expenditures during seasoned equity offerings. Taken together, our results suggest that standard Q-theory of investment provides a useful framework for understanding the dynamics of advertising expenditures by corporations.
