The influence of celebrity endorsements on stock prices

Int. J Latest Trends Fin. Eco. Sc. Vol-2 No. 3 September, 2012

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The Influence of Celebrity Endorsements on

Stock Prices

Ryan Ladner

School of Adult & Graduate Studies, Bryan College

721 Bryan Drive, United States

[email protected]

Abstract

Celebrity endorsements have been long been

used to promote companies’ products and strengthen

brands; however, celebrity endorsements can also be

linked to an increase in company stock prices. The

purpose of this paper is to examine the influence of

celebrity endorsements on stock prices. An overview of

the theoretical framework of the celebrity will be

applied to stock analysts and a review of the abnormal

returns of this influence will be presented.

Keywords

Marketing, stock-price, investor, celebrity

endorsement, efficient market, inefficient market,

behavioural finance

1. Introduction

In traditional financial theory, capital

markets have been regarded as adherent to the

efficient-market hypothesis. The efficient-market

hypothesis assumes a market where all information is

available to all investors. When prices reflect this

availability, the markets are considered efficient

(Fama, 1970). In the efficient-market hypothesis it is

stated that investors with a well-diversified portfolio

cannot consistently earn more or less relative to the

market average (Mayo, 2010). According to the

efficient-market hypothesis, investors react so

quickly to changes in the news that markets remain

efficient; however, based on research, this has not

always been the case. The emerging field of

behavioral finance has placed this theory and the

rationality of investors in question. The argument in

behavioral finance is that individual investors make

decisions based on heuristics and biases due to

limited time and information, and thereby develop

shortcuts to making decisions (Ackert & Deaves,

2009, p. 83). Investors who make decisions based on

heuristics and biases do not make decisions with all

existing information, which leads to anomalies in the

market. These anomalies are counterintuitive to the

concept of market efficiency (Ackert & Deaves,

2009). Upon study, there are many reasons why

these anomalies exist; however, one that has acquired

much attention deals with endorsements by Celebrity

stock endorsers (Barber, Lehavy, McNichols, &

Trueman, 2001; Barber & Loeffler, 1993;

Karniouchina, Moore, & Cooney, 2009; Metcalf &

Malkiel, 1994; Womack, 1996). With the influence

of the Internet, online television, podcasts, and

YouTube, individual investors have unprecedented

access to information and celebrities and experts can

reach a broader audience than ever before. This

reach has produced several event-study analyses that

show market inefficiency and raise questions

regarding the implications of endorsements and stock

price returns for companies.

2. Celebrity Endorsements

Celebrity endorsements provide more value

than merely attracting customers to products. For

example, just the announcement of a celebrity

endorsement can result in a rise of a company’s stock

price. For example, studies have shown when a

company announces that a celebrity will speak for

their product, an increase in the price of company

stock results (Agrawal & Kamakura, 1995). Not only

does the increase in stock price occur during the

initial announcement, the increase remains in effect

for the life of the advertisements or the celebrity’s

popularity. Celebrity endorsements have offered

positive stock returns simply by virtue of the

favourable mention of their financial performance.

The presumed trustworthiness of endorsers entices

investors to purchase the stock without performing

due diligence. Marketing executives can use this

phenomenon to make brand and advertising decisions

and to increase the return on investment of marketing

operations for their companies.

Company leaders have long used celebrity

endorsements to increase awareness and sales of their

products. To understand the effects of celebrity

endorsements and advertising, it is important to

provide a theoretical framework of the celebrity and

the foundational marketing definition. A celebrity is

traditionally defined as “a person who is well known

by the public” (Friedman & Friedman, 1979, p. 63).

This person is usually attractive and/or likeable and

may possess some type of expertise or achievement

(Kamins, Brand, Hoeke, & Moe, 1989).

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Int. J Latest Trends Fin. Eco. Sc. Vol-2 No. 3 September, 2012

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Celebrities are used in advertisements

because they enhance brand awareness and message

recall and produce a higher probability that

consumers will buy the product (Agrawal &

Kamakura, 1995). A celebrity’s achievements and

likeability alone will not entice consumers to

purchase products. To be effective as a celebrity, and

therefore influence stock prices, a celebrity must

possess traits that consumer’s desire and one of those

traits is credibility. There are two models in the

literature that focus on the credibility of a celebrity –

the source credibility model and the source

attractiveness model (Erdogan, 1999).

2.2 Source Credibility and Attractiveness

Models

The source credibility model represents

someone who has expertise, trustworthiness, and

attractiveness (Dholakia & Sternthal, 1977; Doss,

2011; Ohanian, 1991). Expertise “refers to the

amount of knowledge that a source is perceived to

have about a subject” (Erdogan, 1999, p. 298).

Expertise is a key factor in determining the credibility

of the celebrity and has been shown to be the most

influential aspect of selling to the consumer

(Erdogan, 1999). Trustworthiness represents the

confidence that consumers place in the celebrity

advertisers and whether or not they believe he or she

is making valid statements (Amos, Holmes, &

Strutton, 2008; Ohanian, 1990).

Amos et al. (2008) concluded that the

trustworthiness of the celebrity is the most effective

part of the source credibility model and with

advertisements featuring celebrities as a whole. The

source attractiveness model integrates neatly into the

source credibility model. The overlapping factor in

the two models is attractiveness (Ohanian, 1990). It

is important to note that attractiveness does not mean

just the physical aspect of the celebrity advertiser.

Attractiveness also represents the celebrity’s

familiarity and likeability (Erdogan, 1999). When

analyzing the effect of celebrity endorsements on the

price of stocks, it is important that the endorser

represent all three traits in the source credibility

model to be effective. For many individual investors,

the endorser of stocks may be the only source he or

she uses for stock purchase information for

retirement funds or other important monetary aspects

of their life and credibility is an important factor in

making those decisions.

The celebrity endorser is represented in

three main personas: (a) the spokesperson, (b) the

endorser, and (c) the testifier (Erdogan, 1999). An

overview of the personas will be provided with a

focus on a professional expert. A spokesperson or

testimony by a celebrity is generally not going to

appeal to someone who is purchasing stocks. It is

critical that the endorser of the purchase be an expert

in his or her field with experience of stock purchases.

In the case of these stock purchases, the most

influential celebrity will be the professional expert

endorser. The professional expert endorser is “an

individual or group possessing superior knowledge

regarding the product class endorsed and (who) has

obtained this knowledge as a result of experience,

study, and training” (Kamins et al., 1989, p. 63).

Because the purpose of this study is to look at

financials, it is important to note that researchers

have found that experts perform better for products

with high financial performance and therefore are the

most relevant for this review (Friedman & Friedman,

1979).

2.3 Celebrity Stock Endorsers

One of the most popular celebrity endorsers

of stocks is Jim Cramer. Cramer is the host of Mad

Money on CNBC. More than 250,000 viewers watch

Mad Money each day (Karniouchina et al., 2009, p.

245). Cramer’s show is described as a mix of

“professional wrestling, infomercial, pitching, and

hyperkinetic game shows, all the while dispensing

stock tips to the couch potato investors” (Becker,

2005, p. 10). Cramer’s dynamic show attracts many

rookie investors who look to him for

recommendations. Neumann and Kenny (2007)

described Cramer as “a man who blurs the line

between creating business news and covering it” (p.

603). Cramer has critics and may not be appropriate

for all investors; however, for the many people who

watch his show, there is no doubting the influence

that he holds (Lawler, 2009).

Cramer has source credibility and can easily

be categorized as a professional expert. Cramer is a

graduate of Harvard College and a former hedge fund

manager at Cramer Berkowitz. During his tenure as

senior partner, he amassed a 24% rate of return for 15

years (Kadlec, 2002) As far as trustworthiness goes,

Cramer does not invest his own money and therefore

does not directly profit from the recommendations he

makes. Cramer holds a charitable trust and does not

have to make any disclosures when recommending

stocks to individual investors except that it is held by

his charitable trust. Knowing that Cramer is not

making money for himself may entice individual

investors to trust him without inhibition.

In addition to television show hosts like Jim

Cramer, other popular stock analysts must be

considered as celebrity endorsers. One of the most

popular and widely used stock analysts are The

Motley Fools, whose website has been described as

“the most popular internet stock chat website”

(Giacomino & Akers, 2011, p. 37). The Motley

Fools website often provides information that is

“contradictory to academics, often makes mistakes,

and should be critically evaluated” (Giacomino &

Akers, 2011, p. 44). However, even though this

information is well known, The Motley Fools and

their recommendations affect the stock market just as

much as Jim Cramer and other analyst’s

recommendations (Giacomino & Akers, 2011, p. 44).

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240

It is interesting to note that the mission statements of

Jim Cramer and of The Motley Fools are very

similar. Cramer states that he wants to “educate

people, entertain people, and help them make money”

(Becker, 2005, p. 10). The Motley Fools mission

statement says that they are “here to educate, amuse,

and enrich” (Giacomino & Akers, 2011, p. 37).

These mission statements have entertainment and

influence as core values. If the efficient-market

hypothesis was completely valid and investors only

bought and sold stocks based on effective financial

evaluations of financial performance, then the

financially unrelated investment advice and

entertainment value of Cramer and The Motley Fools

would have no weight in the capital markets;

however, event studies show otherwise.

3. Event Study Analysis

3.2

Mad Money

An event study analysis is critical in

determining the celebrity endorsement effect of Jim

Cramer on the efficient-market hypothesis. An event

study focuses on variables that occur during a

specified period of time. In the past, event study

analyses have been used to analyze what type of

effect events have on profitability (Agrawal &

Kamakura, 1995). Results from event analysis

indicate that celebrity endorsements have positive

effects on the return of stock prices around the day of

endorsement. (Agrawal & Kamakura, 1995).

The three event studies analyzed for Jim

Cramer all show similar results: an increase in

volume of shares traded after Cramer’s

recommendations and abnormal stock returns greater

than 1.00% that decrease back to normal levels over

time (Karniouchina et al., 2009; Neumann & Kenny,

2007). Neumann and Kenny (2007) analyzed 216

recommendations by Jim Cramer from July 26, 2005

to September 9, 2005. During the first trading day

after a buy recommendation aired, “abnormal returns

of 1.06%, 1.09%, and 1.00% relative to the market

model, CRSP index, and historical mean (were)

realized” (Neumann & Kenny, 2007, p. 605). In

addition, the estimated volume for the particular

stocks increased by 27.78% the day after the show

date, suggesting abnormal buying and selling after

mentioning them on his show (Neumann & Kenny,

2007). Engleberg, Sasserville, and Williams (2006)

found similar results in their event study of 246 initial

recommendations given by Cramer between July 28,

2005 and October 10, 2005 (p. 2). The cumulative

abnormal return for the study was 6.71% for its value

three days before the recommendation and 1.96%

overnight (Engleberg et al., 2006, p 2). A turnover

ratio was also computed in the study showing that the

volume of shares traded of “smaller firms is 317% of

its typical size the day of recommendation, 890% the

day following recommendation, and 451% on the

second day following the recommendation”

(Engleberg et al., 2006, p. 7). Karniouchina et al.

(2009) also showed abnormal returns of 1.07% and

1.23% on the opening and closing sections of the

show (p. 251). The event studies all portray the

increased volume and abnormal returns of the stock

picks of Jim Cramer.

When looking at Jim Cramer as a celebrity

and professional expert, it is apparent that even

though his show is not an advertisement, it is

definitely persuasive and is lacking ambiguous

statements normally involving stock picks

(Karniouchina et al., 2009). Contrary to an

advertisement where individuals watch paid

promotions, people watching Jim Cramer’s show are

actively looking for recommendations (Karniouchina

et al., 2009). Cramer’s expertise as a celebrity is

reflection of his track record. Even though Cramer is

not trying to sell anything, his track record is

important to his career as a stock analyst

(Karniouchina et al., 2009). It is because of this

endorsement and professional value offered to naïve

investors that abnormal returns occur after his

recommendations.

3.3 Analyst Recommendations

According to Barber and Odean (2008),

investors are more likely to buy rather than sell

stocks that catch their attention (Barber & Odean,

2008). With the explosion of information available

on the Internet, it has become increasingly easy for

stocks to catch the attention of investors. When

analysts such as The Motley Fools change

recommendations, they advertise them publicly and

investors are able to buy or sell, reacting to them

immediately (Barber et al., 2001). Analyst

recommendations are key determinants of trading

volume from day to day. Investors react to changes

in recommendation by security analysts at the end of

the trading day (Barber et al., 2001). Abnormal gross

returns from analyst recommendations are on average

4.13% for buy recommendations and 4.91% for the

sell recommendations (Barber et al., 2001, p. 561)

One of the most famous studies of analyst

recommendations occurred with the very popular

“Dartboard” column of The Wall Street Journal. In

the study by Barber and Loeffler (1993), stocks

picked in the “Dartboard” column by professional

experts of The Wall Street Journal earned abnormal

returns of 4% and abnormal volume for six days after

the picks appeared in the column (Barber & Loeffler,

1993, p. 277). In addition, one of the most famous

analysts, The Motley Fools, also shows abnormal

volume and returns. When The Motley Fools

announce a buy recommendation there is an average

price increase of $3.36 to $3.72 per share and during

the three day period following there is an average

increase of $6.08 to $6.87 per share. In addition,

there is a 126.53% increase in the volume of trades

during an announcement, followed by a 114.43%

increase the day after (Hirschey, Richardson, &

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241

Scholz, 2000, p. 68). This reinforces the belief that

analyst’s recommendations influence the buying

behavior of investors. The research suggests that

investors fail to do their due diligence when they

purchase stocks and instead follow the patterns of

celebrity endorsements by Jim Cramer and other

popular analysts.

3.4

Marketing Strategy

Investors seem to be looking to take

shortcuts when it comes to investing in stocks. The

heuristics involved show that many investors fail to

do their own research when it comes to stock picks.

These shortcuts using the recommendations of Jim

Cramer, The Motley Fools, and other analysts

provide an astonishing opportunity for marketing

executives. First, attention grabbing analysts and

news stories seem to produce abnormal stock returns.

It is the individual investors and not institutional

investors who are the most susceptible to purchasing

stocks that grab attention and produce news (Barber

& Odean, 2008). Marketing executives could

monitor these shows and analyst recommendations

for opportunities to sell products to investors.

One factor being studied is the effect that

ownership of a company stock leads to the purchase

of company products (Aspara & Tikkanen, 2008;

Frieder & Subrahmanyam, 2005). There is evidence

that the investors may buy the products of companies

because they are a stock owner (Aspara & Tikkanen,

2008). In traditional consumer behavior, the positive

attitude a person has about a company influences

their purchases (Aspara & Tikkanen, 2008).

Consumers are influenced on stock ownership and

product purchases because the stock has personal

relevance to them and the company’s brand (Aspara

& Tikkanen, 2010).

Aspara and Tikkanen (2010) found that

consumers manifest the personal relevance of a

product purchase in two ways. First, if a consumer is

evaluating two different stocks and they both have

the same financial returns and risks, the consumer

will be more willing to invest in the one that is

personally relevant. Second, if a stock purchase is

not producing the returns expected, a consumer may

be more willing to deal with the low financial returns

of a stock in which the consumer has no personal

relevance (Aspara & Tikkanen, 2010). According to

the survey sent out in the study, only 14.3% of the

respondents stated that they did not care which stock

to invest in if both had similar financial returns and

risk; accordingly, 85.7% of the respondents were

willing to invest in a stock for a reason beyond its

expected financial returns (Aspara & Tikkanen, 2010,

p. 21).

From the research of stock purchases and

celebrity endorsements, it is apparent that investors

make decisions for reasons other than financial

returns. There are some heuristics and biases that

arise from investing and research shows that

anomalies exist and challenges to the efficient-market

hypothesis are evident. Marketing executives can use

this information to promote products and even their

stock in new ways. First, marketing executives can

identify domains the company’s product represent

and then target customers’ personal relevance of the

company (Aspara & Tikkanen, 2010). Second,

companies could place reminders on packaging or

messaging related to investing in the company.

Significant partnerships with an online broker could

increase the reach for the company and the broker.

Third, companies could market products to buy and

stock to invest in. They could accomplish this

through shareholder advertising and promotion to

customers who already own company stock (Aspara

& Tikkanen, 2010). Celebrity endorsers could

provide the avenue through which to communicate

these strategies to customers.

Following the marketing framework

segmentation, targeting, and positioning, a plan could

be developed using celebrity endorsers and investors.

The segmentation of the market represents a group of

customers who own the stock of a corporation.

Studies could be done to analyze whom this market

represents and products could be marketed directly to

shareholders through the annual report or other

avenues. Using the demographics of the

shareholders, companies could target specific

populations with specific products that a company

could develop. The hybrid marketing concept of

selling not only stock but also products to the

consumer could produce a target audience that

companies do not normally serve and may produce a

form of brand loyalty to the products and the stock.

Finally, a company could position itself to offer

products just to the investor. The opportunity to

market to these investors could open up a new

product or product line when dealing with these

implications. A celebrity endorser could be used to

introduce this information to customers. Sponsorship

on shows such as Mad Money and analyst

recommendation sites offering discounts to

shareholders on products advertised by the endorsers

open the door for company leaders to develop

strategies for stock price and brand loyalty.

4. Conclusion

The efficient-market hypothesis remains a

long-standing theory on how capital markets operate.

Though regarded by many as fact, the literature

examining the decisions based on analyst

recommendations and famous celebrity endorsers

brings to the surface doubts regarding an efficient

market. There is a psychological process involved in

choosing investments and companies can analyze the

decision making process to market products and

stock purchases to shareholders and future

shareholders. Further research needs to be completed

regarding this literature. It is important to understand

how widespread the effects of recommendation

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242

changes are and the possibilities of using them for

hybrid marketing strategies of stock purchases and

product purchases. In addition, could the benefit of

running ads with positive analyst recommendations,

or placing a celebrity stock analyst in a commercial

for the companies, increase not only the brand

purchase but also the ownership in the company’s

stock? To further research the phenomenon that

occurs with celebrity endorsements and stock prices,

a correlation could be conducted between the two

variables using larger than a three-month sample size.

This would help to establish that this was a consistent

anomaly in the capital market. In addition, more

analyst and television stock advice could be analyzed

to determine exactly what type of celebrity

endorsement credibility and trustworthiness is

required to produce these anomalies in stock prices.

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