Discussion: Brand Loyalty, Financial Constraints and Stock Returns by Dou, Ji, Reibstein, Wu

Leena Rudanko January 6, 2018 Federal Reserve Bank of Philadelphia Disclaimer: The views expressed do not necessarily represent those of the Federal Reserve

What the paper does

• Considers impact of customer loyalty on firm financial performance • ...when firms differ in the sensitivity of their customer base to firm financial distress • Proposes customer capital model with two types of customer capital and derives implications for expected returns • Brings evidence from marketing survey data to sort firms, and documents systematic patterns in returns across portfolios

Related literature: Gourio and Rudanko (ReStud 2014), Belo, Lin and Vitorino (RED 2014), Eisfeldt and Papanikolaou (JF 2013) 1

Theory of cross-section of returns Firms: • Technology: Output Y = aK , where K˙ = I − δK K • Customer base constraint: Sales = min{Y , B }, where B customer base • Two customer types:  B loyal to firm F B = BF + BP where BP loyal to key people in firm B˙ F = (1 − f )µ(s )BP − δB BF B˙ P = f µ(s )BP − δB BP — and drops if key people leave! where s sales effort and f stochastic 2

Theory of cross-section of returns

Firms: • Compensation of key people: paid value of outside option, i.e. leaving with share of customers to start new firm • Turnover decisions for key people • External financing decisions: issue equity, hold cash, pay out • Financial distress shocks: aggregate variation in probability of drop in firm cash flow All discounted with same exogenous sdf

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Evidence of customer loyalty

Survey data on consumer perceptions of brands (BAV) Measures: • Brand stature: consumer knowledge and esteem of brand ! total customer capital B • Brand strength: energized differentiation and relevance ! customer capital tied to key people BP

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Core results

Theory: Firms that depend more on key people are more sensitive to financial distress, as demand will drop if key people leave higher excess returns Empirics: • Portfolios with high brand strength (relative to stature) have systematically greater excess returns • Significant difference of 5.6% in return between high vs low brand strength portfolio • Also greater (and positive) α’s in several factor models • Associated with financial constraint risk 5

Comments

Theory: • Simple and natural idea • Model has many elements — possible to simplify? • For some firms, very natural customers care explicitly about key people (hair salon), others less (no direct contact) — emphasize link between product and key people? • Consider model specification with single type of customer capital, where probability of customers leaving with key people varies across markets?

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Comments

Theory vs data: • Great to bring marketing data, interesting relationship with returns • Possible to strengthen link between empirical measures and model mechanism: ”energized differentiation” vs role of key people? • Is there another model specification closer to description that would work?

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