June 2016’s seismic Brexit vote has had an impact on all sectors of the UK economy and advertising has not been immune. Yet months of weak spending and belt tightening has been blown out of the water in the last quarter of 2018. Companies have put their hands deep into their pockets and are expected to spend a record £6.4 billion on advertising.
This is not a case of companies falling into the age-old trap of spending more than intended on Christmas. We believe there is something deeper going on in the way that companies are dealing with the uncertainty of Brexit and are trying to balance their books accordingly.
The Christmas season is a make or break time for many retailers – and their advertising spend often reflects this. But, in the last two years, last-minute Christmas splurges have followed a noticeably prolonged period of low spending.
This trend attracted our attention. In our accounting research we found that managers of companies prefer to reduce advertising expenses to make their annual earnings figures look stronger. By controlling their spending at certain times of the year, companies can keep their balance sheets looking healthy and show shareholders that they can efficiently meet or beat the forecasts made by financial analysts.
Applying this knowledge to this time of Brexit uncertainty and poor business growth, it’s interesting to see that a lot of companies are splurging over the Christmas period. This is probably not reflective of their overall spending, however. Seasonal boosts in advertising spend can be used to tactically increase sales and, as a result, inflate a company’s reported earnings for the period in question. A number of studies show how companies can do this effectively at short notice.
If it’s the right season, the corresponding bump in earnings that advertising can bring allows companies to justify the advertising expense. Plus, out of the various options available to managers to manipulate their accounts, a change in advertising budget is comparatively easy. It does not require any disposal of assets or laying off workers, for example. Christmas is a great time to do this – not just because it’s a season of high spending, but because it comes toward the end of the financial year, when managers and executives are usually under pressure to meet or beat earnings targets.
To avoid scrutiny from investors, it is common practice for managers to make last-minute changes to inflate their earnings figures. But this doesn’t pay in the long term. Research shows how numerous executives sacrifice long-term value by spending on short-term initiatives to make their reported earnings look better toward the end of the financial year.
During the first and second quarters, executives feel like they still have a long time to act and shape their expected earnings targets. In the context of Brexit, there has been significant uncertainty, which makes any long-term planning difficult and prevents executives from fully assessing market conditions.
Dealing with uncertainty
This has especially been the case in 2018 as uncertainty over whether the UK will have a Brexit deal in place or not by March 29 2019 becomes more of an issue. According to the government’s latest analysis, Brexit will reduce the UK GDP by 2-4% in the next 15 years and if there is a no-deal Brexit then the situation will be worse, with the UK economy forecast to shrink by as much as 9.3%. So we can assume that managers will be making strategic decisions in the last quarter of the financial year to deal with this uncertainty.
They have little incentive to make long-term financial plans, as they do not know what the future will look like. So it’s better to increase advertising to generate more earnings in the short term. And, by the third quarter of the year, executives have a much better idea of what targets they need to meet by the end of the year.
The clock is ticking for the UK to secure a Brexit deal, and executives will be conscious of squeezing in as much profits as they can before a potential no-deal Brexit. Plus, accounting rules stipulate that advertising activities must be expensed as they are incurred – so companies cannot hide when the spending takes place. Any big reduction in the traditional Christmas advertising spend might raise questions from prospective investors and give the wrong impression to the wider financial market.