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Taming polysemous signals: The role of marketing intensity on the relationship between financial leverage and firm performance

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  • John Bae
  • Sang‐Joon Kim
  • Hannah Oh

Abstract

This study attempts to reconcile the two strands of research on the impacts of financial leverage on firm valuation. The prior literature has shown that financial leverage has a polysemous effect. In other words, it provides two opposing signals of firm performance (i.e., financial distress vs. a driver of positive change in a firm's prospects). Given that the effects of financial leverage are contradictory, we specify how these divergent signals appear and propose that there is a non‐monotonic effect of financial leverage on firm valuation. The study also shows that marketing activities can be strategically implemented to tame these polysemous signals. Marketing activities are costly actions for a firm, especially one in an adverse environment with high leverage, and are rewarded in terms of firm valuation. Therefore, marketing activities can help reinforce the driver signal and alleviate the distress signal of financial leverage, thus increasing firm valuation. This study finds a U‐shaped relationship between financial leverage and Tobin's q and a positive moderating effect of marketing intensity on the curvilinear relationship.

Suggested Citation

  • John Bae & Sang‐Joon Kim & Hannah Oh, 2017. "Taming polysemous signals: The role of marketing intensity on the relationship between financial leverage and firm performance," Review of Financial Economics, John Wiley & Sons, vol. 33(1), pages 29-40, April.
    • Handle: RePEc:wly:revfec:v:33:y:2017:i:1:p:29-40
    DOI: 10.1016/j.rfe.2016.12.002
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