The hyphenated link between discretionary spendings and product market competitive threats

Purpose This study studies the connection between product market competitive threats with R&D and advertising spending, which is still a hotly contested and inconclusive research topic. We try to fill this research gap by empirically examining this relationship. We also document how the trade-off between these two discretionary spendings mediates the relationship between the competitive threats and firm performance. Design/methodology/approach Instead of using traditional accounting-based measures of industry-level competition, we utilize a novel text-based dynamic measure of firm-level competitive threats for US firms from 1989 to 2019. We estimate net discretionary investments by taking the difference between R&D and advertising spending. We use panel fixed-effect models after controlling for a number of potential biases that may impact the result. We carry out a series of robustness tests to substantiate the main finding. Findings We find that there is a contemporaneous positive relationship between competitive threats and net discretionary investment, indicating that when a firm faces greater competitive threats, it would make a trade-off between R&D and advertising spending. Our mediation analysis suggests how this trade-off improves firm performance. Further, we offer confirmatory evidence of this positive relationship by using several proxies of competition, alternative regression specifications and endogeneity concerns. Originality/value The connection between competitive threats and discretionary spending is still a hotly contested and inconclusive research topic. Our baseline empirical analysis contributes to the behavioral preference theory of managers’ investment behavior, and mediation analysis answers the question of why firms should follow this investment behavior. Therefore, this empirical investigation bridges the gap between management theory and practice and has important ramifications and actionable insights for managers and other shareholders on two overriding investment strategies during competition.