The Economics of Celebrity Endorsements

Bob Greene (CNN) argues that celebrity endorsements are meaningless.  Worse than that, according to Greene, celebrity endorsements necessarily amount to a raw deal for consumers:

This is all elementary. If someone accepts cash in exchange for offering a positive evaluation of something, then the evaluation must be tossed out. It’s worse than meaningless.  Yet in the arena of celebrity endorsements — most notably, endorsements by prominent athletes — not only is the public’s disbelief suspended, but people don’t seem to particularly care that the recommendation is bought and paid for.

When I have tried over the years to make the case for the inherent undependability of these endorsements, people have said that yes, of course, that position is correct — but that it doesn’t matter. When celebrities are paid to say they like something, studies show, it generally translates into increased sales for the companies that hire them.

So — apparently consumers have stubbornly refused to believe Mr. Greene’s model of advertising economics.  There is a saying in economics, or at least, I remember this being said to me around UCLA, that when economic agents do not act as your model predicts the good economist blames the model not the agents.  But let’s give Greene a break — he’s not an economist.  And modern economists seem to be getting more and more comfortable blaming agents whose behavior doesn’t comport with their models anyway.  More importantly, Greene’s column gave me an excuse to write about one of my my favorite subjects: the economics of advertising and promotion.

There is another model of advertising.  Consider Klein & Leffler (1981), in which the a price premium assures contractual performance in competitive equilibrium.  The presence of advertising provides consumers information — specifically, information that the firm is in fact advertising.  In other words, an investment in advertising implies the presence of a price premium (gap between price and production costs) and thus, losses to the firm for shirking on its commitment to supply high quality.  This argument, of course, applies to the pure celebrity endorsements of the variety Greene criticizes — and in so doing, allows one to explain the persistence of the phenomena in a manner consistent with consumer rationality rather than the alternative which requires a steadfast commitment to the belief that consumers are not only irrational, but incapable of learning.

Klein and Leffer explain the relationship between their theory and celebrity endorsements directly:

Our theory also suggests why endorsements by celebrities and other seemingly “noninformative” advertising such as elaborate (obviously costly to produce) commercials, sponsorships of telethons, athletic events, and charities are valuable to consumers.  In addition to drawing attention to the product, such advertising indicates the presence of a large sunk “selling” cost and the existence of a price premium.  And because the crucial variable is the consumers’ estimates of the stock of advertising capital (and not the flow), it also explains why firms advertise that they have advertised in the pat (e.g., “as seen on ‘The Tonight Show'”).  Rather than serving a direct certifying function (e.g., as recommended by Goode Housekeeping magazine), information about past advrtising informs consumers about the magnitude of the total brand name capital investment.

Its really one of those papers that is worth re-reading every once in awhile.