Q

Tobin argued that monetary policy is effective in only one area—capital investment—and that interest rates are an important factor in capital investment but not the only one factor: (q).

Tobin's q: compares the value of a company given by financial markets with the value of a company's assets. It is calculated by dividing the market value of a company by the replacement value of its assets:

                            Tobin's q = market value / asset value

Another use for q is to determine the valuation of the market as a whole. The formula for this q is:

                          value of stock market / corporate net worth

Tobin's Marginal Q: Tobin's marginal q is the ratio of the change in the value of the firm to the added capital cost for an increment to the capital stock.

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Applications: What's important to remember is that Tobin's q can be used to measure several variables, but they all follow a similar doctrine and lead to the same conclusions.

Application (applied to market value):

If the market value reflected solely the recorded assets of a company, Tobin's q would be 1.0.

If Tobin's q is greater than 1.0, then because the market value is in the numerator, the market value is greater than the value of the company's recorded assets. This suggests that the market value reflects some unmeasured or unrecorded assets of the company. High Tobin's q values encourage companies to invest more in capital because they are "worth" more than the price they paid for them.

On the other hand, if Tobin's q is less than 1, the market value is less than the recorded value of the assets of the company. This suggests that the market may be undervaluing the company.

Application (applied to assets):

If an asset's q is less than one—that is, the asset's value is less than its replacement cost—then new investment in similar assets is not profitable. If, on the other hand, q exceeds one, this is a signal for further investment in similar assets. Tobin argued that his q, by predicting future capital investment, would be a good predictor of economy-wide economic conditions.

Application (applied to stocks):

A low Q (between 0 and 1) means that the cost to replace a firm's assets is greater than the value of its stock. This implies that the stock is undervalued. Conversely, a high Q (greater than 1) implies that a firm's stock is more expensive than the replacement cost of its assets, which implies that the stock is overvalued. This measure of stock valuation is the driving factor behind investment decisions in Tobin's model.

                                File:Tobin\'s q.JPG
                      A graph of Tobin's q for the US market from 1900 to 2003. 
                      By looking at the graph you can easily tell when the market 
                      was overvalued or undervalued. When Tobin's q spikes upward 
                             (like at 1929 or 1999) the market is expensive. 
                                  

Variables:

Tobin's q reflects a number of variables, and in particular:

   * The recorded assets of the company.
   * Market sentiment, reflecting, for example, analysts' views of the prospects for the company, or 
     speculation such as bid rumors.
   * The intellectual capital of the company.

Since Tobin's q reflects a number of variables it can only be an approximation of the value of intellectual capital. Many companies now seek to develop ways to measure intangible assets such as intellectual capital.

What we learned in class:

Tobin's q is a monetary transmission mechanism which states that:

                                        M?, Ps?, q?, I?, Y?,

tobin's q