Criticism: Difference between revisions
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[http://www.findarticles.com/p/articles/mi_m4130/is_3_35/ai_n16819410/pg_1 Study] | Timothy Erickison and Toni Whited [http://www.findarticles.com/p/articles/mi_m4130/is_3_35/ai_n16819410/pg_1 Study] | ||
[[Tobin's q]] | [[Tobin's q]] | ||
Latest revision as of 13:57, 7 December 2006
Tobin's q, is the ratio of the market value of a firm's assets (as measured by the market value of its outstanding stock and debt) to the replacement cost of the firm's assets (Tobin 1969). This measure of performance is not used as often as either rates of return or price-cost margins. If a firm is worth more than its value based on what it would cost to rebuild it, then excess profits are being earned. These profits are above and beyond the level that is necessary to keep the firm in the industry.
The advantage of using Tobin's q is that the difficult problem of estimating either rates of return or marginal costs is avoided. On the other hand, for q to be meaningful, one needs accurate measures of both the market value and replacement cost of a firm's assets.
It is usually possible to get an accurate estimate for the market value of a firm's assets by summing the values of the securities that a firm has issued, such as stocks and bonds. It is much more difficult to obtain an estimate of the replacement costs of its assets, unless markets for used equipment exist. Moreover, expenditures on advertising and research and development create intangible assets that may be hard to value. Typically, researchers who construct Tobin's q ignore the replacement costs of these intangible assets in their calculations. For that reason, q typically exceeds 1. Accordingly, it can be misleading to use q as a measure of market power without further adjustment.
In his book, Wall Street, Doug Henwood argues that the q ratio fails to accurately predict investment, as Tobin claims. "The data for Tobin and Brainard’s 1977 paper covers 1960 to 1974, a period for which q seemed to explain investment pretty well," he writes. "But as the chart (see above) shows, things started going awry even before the paper was published. While q and investment seemed to move together for the first half of the chart, they part ways almost at the middle; q collapsed during the bearish stock markets of the 1970s, yet investment rose."
Timothy Erickison and Toni Whited Study
