Tobin's q

Tobin's q is sometimes written as "Tobin's-q", "Tobin's Q" or simply Q. It is also called Tobin's
Quotient, since the Q stands for Quotient. Sometimes, people call it the "Brainard-Tobin Q."

Tobin's q (also known as Kaldor's v) is the ratio between a physical asset's market value and
its replacement value. It was first introduced by Nicholas Kaldor in 1966 in his article
"Marginal Productivity and the Macro-Economic Theories of Distribution: Comment on
Samuelson and Modigliani". It was then reintroduced in 1968 by James Tobin and William
Brainard, although the use of the letter "q" did not appear until Tobin's 1969 article "A general
equilibrium approach to monetary theory". Tobin (1977) writes

One, the numerator, is the market valuation: the going price in the market for exchanging
existing assets. The other, the denominator, is the replacement or reproduction cost: the price
in the market for the newly produced commodities. We believe that this ratio has considerable
macroeconomic significance and usefulness, as the nexus between financial markets and
markets for goods and services.

Measurement
Single company
Although it is not the direct equivalent of Tobin's q, it has become common practice in the
finance literature to calculate the ratio by comparing the market value of a company's equity
and liabilities with its corresponding book values, as the replacement values of a company's
assets is hard to estimate:
( Equity Market Value + Liabilities Market Value)
Tobin's =
( Equity Book Value + Liabilities Book Value)

It is also common practice to assume equivalence of the liabilities market and book value,
yielding:

( Equity Market Value + Liabilities Book Value) Equity Market Value

Tobin's = 
( Equity Book Value + Liabilities Book Value) Equity Book Value

For stock listed companies, the market value of equity is often quoted in financial databases. It
can be calculated for a specific point in time by number of shares x share price

Aggregate corporations
Another use for q is to determine the valuation of the whole market in ratio to the aggregate
corporate assets. The formula for this is:

Value of Stock Market

q
Corporate net worth

Application
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 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.

1
 Market Value of installed capital
q
Replacement cost of capital

If a company's stock price (which is a measure of the company's capital market value) is $2
and the price of the capital in the current market is $1, the company can issue shares and with
the proceeds invest in capital. In this case q  1 .

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.
John Mihaljevic points out that "no straightforward balancing mechanism exists in the case of
low Q ratios, i.e., when the market is valuing an asset below its replacement cost ( Q  1 ).
When Q is less than parity, the market seems to be saying that the deployed real assets will not
earn a sufficient rate of return and that, therefore, the owners of such assets must accept a
discount to the replacement value if they desire to sell their assets in the market. If the real
assets can be sold off at replacement cost, for example via an asset liquidation, such an action
would be beneficial to shareholders because it would drive the Q ratio back up toward parity (
Q  1 ). In the case of the stock market as a whole, rather than a single firm, the conclusion that
assets should be liquidated does not typically apply. A low Q ratio for the entire market does
not mean that blanket redeployment of resources across the economy will create value. Instead,
when market-wide Q is less than parity, investors are probably being overly pessimistic about
future asset returns."

Lang and Stulz found out that diversified companies have a lower Q-ratio than focused firms
because the market penalizes the value of the firm assets.

Tobin's discoveries show us that movements in stock prices will be reflected in changes in
consumption and investment, although empirical evidence reveals that his discoveries are not
as tight as one would have thought. This is largely because firms do not blindly base fixed
investment decisions on movements in the stock price; rather they examine future interest rates
and the present value of expected profits.

Other influences on q
Tobin's q measures two variables - the current price of capital assets as measured by
accountants or statisticians and the market value of equity and bonds - but there are other
elements that may affect the value of q, namely:
 Market hype and speculation, reflecting, for example, analysts' views of the prospects
for companies, or speculation such as bid rumors.
 The "intellectual capital" of corporations, that is, the unmeasured contribution of
knowledge, goodwill, technology and other intangible assets that a company may have
but aren't recorded by accountants. Some companies seek to develop ways to measure
intangible assets such as intellectual capital. See balanced scorecard.

Tobin's q is said to be influenced by market hype and intangible assets so that we see swings
in q around the value of 1.

Tobin's marginal q
Tobin's marginal q, is the ratio of the market value of an additional unit of capital to its
replacement cost.

2
Price-to-book ratio (P/B)]
In inflationary times, Q will be lower than the price-to-book ratio. During periods of very high
inflation, the book value would understate the cost of replacing a firm's assets, since the inflated
prices of its assets would not be reflected on its balance sheet.