16.5 Tobin’s Q

Traditional Tobin’s q (V. R. Rao, Agarwal, and Dahlhoff 2004)

$$q = \frac{MVE + PS + DEBT}{TA}$$

where

• MVE = share price x number of common stock outstanding

• PS = liquidating value of the firm’s preferred stock

• DEBT = (short-term liabilities - short-term assets) + book value of long-term debt

• TA = book value of total assets

Tobin’s q is scale independent. Hence, it’s a good measure of relative market performance

(R. H. Peters and Taylor 2017) Peters and Taylor Total Q

• The neoclassical theory of investment can still be applied to intangible assets.

• Propose a new Tobin’s q proxy that accounts for intangible capital, which is called total q

  • = the firm’s market value divided by the sum of its physical and intangible capital stocks

  • Firm’s intangible capital = sum of its knowledge capital and organizational capital

    • R&D spending = an investment in knowledge capital (using the perpetual -inventory method to a firm’s past R&D to measure the replacement cost of its knowledge capital)

    • Fraction of past selling, general, and administrative (SG&A) spending is organization capital, which includes human capital, brand, customer relationship,s and distribution systems.

    • A firm’s total capital as the sum of its physical and intangible capital (measured at replacement cost

• Intangible capital is costlier than physical capital to adjust

• Download Data from WRDS

• Sample excludes utilities (SIC 4900-4999), financial firms (6000-6999), others (9000+), missing or non-positive book value of assets or sales, and firms with less than $5mil in physical capital. Winsorize all regression variables at the 1% level to remove outliers.

Proposed total q

$$\begin{aligned} q^{tot}_{it} &= \frac{V_{it}}{K_{it}^{phy} + K_{it}^{int}} \\ &= \frac{prcc_f \times csho + dltt + dlc- act}{ppegt + K_{it}^{int}} \end{aligned}$$

where

• $V_{it}$ = firm’s market value = outshining equity (prcc_f times csho)+ book value of debt (dltt + dlc) - firm’s current assets (act)

• $K_{it}^{phy}$ = replacement cost of physical capital = ppegt

• $K_{it}^{int}$ = replacement cost of intangible capital

Previous Tobin’s q measure did not include the intangible part (Fazzari, Hubbard, and Petersen 1987) (Erickson and Whited 2011)

Intangible capital can be

• Created internally

  • knowledge knowledge (e.g., patents, software): using perpetual inventory method $G_{it} = (1- \delta_{RD}) G_{i, t-1} + RD_{it}$

    • $G_{it}$ = the end-of-period stock of knowledge capital (for $G_{i0}$ can assume to be 0)

    • $\delta_{RD}$ =depreciation rate (use BEA’s industry-specific R&D depreciation rates (W. C. Y. Li and Hall 2018) and 15% for missing data)

    • $RD_{it}$ = real expenditures on R&D during the year (if missing treat as 0, (Lev and Radhakrishnan 2005)

  • brand capital (advertising under selling expense within SG&A)

  • human capital (employee training under general or admin expense within SG&A)

  • Others: Other Intangible Assets (intano) in Compustat

• Purchased externally

  • Goodwill (not separately identifiable e.g., human capital is booked under goodwill).

  • Other Intangible Asset: (e..g, patent, software if separately identifiable)

References

Erickson, Timothy, and Toni M. Whited. 2011. “Treating Measurement Error in Tobin’sq.” Review of Financial Studies 25 (4): 1286–1329. https://doi.org/10.1093/rfs/hhr120.

Fazzari, Steven, R. Glenn Hubbard, and Bruce Petersen. 1987. “Financing Constraints and Corporate Investment.” NBER. https://doi.org/10.3386/w2387.

Lev, Baruch, and Suresh Radhakrishnan. 2005. “The Valuation of Organization Capital.” In, 73–110. University of Chicago Press. https://doi.org/10.7208/chicago/9780226116174.003.0004.

Li, Wendy C. Y., and Bronwyn H. Hall. 2018. “Depreciation of Business R and D Capital.” Review of Income and Wealth 66 (1): 161–80. https://doi.org/10.1111/roiw.12380.

Peters, Ryan H., and Lucian A. Taylor. 2017. “Intangible Capital and the Investment-q Relation.” Journal of Financial Economics 123 (2): 251–72. https://doi.org/10.1016/j.jfineco.2016.03.011.

Rao, Vithala R., Manoj K. Agarwal, and Denise Dahlhoff. 2004. “How Is Manifest Branding Strategy Related to the Intangible Value of a Corporation?” Journal of Marketing 68 (4): 126–41. https://doi.org/10.1509/jmkg.68.4.126.42735.