these slides will tell about the Tobin's Q theory of monetary economics

1. 1
Tobin’s q Theory

2. 2
Definition
It is a ratio devised by James Tobin of
Yale University, Nobel laureate in
economics. It is the ratio between market
value and replacement value of the same
physical asset.

3. 3
 For example, a low Q ratio (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.

4. 4
“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.” - A general equilibrium
approach to monetary theory

5. 5
How it is measured:
For Single company:
In Finance literature it is calculated by
comparing the market value of a
company’s stock with its equity book
value.

Tobin q=

6. 6
The following graph is an example of Tobin's q for all U.S. corporations. The
line shows the ratio of the US stock market value to US net assets at
replacement cost since 1900.

7. 7
Influences on q:
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.

8. 8
 Tobin’s marginal q:
It is the ratio of the market value of an
additional unit of capital to its replacement
cost.
 P/B Ratio:
In the case of inflationary time, Q will be lower
than P/B ratio; conversely it will be higher
than Q.
During periods of very high inflation, the book
value would not reflect the cost of replacing a
firm's assets, since the inflated prices of its
assets would not be reflected on its balance
sheet.

9. 9
Criticism:
 Doug Henwood, in his book Wall Street, 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.
“things started going away 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."