Tobin’s Q as a market-based measure of firm’s performance and as a proxy for exposure to systematic risk.

Abstract

Since its introduction in 1969, the q ratio has been used to explain a wide variety of phenomena. It has increasingly been used as a financial-market measure of firm’s performance, and also a measure of a firm’s intangible value. In this paper, we use Tobin’s q as a financial market-based measure of firm performance and examine the association between firm performance and stock market valuation of equities, plus 2 factors: book-to-market equity and size, which according to Fama and French [1992], explain the variation of cross section expected returns. We also controlled for firm-specific and macroeconomic variables. The results based on data from 1995-2007, of 25 listed corporations in the Singapore market, indicate that the inclusion of the 3 factors and industrial dummies increased the variance explained in q significantly. Stock price performance and size have significantly positive association with q ratio; book-to-market equity has an inverse association. The results also show that firms in industries with average q more than 1 have a premium in performance and valuation relative to those firms in industries with average q equal or less than 1.

We also substituted Tobin’s q for book-to-market equity as one of the factors that proxy for exposure to systematic risk to examine if this ratio has a relatively stronger association with an asset’s returns. The other factors included are market return and size, and we controlled for macroeconomic-wide variables. The results indicate a negative association between asset returns and book-to-market equity; and a positive one between asset returns and q ratio. The results show that after controlling for macroeconomic variables and size, market return and q ratio are the only 2 significant factors in predicting security returns; and that q ratio is a more superior factor in explaining security returns. In fact, the results also indicate those firms with high q commands a premium in security returns relative to firms with low q ratio.