Abstract
The informational content of prices hypothesis in Modigliani and Miller (and Fisher before them) advocates that organizations’ market prices could somehow estimate their growth prospects and intangible assets. For this estimation, discounted cash flow models are frequently employed. However, these models require information about monetary flows and discount rates in the long future, which are most difficult to confirm in the moment of the analysis. Thus, Tobin’s q or similar procedures as the market-to-book value of the firm have been claimed (and presupposed) as evidence that markets could identify growth prospects and intangible assets. Indeed, Tobin’s q tends to be higher for new and/or intangible intensive firms. Nevertheless, we know that for q > 1, less debt tends to imply a higher q, whereas the inverse holds for the less frequent q < 1. To explain this phenomenon, we propose a “mechanical effect hypothesis” describing an automatic relationship between q and capital structures at the variable computation. Accordingly, as intangible-intensive and/or new firms are likely to have q > 1 and less debt, a mechanical effect increases their q-values without requiring growth perspectives, or intangibles. Hence, this new hypothesis disputes Fisher-Modigliani-Miller’s utilization of discounted cash flow models to explain markets and prices.
PUBLIC INTEREST STATEMENT
This study disproves one of the most used empirical indicators in economics and finance, namely, Tobin’s q. Researchers employ Tobin’s q to identify firm’s intangible assets and growth opportunities. Indeed, q tends to be higher for intangible-intensive firms (e.g., Alphabet, Meta, ByteDance) and new firms. Thus, many studies are quick to presuppose that firms’ q can identify their intangible assets and future growth opportunities. Rather, what Tobin’s q has been empirically capturing is firms’ debt levels. As intangible-intensive firms and new firms tend to have less debt in their capital structures, a mechanical effect in the computation automatically makes them have a higher q every time that q is higher than 1 (common case). No intangible assets or growth opportunities are required. Given this indicator’s prominence, these findings raise questions about the capacity of economic and finance theory to understand firms, markets, prices, intangible assets, and performance.
Acknowledgements
Joao Silva Ferreira, Julia Smith, Patrick McColgan, Andrew Marshal, Christine Cooper, David McMillan (the Editor), two anonymous referees, and the ADVANCE Research Center at ISEG, and Portuguese national funding agency for science, research and technology (FCT) under the Project UIDB/04521/2020.
Disclosure statement
No potential conflict of interest was reported by the author(s).
Notes
1. Many studies employ this interpretation of Tobin’s q (e.g., Tobin and Brainard, Citation1977, Wernerfelt & Montgomery, Citation1988; Morck et al., Citation1989; Chen & Lee, Citation1995; Canibano et al., Citation2000; Lockett & Thompson, Citation2001; Mahoney, Citation2001; García-Ayuso, Citation2003, Gietzmann and Ostaszewskia, Citation2004; Ng, Citation2005; Wyatt, Citation2005, Fanelli and Grasselli, Citation2006; Abeysekera, Citation2008; Ceccagnoli, Citation2009; McClelland et al., Citation2010; Surroca et al., Citation2010; Alcaniz et al., Citation2011; Zéghal & Maaloul, Citation2011; Khallaf, Citation2012; Chen, Citation2013; Zhang, Citation2013; Wang et al., Citation2016; Ray et al., Citation2013, Servaes and Tamayo, Citation2014; Castilla-Polo & Gallardo-Vázquez, Citation2016; Biswas et al., Citation2017; Galant & Cadez, Citation2017; Gupta et al., Citation2017; Kabukcuoglu, Citation2017; Girod & Whittington, Citation2017; Peters & Taylor, Citation2017; Entezarkheir & Moshiri, Citation2018; Muchtar et al., Citation2018; Feng & Chan, Citation2018; Paugam et al., Citation2018; Lian & Wang, Citation2019; Lim et al., Citation2020, Nemlioglu, and Mallick, 2020; Agyei-Boapeah et al., Citation2020; Cheong and Hoang, 2021; Sagliaschi & Savona, Citation2021).
3. McConnell and Servaes’ (1995) q variable is identical to the firm’s market-to-book value variable used by many other studies (e.g., Rajan & Zingales, Citation1995)
4. Many research papers employ the Tobin’s q variable without mentioning this empirical phenomenon (e.g., Tobin and Brainard, 1977, Wernerfelt & Montgomery, Citation1988; Morck et al., Citation1989; Chen & Lee, Citation1995; Canibano et al., Citation2000; Lockett & Thompson, Citation2001; Mahoney, Citation2001; García-Ayuso, Citation2003, Gietzmann and Ostaszewskia, 2004; Ng, Citation2005; Wyatt, Citation2005, Fanelli and Grasselli, 2006; Abeysekera, Citation2008; Ceccagnoli, Citation2009; McClelland et al., Citation2010; Surroca et al., Citation2010; Alcaniz et al., Citation2011; Zéghal & Maaloul, Citation2011; Khallaf, Citation2012; Chen, Citation2013; Zhang, Citation2013; Wang et al., Citation2016; Ray et al., Citation2013, Servaes and Tamayo, 2014; Castilla-Polo & Gallardo-Vázquez, Citation2016; Biswas et al., Citation2017; Galant & Cadez, Citation2017; Gupta et al., Citation2017; Kabukcuoglu, Citation2017; Girod & Whittington, Citation2017; Peters & Taylor, Citation2017; Entezarkheir & Moshiri, Citation2018; Feng & Chan, Citation2018; Paugam et al., Citation2018; Xiang & Qu, Citation2018; Lian & Wang, Citation2019; Lim et al., Citation2020, Nemlioglu, and Mallick, 2020; Agyei-Boapeah et al., Citation2020; Sagliaschi & Savona, Citation2021).
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Economic Research-Ekonomska Istraživanja, 30(1), 676–693. https://doi.org/10.1080/1331677X.2017.1313122 Gupta, K., Banerjee, R., & Onur, I. (2017). The effects of R&D and competition on firm value: International evidence. International Review of Economics & Finance, 51, 391–404. https://doi.org/10.1016/j.iref.2017.07.003 Kabukcuoglu, Z. (2017). The cyclical behavior of R&D investment during the Great Recession. In Empirical Economics. first online, 1-23. Girod, S., & Whittington, R. (2017). Reconfiguration, restructuring and firm performance: Dynamic capabilities and environmental dynamism. Strategic Management Journal, 38(5), 1121–1133. https://doi.org/10.1002/smj.2543 Peters, R., & Taylor, L. (2017). Intangible capital and the investment-q relation. Journal of Financial Economics, 123(2), 251–272. https://doi.org/10.1016/j.jfineco.2016.03.011 Entezarkheir, M., & Moshiri, S. (2018). Is innovation a factor in merger decisions? evidence from a panel of US Firms. Empirical Economics. Feng, X., & Chan, K. (2018). Mutual funds’ selective participation and subsequent performance of seasoned equity offerings. In Empirical Economics. Online First, 1-26. https://doi.org/10.1007/s00181-018-1420-0 Paugam, L., Casta, J., & Stolowy, H. (2018). Non‐additivity in Accounting Valuation: Theory and Applications. Abacus, 54(3), 381–416. https://doi.org/10.1111/abac.12125 Xiang, P., & Qu, L. (2018). The influential factors for the performance of Chinese enterprises’ international takeovers. Cogent Economics & Finance, 6(1), 1442631. https://doi.org/10.1080/23322039.2018.1442631 Lian, Q., & Wang, Q. (2019). How Does the Primary Market Value Innovations of Newly Public Firms? Journal of Accounting, Auditing and Finance, 34(1), 3–29. https://doi.org/10.1177/0148558X16665964 Lim, S., Macias, A., & Moeller, T. (2020). Intangible assets and capital structure. Journal of Banking and Finance, 118(2020), 105873. https://doi.org/10.1016/j.jbankfin.2020.105873 Agyei-Boapeah, H., Fosu, S., & Ntim, C. (2020). Corporate multinationality and acquirer returns. Abacus, 56(2), 230–267. https://doi.org/10.1111/abac.12146 Sagliaschi, U., & Savona, R. (2021). Imperfect Competition, Working Capital and Tobin’s Q. Springer. Additional information
Funding
This work was supported by the ADVANCE Research Center at ISEG, and Portuguese national funding agency for science, research and technology (FCT) [Project UIDB/04521/2020].
Notes on contributors
Tiago Cardao-Pito
Tiago Cardao-Pito is an assistant professor at ISEG, Universidade de Lisboa (University of Lisbon), Portugal. He has been invited as a guest lecturer to several academic programs such as those of the Massachusetts Institute of Technology in Portugal (MIT in Portugal), University of Strathclyde and the Portuguese Military Academy. He also has experience working at the Portuguese Ministry of Finance and Public Administration, the Portuguese Ministry of Health and the private sector. He has published two books and more than twenty research papers.
https://orcid.org/0000-0002-0513-9306
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