Theory and Tobin coefficient: estimation methods, calculation formula

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

Tobin's Ratio is the ratio between a physical asset's market value and its replacement amount. It was first introduced by Nicholas Kaldor in 1966 in his paper "Marginal Productivity and Macroeconomic Theories of Distribution: A Commentary on Samuelson and Modigliani". It was popularized a decade later, however by James Tobin, who describes it in two quantities.

One of them, the numerator, is the market value: the current value in the market for an exchange of existing assets. The other, the denominator, is the replacement or reproduction price, that is, the market value for newly produced goods. He believes that this ratio has significant macroeconomic importance and utility as a link between financial markets as well as individual goods and services.

One Company

Although this is not a direct equivalent of Tobin's ratio, it has become common practice in the financial literature to calculate this ratio by comparing the market value of capital and liabilities of enterprises with itscorresponding book value, since the replacement amount of the company's assets is difficult to estimate:

Common practice suggests equivalence of production commitments. This gives the following expression:

Note that even if the market value and book value of liabilities are assumed to be equal, this is not the same as the "Market Ratio" or "Price to Average Ratio" used in financial analysis. This analysis is calculated only for equity values:

Tobin's ratio also often uses the reciprocal of this ratio. And more specifically, it looks like this:

For listed companies, the market value of shares (capitalization) is often reported in financial databases. This can be calculated for a specific point in time.

Total corporations

Another use for the Tobin ratio is to determine the valuation of the entire market in relation to total corporate assets. The formula for this is:

The following chart is an example for all organizations. The line shows the ratio of the market value of shares to net assets at the replacement price since 1900.

Application

If the market value reflects only the registered assets of the company,Tobin's q coefficient would be 1.0. This suggests that the market value reflects some of the company's unmeasured or unlisted assets. High Tobin ratio values encourage organizations to invest more in capital because they are “worth” more than the price they were paid for.

If the value of the company's shares is 2 dollars, and the capital in the current market is 1, the organization can issue securities and invest the proceeds. In this case, q> is 1. Tobin's ratio is a ratio, so on the other hand, if it's less than 1, the market value will be lower than the recorded amount of assets. This suggests that he may underestimate the company.

A low quality factor for the entire market does not mean that a complete reallocation of resources in the economy will create value. Instead, when market Q is less than parity, investors are overly pessimistic about future asset returns.

Smart implementation

Lang and Stultz found that the Tobin ratio indicates a lower quality factor in diversified firms than in oriented firms because the market reduces the value of assets.

Tobin's findings show that changes in stock prices will be reflected in retrofitting, consumption and investment, although empirical evidence suggests that his introduction is not as harsh as one might think. This is largely due to the fact that firms do not blindly base fixed investment decisions on stock price changes. Rather, they study future interest rates and the present value of expected returns.

Intellectual capital valuation methods, Tobin coefficient

It measures two variables: the current value of fixed assets, calculated by accountants or statisticians, and the market value of capital, bonds. But there are other elements that can influence, namely, market hype and speculation, reflecting, for example, analysts' views on the prospects of companies. An important role is also played by the intellectual capital of corporations, that is, the immeasurable contribution of knowledge, technology and other intangible assets that a company may have, but they are not taken into account by accountants. Some organizations are seeking to develop ways to measure intangible assets, including intellectual capital.

It is believed that Tobin's q theory is influenced by market hype and intangible assets, so you can see fluctuations around the value of 1.

Kaldor and his definition

In his 1966 paper "Marginal Productivity and the Macroeconomic Theory of Distribution: A Commentary by Samuelson and Modigliani," Nicholas presented this relationship as part of his larger theory. In the article, Kaldor writes: "The valuation ratio is the ratio of the market value of shares to the capital used by corporations." The author then continues to explore the q properties of Tobin's investment theory at the proper macroeconomic level. As a result, he derives the following equation:

Where c is net consumption fromcapital;

sw - employee savings;

g - growth rate;

Y - income;

k - capital;

sc - savings from capital;

i - share of new securities issued by firms.

Caldor then completes this with the p value equation for stocks:

Own interpretation

Taking into account savings and capital gains rates, there will be some valuation that will ensure there is sufficient volume from the private sector to place new securities issued by corporations. Thus, the financial network will depend not only on the inclinations of individuals to save, but also on the policy of corporations in relation to new problems.

In the absence of fresh issues, the value of securities will be set at the moment when the purchases of currency by depositors are balanced by the sale, as a result of which the net savings of the personal sector will become zero. The issuance of new shares by corporations will lower prices (i.e., the valuation factor v) enough to reduce sales enough to stimulate the net savings needed to accept new issues. If it were negative and corporations were treated as net buyers of private sector securities, then the valuation factor v would be adjusted to such an extent that net savings would be negative, in excess of the amount required to match sales.

Kaldor clearly establishes the equilibrium condition under which, other things being equal,mutual obligations, the stock of savings that exists at any point in time is compared with the total number of securities in circulation in the market. He goes on to state: "In a state of Golden Age equilibrium (given g and K/Y, however defined), v will be constant with a value that may be > <1, depending on the meanings of sc, sw, c." In this sentence, Kaldor lays out the definition of the ratio v in equilibrium (constant g and K/Y) of capital and worker savings, and net outward consumption and issuance of new shares across firms.

Failure of capitalism

Finally, Kaldor considers whether this exercise gives a hint about the future development of income distribution in the system. Neoclassicals tended to argue that capitalism would eventually liquidate society and lead to a more equal distribution of income. Kaldor lays out a case whereby it can be within his scope.

Does this "neo-Pacinetti theorem" have any very long-term solution? So far, no one has taken into account changes in the distribution of assets between "workers" (i.e. pension funds) and "capitalists" - many indeed assumed that it would be permanent. However, since they sell shares (if c > 0) and the pension funds buy them, it can be assumed that the share of total assets in the hands of the former will constantly decrease, while the share in the hands of workers will increase continuously until, in some day the capitalists will not have shares. Pension funds and insurancecompanies will own them all.

Another look

While this is a possible interpretation of the analysis, Kaldor cautions against it and lays out an alternative possibility: This view ignores that the ranks of the capitalist class are constantly being renewed by the sons and daughters of new industry leaders, replacing the grandsons and granddaughters of senior captains who are gradually dissipating his inheritance while living beyond the maximum dividend income.

It is reasonable to assume that stocks of newly formed and growing companies rise faster than average, while older stocks (which are declining in relative importance) rise at a slow pace. This means that the rate of appreciation of the value of savings in the hands of the capitalist group as a whole, for the reasons given above, is greater than the rate of growth of assets in the hands of pension funds, and so on."