On the measurement of Tobin's q

Abstract

We examine the methods commonly employed to estimate Tobin's q ratios and find them to be flawed in design and arbitrary in implementation. We propose an alternative procedure which is both simpler and more accurate. The key to the procedure is an improved measure of fixed asset replacement costs, through the proper identification of the vintages of fixed assets that are in place for a firm. Application of this procedure to a large sample of nonfinancial corporations indicates that existing methods generally produce downward-biased measures of q and can result in errors in the ordering of firms by their q's.