Hypothesis that Tobin’s q captures organizations’ debt levels instead of their growth opportunities and intangible assets

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.

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