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The Case of Effect_of_R&D_on_Tobins_q

The Case of Effect_of_R&D_on_Tobins_q - MGNT...

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MGNT 6005-Managerial Economics Professor J. Elu Case Analysis: Effect of Research and Development on Tobin’s Q Group Members: Joel Njenga, Mohammad Aladalh Verda Weekes EL Drame
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Overview: According to the article 1 , James Tobin, a Nobel Laureate pioneered the idea of measuring the market power of business firms by comparing their market value against accounting book values. He introduced businesses to the q ratio, defined as the market value of a firm divide by replacement cost of tangible assets. The article illustrates that by end of 1990’s the q ratio had surged, the economy logged the longest peacetime expansion in history and that both corporate profits as well as stock prices were said to have soared to record levels. However between 2000 and 2003, corporate profits, stock, and Tobin’s q ratios for major corporations took a sharp tumble as the country entered a mild recession. Having said all this it becomes inevitable to conclude that variations in Tobin’s q ratios for corporate giants could be explained by the business cycle. The article adds to say that leading firms today are characterized by reliance in intangible assets such as advertising, capital, brand names, customer goodwill and patents among other things. Empirically, q > 1 if valuable intangible assets derived from R & D and other such expenditures with long-lived benefits are excluded in the accounting methodology. Theoretically it can be argued that q → 1 over time only holds when economic values of tangible and intangible assets are precisely measured. If q > 1 continuously and Tobin’s q is closely tied to the level of R&D intensity, one might argue successfully for the presence of intangible R&D. According to studies carried out by Joseph Cheng 2 , the results suggested that R&D investments added value to firms. He gives an example where Goloto and Kim (2003) found that dot com companies with high R&D expenditures tend to have higher stock market values in the subsequent years. Problems: One major problem is the fact that the output of R&D being an intangible asset and thus labeled as “knowledge stock”. Since this knowledge stock is known to contribute positively to the firm’s future cash flows, then it becomes imperative that we include it in the observed market value or q ratio. This intangibility of R&D makes it hard to
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