A Study of Tobin’s Q on Indian Stock Exchange Using Economic Profit Measurement Indicators

Abstract

(ProQuest: ... denotes formulae omitted.)1. IntroductionPerformance evaluations using performance metrics or performance measurement tools are increasingly becoming important for all companies. The major responsibility of a Management Accountant is to assess performance properly using suitable performance metric. In most of the cases, performance assessment is expressed in terms of earnings per share (EPS), accounting profit (PBT/PAT) etc. Even it has been observed that a few companies having satisfactory financial position suffer from liquidity due to use of improper accounting performance metrics resulting in reduction in market capitalisation of the company. Hence the traditional indicators are quickly replaced by different other indicators to measure economic profit or residual income.Economic profit is viewed as a source of value creation for businesses which boosts their share prices on the market. Economic profit making means value creation for enterprises, increased share price on the market and more wealth for shareholders. A wide range of indicators of wealth generation have been developed. These include Economic Value Added (EVA), Market Value Added (MVA), Refined Economic Value Added (REVA), Adjusted Economic Value Added (AEVA), Shareholder Value Added (SVA), Created Shareholder Value (CSV), Cash Flow Return on Investment (CFROI), and Cash Value Added (CVA). These indicators have been well explored by many researchers for examining the profitability of different companies.However, there are two other performance metrics, namely Equity Economic Value Added (EEVA) and True Value Added (TVA), which have not yet been adequately investigated for the Indian capital market. EEVA was proposed by Damodaran (2002) and TVA was the concept introduced by Mohanty (2003). In addition to these, a third performance assessment measure which has not been well investigated for the Indian capital market is Tobin's q, which is basically calculated with the help of information of financial statements and information of market value of a company. This paper focuses on explanation of Tobin's q and on determining the differences between the two indicators in terms of their interpretation and explanatory predictive ability towards Tobin's q. The purpose of this is to help the investors to take the right decision by using the most appropriate performance measurement indicators.2. Literature ReviewKavosi (2001) found a significant relationship between EVA and Tobin's q. Wolf (2003) suggested that Tobin's q is an important technique for the evaluation of management operations. Arcelus et al (2005) investigated the relationship between return on investment (ROI) and the economic return calculated by Tobin's q and their results suggested a non-linear relationship between the two mentioned variables. Heidarpour & Mostoufi (2009) opined a significant relationship between Tobin's q and refined economic value added (REVA). Modarres & Farajzadeh (2009) suggested that Tobin's q should not be used alone to evaluate any financial performance of a company. Namazi & Zara-atgari (2009) conducted a feasibility study on application of Tobin's q compared to other performance criteria. Catapan et al (2012) examined the relationship between profitability indicators and Tobin's q in the Brazilian electric sector and found that Tobin's q is significantly correlated with profitability indicators ROE, ROAE, EBITDA/TA, EBITDA/NW.Joneidiyekta (2012) observed through Iranian stock market that there is a positive and significant relationship between Tobin's q and P/B ratio and no significant relationship between P/E ratio and shareholders return. Raeeszadeh et al (2012) showed that there is a positive relationship between Tobin's q and dividend per share (DPS) but concluded that Tobin's q could not replace DPS.3. Research Hypotheses, Model Variables and Parameters and Research Model3.1. Research HypothesisOur research hypotheses are as follows:Hypothesis 1: Equity Economic Value Added (EEVA) conveys explanatory information in regard to Tobin's q. …