LAW & ECONOMICS COLLOQUIUM
presents
Frank Partnoy
University of California, Berkeley School of Law
The Misuse of Tobin's Q
Tuesday, January 29, 2019
4:10 - 5:45
Room FL219 (John Willis Classroom)
78 Queen's Park
We examine the common and growing misuse of Tobin’s qas a proxy for firm value within the law and finance literatures. We trace the history of Tobin’s q, beginning with its original role as a mean-reverting construct that macroeconomists used to model investment policy. We document how the original version of q morphed into the simplified market-to-book ratio version that law and finance scholars regularly use today to examine regulatory policy, corporate governance, and other economic phenomena. Whereas macroeconomists rejected this simplistic version of q because of measurement error problems, law and finance scholars embraced it as a proxy for firm value.
In addition, we demonstrate empirically why the simplistic version of q is so problematic. Many of the problems arise because regressions that have as their dependent variable a ratio with book value in the denominator are likely to produce biased estimates, due to both omitted assets and time-varying, firm-specific characteristics that can systematically alter a firm’s book value. As a result, the simplistic version of q produces non-classical measurement error in regression specifications that seek to estimate the relationship between firm value and various corporate and regulatory phenomena. We also confirm, consistent with macroeconomists’ view of the original Tobin’s q, that the market-to-book estimate of q is mean-reverting in terms of stockholder returns.
Finally, we suggest a new approach. We replicate the details of one leading study that was based on the simplistic version of q and then show how its results differ when we employ several alternative approaches. We propose that scholars should use these alternative approaches, including direct estimates of firm value instead of the simplistic market-to-book ratio, and, when possible, should supplement the popular fixed effects estimator with the first difference estimator. Overall, our message is straightforward: scholars should view with suspicion any assertions about corporate governance and regulation that are based on the use of market-to-book ratios as the dependent variable in regressions.
Bio: Before joining Berkeley Law in 2018, Frank Partnoy taught for twenty-one years at the University of San Diego, where he was the George E. Barrett Professor of Law and Finance and received the Thorsnes Prize for Excellence in Teaching three times. Partnoy has been an international research fellow at Oxford University since 2010, and has been a visiting professor at the University of Sydney and the Rady School of Management. He is currently a member of the Financial Economists Roundtable. Partnoy has written several dozen scholarly publications on topics in business law and financial markets, including in peer-reviewed journals (e.g., Journal of Finance, Journal of Accounting and Economics, Journal of Corporate Finance, Accounting Review, Socio-Economic Review), in chapters of academic press books (e.g.,Oxford, Cambridge, Chicago, Brookings), and in law reviews (e.g., Chicago, Pennsylvania, Georgetown). Partnoy also is co-author of several academic books, including a leading casebook that he assigns for Business Associations. Partnoy is the author of four trade press books: WAIT, The Match King, Infectious Greed, and F.I.A.S.C.O. He writes regularly for The Atlantic, and has written multiple articles each for The New York Review of Books, Harvard Business Review, and The Wall Street Journal, as well as more than fifty opinion pieces for the print editions of The New York Times and the Financial Times. Partnoy has appeared on numerous media programs, including 60 Minutes and The Daily Show with Jon Stewart, and has testified as an expert before both houses of Congress. Before becoming a professor, Partnoy worked as a lawyer at Covington & Burling and as a fixed income derivatives specialist at Morgan Stanley and CS First Boston. He clerked for the Honorable Michael B. Mukasey in the Southern District of New York.
For more colloquium information, please send an email to events.law@utoronto.ca.
