Tobin’s Q as an Indicator of Firm Performance: Empirical Evidence from Manufacturing Sector Firms of Pakistan

Maryam Ishaq, Yasir Islam, Ghulam Ghouse
International Journal of Economics and Business Administration, Volume IX, Issue 1, 425-441, 2021
DOI: 10.35808/ijeba/683


Purpose: The study econometrically investigates the misperceived connection between improved firm performance (measured through scale efficiency and cost discipline) and Tobin’s Q for 51 manufacturing sector firms of Pakistan. Design/Methodology/Approach: Using firm-level data, panel least squares regression estimator is employed to test if the firms’ improved operating efficiency (measured through (i) scale efficiency, and (ii) cost discipline) bears statistically significant impact on Tobin’s Q. To gauge the sustainability and robustness of acquired results, cross-section regression estimator is also applied. Findings: With high statistical significance, we tend to reject our hypothesized relationship between firm performance and Tobin’s Q. Subject to the relative importance of scale decisions versus cost disciplines of firms, their declining performance (in terms of under-investments) is found to be either bearing no impact or inflating Tobin’s Q. Practical Importance: Inflating values of Tobin’s Q raise importance of poor scale decisions. Therefore, scale efficiency, reflected in firm’s managerial decisions, holds substantial importance in determining Tobin’s Q. The analysis also confirms ignorable role of cost discipline in describing Tobin’s Q, thus negating the much-advocated contribution of cost disciplines in determining firm performance. Originality/Value: To the best of authors’ knowledge, no study has been done so far on Pakistani firms, empirically investigating how effectively firms’ performance can be reflected through Tobin’s Q. The paper makes novel contribution to the existing research works on the subject as (i) advance econometric procedures are applied, and (ii) robustness of results are not only verified across two different econometric estimators but also against alternative measures of Tobin’s Q, scale efficiency and cost discipline, highlighting their relative importance.

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