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Total Q Measures Investment Opportunities Not Firm Value

Papers in finance can sometimes get a hefty citation count boost when they get picked up in marketing. Peters and Taylor‘s 2017 paper on Total q is a nice paper. They make the very reasonable assertion that their Total q measures investment opportunities better than current Tobin’s q approximations. While I’m not a finance person their arguments make sense to me. They seem like sensible scholars who make excellent points about how accounting choices distort reported financial data. I wish them all the best in garnering citations.

Yet, I hope few citations come from marketers. This is a bear trap for marketing. To be clear the trap is of marketers own making as we look for magic wands to solve our data problems. It is not Peters’ or Taylor’s fault but marketers may wish to use Total q as a firm value metric. I hope to slow the marketers down.

Total Q Measures Investment Opportunities Not Performance Metrics

Probably the most glaringly obvious point is that Peters and Taylor are aiming to predict investment opportunities with their new q measure. To be very explicit they argue that Total q measures investment opportunities not that their measure captures firm value. Investment opportunities may have a conceptual link to performance but they are not the same as firm performance. No firm I know of aims to optimize investment opportunities. It would be eminently possible for the authors to develop a perfect q measure for their purpose and this not to be useful to measure what marketers seek to use it for.

Investment Is Not The Same As Performance

How Do They Measure Total Q?

Total q is just the accounting-based approximations of Tobin’s q adjusted for unrecorded intangibles. Peters and Taylor have noted exactly what we noted in our paper on Tobin’s q. (To be fair they noted it first it was just that I didn’t read it till recently). Still it was never a secret that accounting measures omit many intangible assets — marketers (correctly) constantly complain about this.

On a side note I have never understood why many academic marketers never noticed this obvious problem with Tobin’s q. I can remember saying the first time I read a paper using Tobin’s q as a performance metric that this was obviously erroneous. Anyone with even a superficial knowledge of accounting should surely have noticed this. Never mind.

So to return to the point Peters and Taylor have a problem constructing Total q. They want to bring in numbers that are by their nature unrecorded. This is a challenge, to say the least.

“Measuring the replacement cost of internally created intangible assets is difficult as they appear nowhere on the balance sheet”

Peters and Taylor (2017) page 256

What do they do?

Adding The Value Of Unrecorded Intangible Assets

The authors assume that spending on R&D creates assets directly related to the value of the R&D spending. This is obviously imperfect but for their purposes it may well be good enough.

How to estimate organizational capital? In this catch-all term, they include most marketing-related unrecorded intangible assets. Basically most of what we would call market-based assets. They base their asset estimates on spending reported by financial accountants and assume 30% of Selling, General and Administrative spend is an investment. This is a bit random but at least they tell us what they did. (To be fair they do robustness checks later).

A big note of caution is that even if you estimated the spend on intangible assets perfectly you aren’t really interested in spending. You are interested in intangible assets actually created not money spent. Spend may help estimate assets created but it certainly isn’t the same as assets created. What they are trying is very hard to do.

I’d also say I sometimes found their discussion of intangibles versus unrecorded assets a little unclear but given they aren’t writing for a marketing audience I won’t care about it too much here.

Total Q Is Far From Perfect

This is no criticism of the authors but is should be obvious that their Total q is far from perfect. Throughout the text they are at pains to agree and emphasize that their approach is imperfect. (It is practical achievable which, to be fair, is far from a trivial contribution). Indeed, the final line of the main paper says:

“Finally, there is more work to do on measuring intangible capital”

Peters and Taylor (2017) page 270

If you need another quote to show they have no illusions that their metric is perfect see below.

“We recognize, however, that total q is still a noisy proxy.”

Peters and Taylor (2017) page 260

Clearly they mean Total q is a noisy proxy for investment opportunities. Note that they do not even describe Total q as a noisy proxy for firm performance.

They make a practical contribution. Their offer is that if you need a q to measure investment opportunities ours is better than the prior alternative. They, therefore, compare the success of their metric to Tobin’s q.

“While our intangible-capital measure has limitations, we believe, and the data confirm, that an imperfect proxy is better than setting intangible capital to zero.”

Peters and Taylor, (2017), page 252

They are right but look at their comparison. Their measure is better than something else which is really quite bad. This is all to do a task that I don’t think any marketer ever really wants done, estimate investment opportunities. This is important in econ, and understanding what happens in markets, but not really in marketing. At the risk of being too crude I’d say marketers are more interested in the results of actions for specific firms. This makes the assumptions used to deliver Total q more challenging.

Progress But…

I like progress, and this is progress, but it is narrow progress on a specific goal. What is more the goal is not really one where marketers care a lot about whether progress is made. I would say that this paper from a marketing perspective (I don’t mean to understate other contributions) is mostly financial economists recognizing what marketers already know. Namely that unrecorded intangibles matter.

Robustness Checks

Peters and Taylor reassure the reader by a series of robustness checks. The authors are able to do these because they use Total q as an independent variable. They can, thus, see what best predicts what they want to predict of the alternatives: Tobin’s or various Total q variants. Remember for them Total q aims to predict investment opportunities. The metric being developed is used to predict something else. It is not to be what is predicted. Therefore, you can test whether Total q is good for prediction.

If you use Total q as a proxy for firm performance you can’t really do the same robustness checks. Firm performance is what you want to predict. This means that there are then two broad possibilities:

Peters and Taylor establish that, although there are problems with Total q, it at least does a better job at predicting investment opportunities than a Tobin’s q measure which ignores unrecorded intangible assets. Interesting and reasonable. Still it is hardly a game-changer for marketers who already thought investments in intangibles matter.

Marketing Theory

One of the things marketers will like is that this paper explicitly makes arguments that marketers often make. Peters and Taylor speak a lot of sense when they talk about investment in intangibles being an investment. The tangibility of any investment, or most correctly what financial accountants choose to recognize, isn’t what make an investment an investment to marketers.

I imagine these scholars are useful allies. Still, I don’t think it is fair to expect them to find the perfect metric for use in marketing and then blemish their good names by citing them to support dubious statements about Total q as a performance metric. Please don’t make us marketers look bad in front of the finance people by using Total q as a performance metric.

Conclusion For Marketers: Total Q Measures Investment Opportunities (Not Firm Performance)

I want to be very clear for any marketers reading. The fact that Peters and Taylor, who seem like impressive scholars writing in a good journal, describe Total q does not mean the metric is ‘approved’ for any use you want to put it to. You cannot just say, “We used Total q (Peters and Taylor, 2017)” and think this is a meaningful way to describe your dependent variable. The dependent variable is the most important thing in your paper — it is, literally, what you care about. At the risk of sounding like a bad 80’s pop song, you must show that you care.

Most obviously Total q was never designed to be a measure of firm performance. Peters and Taylor never say ‘you can use this as a firm performance metric’ so citing them in justification of this use of their metric is, quite frankly, wrong. At no point do they recommend Total q’s use as a firm performance metric. Marketers must read the original article if they think I am wrong.

Arguments For Total Q As Firm Performance. Are There Any?

I doubt it yet it may be possible to come up with a plausible argument for Total q as a firm performance metric. Still, Peters and Taylor most certainly haven’t done it for you. This means to use it as such that you need to construct the arguments for your own use of Total q as a dependent variable in your paper. You should simply not pretend it has already happened somewhere else when it hasn’t.

Total q also requires a bunch of decisions to be made to implement it. Peters and Taylor examine theirs with robustness checks. Whenever a marketer wants to use Total q the reviewers should ask: Have you done this? How?

Total q should not make Tobin’s q socially acceptable as a performance metric. Yes, it is likely to be a little better than Tobin’s q but it still doesn’t make sense as a performance metric.

Further Reading

Read: Ryan H. Peters and Lucian A. Taylor (2017) Intangible Capital and the Investment-q Relation, Journal of Financial Economics, 123, 251-272

For more on Total q see here.

For more on Tobin’s q see here.

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