Tobin's q Does Not Measure Firm Performance : Theory, Empirics, and Alternatives

Tobin's q is often used to proxy for firm performance when studying the relation between corporate governance and firm performance. However, our theoretical and empirical analysis demonstrate that Tobin's q does not measure firm performance since underinvestment increases rather than decreases Tobin's q. As an alternative to Tobin's q, our theoretical framework provides two new operating efficiency measures: the first assesses scale efficiency and the second assesses cost discipline. These proxies are justified by the ideal of maximizing firm value net of invested capital, and can be computed for a wide cross-section of firms. In a canonical governance-performance regression specification, our operating efficiency measures lead to a different conclusion than Tobin's q