Tobin's 'q' theory

Definition

Economics theory of investment behavior where 'q' represents the ratio of the market value of a firm's existing shares (share capital) to the replacement cost of the firm's physical assets (thus, replacement cost of the share capital). It states that if q (representing equilibrium) is greater than one (q > 1), additional investment in the firm would make sense because the profits generated would exceed the cost of firm's assets. If q is less than one (q < 1), the firm would be better off selling its assets instead of trying to put them to use. The ideal state is where q is approximately equal to one denoting that the firm is in equilibrium. Also called general equilibrium theory or 'q' theory, it was proposed by the US Nobel laureate economist James Tobin (1918-).