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|Title: ||Measuring a firm's economic profitability: a study of the measurement of a firm's economic profitability with proposals for, and evaluations of, an ex post measure, return on total capital employed (ROTCE), and an ex ante measure, a modified version of Tobin's q (modq) employing current earnings in lieu of capital employed|
|Authors: ||Graham, Martin|
|Issue Date: ||1994|
|Publisher: ||© Martin Graham|
|Abstract: ||Despite its significance for industrial economics, utility
regulation and competition policy, the measurement of the
economic profitability of a firm remains a relatively underresearched
area. The difference between the Accounting Rate of
Return (ARR), measured on a net replacement cost or current
cost basis, and a firm's estimated risk adjusted cost of
capital is favoured by many economic researchers and is widely
employed in utility regulation, but strong claims have been
made for Tobin's q (q - the ratio of the market value of a
firm's securities to the cost of replicating the firm, often
identified with the net replacement cost of its net assets).
Both measures have shortcomings. Davis and Kay have drawn
attention to, but have failed to fully explain, a bias in ARR
when firms buy in goods and services. Bias in q due to the
omission of hidden capital can be significant.
In this paper, economic profitability is identified with a
firm's input-output ratio expressed in present value terms,
and with the internal rate of return on a firm's expenditure
in the accounting year, both revenue and capital. In the case
of ex Post profitability, the last two measures are shown to
be equivalent. Departures from the form of these ideal
measures explains the biases in both ARR and q.
Employing the Capital Asset Pricing Model, two alternative,
operational measures of a firm's economic profitability are
derived from the ideal measures with a view to eliminating the
biases in q and ARR. The ex post measure is called here the
Return on Total Capital Employed (ROTCE) and the ex ante
measure is called here modified Tobin's q (modq).
ROTCE is appraised using data from a simple corporate model.
modq is appraised using data extracted from the accounts of
companies comprising the Buildings Materials and Food
Manufacturing sectors of the FTA All Share Index. In this
study, I/modq and 1/q are shown to be significantly correlated
at the 95t confidence level, and some 45k of the difference
between them can be associated with taxation effects.
Associating market power with the product of Beta and the
Return on Sales, 1/modq is found to be significantly related
at the 95t confidence level with market power and wages
deflated by market value.|
|Description: ||A Doctoral Thesis. Submitted in partial fulfillment of the requirements for the award of Doctor of Philosophy of Loughborough University.|
|Appears in Collections:||PhD Theses (Business School)|
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