The generation and exploitation of technological change: market value and total factor productivity

In this paper we articulate and test the hypothesis that TFP is a reliable and relevant measure of firm's innovation capabilities, and, as such, accounts for Tobin's q indicator. With this aim, we investigate empirically the relationship between firm level total factor productivity and the Tobin's q. Measuring Tobin's q allows inferring the actual value of knowledge capital from stock market valuation. We use a panel of companies listed on UK and the main continental Europe financial markets (Germany, France and Italy) for the period 1995-2005. Our results confirm that TFP is a reliable indicator of firm's innovative capabilities. When we control for firm's R&D investments and intangible assets, the effects of TFP on market value remain highly significant. This suggests that TFP is a broader measure of innovation capability than R&D is. The validation of the Tobin's q and TFP relationship has important implications concerning firm's technological innovation measurement.