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, 2013

"... We develop a new methodology for equity valuation from the perspective of managers’ supply of capital assets. Under the q-theory of investment, managers will adjust the supply of assets to changes in their market value. The optimal investment condition then provides a valuation equation that infers ..."

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We develop a new methodology for equity valuation from the perspective of managers’ supply of capital assets. Under the q-theory of investment, managers will adjust the supply of assets to changes in their market value. The optimal investment condition then provides a valuation equation that infers asset prices from managers ’ costs of supplying the assets. This equation fits well the Tobin’s q levels across many testing assets, including portfolios formed on q. With current investment-to-capital as the only input, the supply approach does not require cash flow forecasts or discount rate estimates,

### [15:56 6/11/2013 RFS-hht067.tex] Page: 3029 3029–3067 A Supply Approach to Valuation

"... A new methodology for equity valuation arises from the perspective of managers ’ supply of capital assets. Under q-theory, managers optimally adjust the supply of assets to changes in their market value. The first-order condition of investment then provides a valuation equation that infers asset pri ..."

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A new methodology for equity valuation arises from the perspective of managers ’ supply of capital assets. Under q-theory, managers optimally adjust the supply of assets to changes in their market value. The first-order condition of investment then provides a valuation equation that infers asset prices from managers ’ costs of supplying the assets. This equation fits well the Tobin’s q levels across many testing assets, including portfolios formed on q. With current investment-to-capital as the only input, the supply approach does not require cash flow forecasts or discount rate estimates, both of which are notoriously difficult to obtain in practice. (JEL D21, E22, G12) What determines equity valuation? This economic question is immensely important in theory and practice. A vast literature has built on present value models such as the dividend discounting and the residual income models for equity valuation (e.g., Ohlson 1995; Dechow, Hutton, and Sloan 1999; Frankel and Lee 1998). Widely practiced in the financial services industry, valuation is at the core of standard business school curricula around the world with many textbook treatments (e.g., Lundholm and Sloan 2007; Palepu and