SENSITIVITY ANALYSES

Sensitivity Analyses

Sensitivity Analyses

Sensitivity Analyses

Sensitivity Analyses is an investigation into how projected performance varies along with changes in the key assumptions on which the projections are based. A technique used to determine how different values of an independent variable will impact a particular dependent variable under a given set of assumptions. This technique is used within specific boundaries that will depend on one or more input variables, such as the effect that changes in interest rates will have on a bond's price.

Tobin-Q theory, advocated by Tobin (1969) and developed by Summers (1981), Hayashi (1982), etc. argues that if the capital market is complete, firm's investment will depend on the ratio of the marginal market value of capital to the marginal cost. When Q is more (less) than 1, the firm should increase (decrease) its investment. As an important branch of investment theory, Tobin-Q has been a fundamental theoretical for the firm's decision. Numerous tests prove that Tobin-Q can explain the investment expenses.

Since Q-ratio, advocated by Tobin (1969), is on the concept of marginal, which is difficult to measure in practice, researchers always use average-Q to proxy it. In practice, Tobin-Q is the ratio of a firm's market value to the reproduction cost (Furstenberg, 1977). As for the market value, we usually use the market price of the stock, which implies the hypothesis of market efficiency. Later, Lindenberg and Ross (1981) and Lang and Litzenberger (1989) provide the detail to calculate the average value and Chung and Pruitt (1994) simplify these methods. However, Hayashi (1982) points out that the replacement of average Q to Tobin Q should be on the condition that firms are the complete price takers.

Studies of Morck et al. (1990) and Blanchard et al. (1993) show significant positive correlation between price and firm investment, but these researchers have got no agreement on what is the reason for the positive correlation. Since the existence of market friction and incompleteness of information transfer, market information is asymmetric. Firms make their optimal strategy from the maximization of firm value and individuals from the maximization of utility. In this sense, one convincing explanation for the correlation between firm investment and stock price is, with the stock price, managers can learn some information about firm performance in future. Namely, the stock prices reflect information of various market participants and these participants may have no information communication with firms, so the stock prices may contain some information unknown to the managers which will help managers to form strategies such as investment decisions.

In fact, in their early studies, Grossman and Stiglitz (1980), Glosten and Milgrom (1985) and Shleifer and Vishny (1997) point out that firm information produced by investors will be used in the transaction actives, so this information can be naturally reflected in the market price and the price fluctuation can deliver the information about the future prospect of firms. Boot and Thakor (1997) argue individual investors in the market may be business experts and be better informed about the change in the industry and customers' ...