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We decompose the market-to-book ratio into two additive components: a conservatism correction factor and a future-to-book ratio. The conservatism correction factor exceeds the benchmark value of one whenever the accounting for past transactions has been subject to an (unconditional) conservatism bias. The observed history of a firm�s past investments allows us to calculate the magnitude of its conservatism correction factor, resulting in an average value that is about two-thirds of the overall market-to-book ratio. We demonstrate that our measure of Tobin�s q, obtained as the market-to-book ratio divided by the conservatism correction factor, has greater explanatory power in predicting future investments than the market-to-book ratio by itself. Our model analysis derives a number of structural properties of the conservatism correction factor, including its sensitivity to growth in past investments, the percentage of investments in intangibles, and the firm�s cost of capital. We provide empirical support for these hypothesized structural properties.
