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Stern Stewart & Co, a consulting firm based in New York, introduced the concept of EVA as a measurement tool in 1989, and trademarked it. EVA is the quantum of economic value (or profits) generated by a company in excess of its cost of capital. Mathematically, it is the difference between the Net Operating Profit after Taxes (NOPAT) and the capital charge; or, the product of the capital employed and the difference between the Return on Capital Employed (ROCE) and the COC. In principle, it is a comprehensive financial management system that encompasses a range of functions like capital budgeting, acquisition pricing, goal-setting, and strategic planning.
The development in the Indian capital market along with the increased awareness among the shareholders has increased the pressure on the companies to consistently perform better. Investors are very much keen in knowing what amount of wealth the company has created for the shareholders. The value created by the company is more linked to the market price of the shares. The objectives of this study were to ascertain EVA and other traditional determinants of share price for sample companies, to analyse the relationship between EVA and share price to ascertain whether EVA is superior to traditional determinants of share price & to assess the impact of EVA on market return. The study was carried out on companies listed in BSE Sensex and Nifty for a period of 5 years beginning from FY 2007-08 to FY 2010 - 11.
From the analysis of the EVA of the company it was concluded that the value drivers which is responsible for the value creation and value erosion of the company are operating profits, Cost of capital and return on new investments made. Hence, the company should focus on redesigning the capital structure in order to reduce the capital cost and invest on only those investments which will earn more returns.
The study concluded that the relationship between the EVA and share price is not significant. There is a negative relationship between the share price and EVA in some occasion, which is an unrealistic outcome. In real life situation there can be negative
relationship between the share price and EVA of the company. Hence, it could be said that the EVA does not influence share price significantly. But when other determining factors such as EPS, ROCE, RONW and profit of the company are considered EPS turned out to be a major determining factor of share price. Hence, it could be concluded that Earning per Share is a major influencing factor of the share price among EVA, ROCE, RONW and Profit of the company.
The study also concludes that there will be a deviation from EVA as per investors' calculation using the secondary data available in order to make investment decision and the actual EVA calculated by the company. This is mainly due to the inadequate information available to make the accounting adjustments that have to be made during the calculation of EVA of the company.
This study is presented in five chapters, first chapter in the introductory chapter explaining the background, objectives and scope of the study. Second chapter presents the literature review based on the topic and is divided into Conceptual review, Empirical Review and Contextual review. Third chapter explains the research methodology of doing the analysis, Research industry information, Research design and Mode of analysis. Fourth chapter explains the analysis and interpretation of the study. Fifth chapter presents the findings based on the analysis and also the conclusion.
CHAPTER - 1
Economic Value Added, (or EVA), has become a new buzz word in the corporate movement toward emphasizing shareholder value. Displaying a pattern familiar for corporate fads, EVA citations have grown exponentially from a handful in 1993 to more than 300 in 1997. Fortune magazine has touted EVA as "The Real Key to Creating Wealth", "A New Way to Find Bar gains," and since 1993 has published an annual "Performance 1000" issue featuring EVA. While many know EVA as a long established concept called "residual income", it is safe to say that residual income under its old name never received the excitement that EVA has generated. A number of consultancies now market EVA- type metrics, but Stern Stewart & Co. is commonly recognized as the industry leader. Stern Stewart has been mainly aggressive in marketing their version of residual income, which they have trademarked EVA. Stern Stewart & Co, a consulting firm based in New York, introduced the idea of EVA as a measurement tool in 1989, and trademarked it. The EVA concept is often called Economic Profit (EP) to avoid problems caused by the trade marking.
Literally, EVA is the quantum of economic value (or profits) generated by a company in excess of its cost of capital. Mathematically, it is the difference between the Net Operating Profit after Taxes (NOPAT) and the capital charge; or, the product of the capital employed and the difference between the Return on Capital Employed (ROCE) and the COC. In principle, it is a comprehensive financial management system that encompasses a range of functions like capital budgeting, acquisition pricing, goal-setting, and strategic planning. In accounting terms, the concept EVA is based on the principle of residual income, which states that the real income generated by a company is the residue that remains after a company's shareholders and debtors have been paid their annual required return.
: Statement of problem :
The expansion in the Indian capital market along with the increased alertness among the shareholders has increased the pressure on the companies to regularly achieve better. Investors are very much keen in knowing what amount of wealth the
company has created for the shareholders. So, the worth created by the company is more related to the market price of the shares. So, the question that has to be addressed here is that whether the value addition by the company is also a dependent factor for the movement in the share price. Hence, there is a need to find out the relationship between the value added by the company and share price.
: Purpose of Study:
This study aims at assessing the impact of EVA on financial performance of the companies as well as the market returns.
: Objectives of the study:
The objectives of this study are as follows:
To assess the relationship between EVA and share price.
To Compare EVA with traditional determinants of share price.
To assess how financial performance of the company impacting EVA.
To assess the impact of EVA on market return.
: Research Questions
What is the relationship between EVA and share price?
How is the financial performance of the company impacting EVA?
Which financial performance measure is more efficient? Whether is it EVA or traditional measures?
What is the impact of EVA on market return?
1.6: Scope and Limitations:
The study is confined to cement companies listed in BSE Sensex and Nifty for a period of 8 years beginning from FY 2006-07 to FY 2010-11. Since EVA calculation involves lot of subjectivity, it may influence accuracy of the findings to a certain extent. Statistical techniques have been used for the analysis and the limitations of those techniques are applicable here also.
A literature review is a specific type of research paper that focuses on published literature on the given topic. It is more than a mere summary of the literature, however, as it presents analysis, patterns, and critiques of individual sources, groups of sources, and the body of literature as a whole. In this chapter the review of literature has been made which is divided into three sections. Conceptual Review: digests areas of conceptual knowledge that give rise to a better knowing of the issues. Empirical Review is the literatures, or past research that report or dispute confidently with your research speculation and factors. Contextual evaluation reveals the research which has been done formerly on the particular subject.
2.1 Conceptual Review
2.1.1: Economic Value Added - A General Perspective
Asish K Bhattacharyya & B.V.Phani (2001) in their study analyse whether EVA is a higher measure both for corporate reporting and for domestic governance. They opened that though EVA does not offer details to traders, it can be improved as a company point of view for motivating and teaching workers to tell apart between value developing and value destructing activities. This would guide to direct all initiatives in creating shareholder worth. The document features the attention of the risky activity of confirming EVA casually that might deceive investors.
Economic Value Added - the concept
The concepts of EVA and 'residual income' are based on the theory that a firm creates wealth on behalf of its owners only if it generates extra over the cost of the total invested capital. EVA is nothing other than the residual income after factoring the cost of capital into net operating profit after tax. This paper examines EVA both as to assessment of overall performance and management beliefs that helps to progress the productivity of resources.
EVA= (adjusted NOPAT - cost of capital) x capital employed------- (I)
EVA = (Rate of return - cost of capital) x capital --------- (II)
Rate of Return = NOPAT/Capital
Capital = total assets minus non-interest bearing debt, at the beginning of the year
Cost of capital = cost of equity x proportion of equity + cost of debt (1-tax rate) x proportion of debt in the capital.
The above cost of capital is nothing but the weighted average cost of capital (WACC)
Cost of equity is normally estimated using capital asset pricing model (CAPM) that estimates the expected return commensurate with the riskiness of the assets.
If ROI is defined as NOPAT/capital then the above equation can be rewritten as
EVA= (ROI- WACC) x CAPITAL EMPLOYED----- (III)
This paper examines the EVA concept from two perspectives, EVA as a performance measure and EVA as a corporate philosophy.
EVA as a performance measure
The authors argue that EVA is a superior measure as compared to other performance measures on four counts:
ô€‚ƒ It is nearer to the real cash flows of the business entity;
ô€‚ƒ It is easy to calculate and understand;
ô€‚ƒ It has a higher correlation to the market value of the firm and
ô€‚ƒ Its application to employee compensation leads to the alignment of managerial interests with those of the shareholders, thus minimizing the supposedly dysfunctional behaviour of the management.
EVA a superior performance measure
EVA is considered as being innovative than the regular measures such as ROI, ROE and ROA, which are depending on the accounting data by these authors. With regard to investment spent in the company, these actions measures the rate of return earned by the firm. The main restriction of these measures is derived from limitations inherent in the measurement of accounting profit. EVA claims that because of these imperfections, the accounting centered techniques are not good proxies for value making. Whether EVA is an
enhancement over straight measures and serves the purpose of attractive the professionals to pay thought to investors' value even if that outcomes in limiting present performance. The response may be adverse because all the above restrictions are also relevant with EVA.
EVA as a Corporate Philosophy
According to authors, EVA may not have superior informational value to capital markets; it can be very practical in recovering the productivity of a firm, if adapted as a corporate philosophy. EVA, as a corporate philosophy, entails using of EVA at each decision level in the organization. In fact EVA should be personalized as a culture inside the organization rather than as a scheme. EVA when used as a corporate philosophy does not require accurate opinion, therefore hurdles in calculating EVA does not come in the way of building the EVA traditions in an organization. Consequently it is not hard for workers to use EVA for making choices counting operational decisions. As a result it is not hard for employees to use EVA for decision making counting operational decisions. The benefit of EVA over other alike tools is that it improves business literacy because of easy understand expertise and theoretical quality. The one factor that sets it apart over usual measures is its reflection of the cost of capital and this is the one part, which have to be recognized by everyone occupied in operations.
2.1.2: Economic Value Added (EVA) - Relevant Issues
Dr. Anil K. Sharma and Satish Kumar (2010) in their paper emphasize the idea of EVA have obtained considerable notice in the advanced economies, but execution problems and its soundness is under controversy all over the world. This paper provides a wide literary works evaluation and a considerable research to move to the developments in EVA. The EVA of the company is just a measure of the incremental return that the asset earns over the market rate of return. In simple terms, it can be acknowledged that EVA defines the profitability net of cost of capital. EVA can be derived by the net operating profit minus suitable charge for the opportunity cost of all the capital invested in a project. EVA is an evaluation of true financial revenue or fall short of the minimum rate of return that investor and lenders could get by investing in other securities of similar risk.
Relationship between Economic Value and Stock Returns.
Relationship between Economic Value and Stock Returns are discussed by the authors. The supporters of EVA argue that EVA is highly correlated with stock returns. Stock
prices can be derived superior than other accounting based performance indicators through EVA. EVA is better correlated with stock returns as compared to traditional performance measures. Machuga et al. (2002) in their study highlighted that EVA can be used to progress future earnings predictions. They also found that EVA and RI (Residual Income) variables are highly correlated and alike in terms of relationship with stock returns. Some researchers state that EVA performs relatively poor in association with other measures like earnings in explaining the stock returns. The significant reasons are estimation errors in calculating capital charge (WACC) and accounting adjustments as compared to what market is using to value firms.
EVA adoption and firm value
The Firms which adopt EVA will have above average profitability compared to their peers Additional facts too state those EVA adopters generate improved profitability relative to their peer after implementation of EVA. The firms using EVA show a superior proportion of institutional rights and a lower percentage of insider rights than non-adopters. An important study of Wallace (1997) that addresses the changes made by EVA adopters is being cited by the authors. It examines the resulting performance of firms using EVA and other residual income methods. The author finds that EVA adopters dispose of more assets and fewer new investments. Shareholders get what they pay for; i.e. performance is greater in the areas that are resistant by the EVA bonus plan.
Relationship between EVA and Market Value Added (MVA)
These authors examined the connection between EVA and MVA of companies and found a stronger correlation between EVA and MVA. They established that MVA and NOPAT were positive or normal but the average EVA over the period was negative.
EVA and Managerial Performance
The authors observed EVA is measured as better choice to the traditional performance method such as Profits, EPS, and ROE etc. EVA based performance drive managers to use firm's assets more successfully and it helps in lessening of modifications in the interests of the managers and shareholders. The firms that take on residual income based incentives plans show increased income. EVA and residual income could show useful in motivating managers for shareholder wealth formation but whether execution of EVA and residual income based incentives have been truly useful remain an open question for future research. An efficient EVA reward system requires a huge commutation attempt and extensive guidance for both managers and their subordinates.
2.1.3: Value Creation and Its Measurement: A Critical Look at EVA
Ignacio Vélez-Pareja, 2001, study's the Financial Value Included, EVA. First, a conceptual structure regarding the Net Existing Value, NPV, is provided. The NPV is a means for financial decision-making based on value maximization. Second, an approach to determine the no cost income beginning from the period's money funds is suggested. Third, a process for determining the actual no cost income is designed. Fourth, the EVA is provided as it chases to evaluate the same idea as the NPV does. However, EVA begins from bookkeeping outcomes (profit) and NPV begins from net money moves. The chance between MVA and NPV is analysed. Four cases are provided where some variance between the two dimensions are discovered. The four cases demonstrate that EVA consistently undervalues the value produced by company as in contrast to the NPV. A strategy for determining the actual EVA is provided. Some understandings about what outcomes should be applied in order to determine the cost of the spent invested capital or equity to be involved in the computation of EVA. Lastly, different techniques to determine EVA and MVA are in contrast to NPV outcomes.
2.1.4: Economic Value Added Performance Indicators for Comparison with the Traditional.
In this article the author tried to explain the importance of EVA and its relationship with other traditional performance indicators of an organisation. EVA is compared with the traditional performance evaluation methods.
Stock Market Act
Stock market law can advise managers how to look at the market is the company's management and value creation ability to the manager critical out over a longer period of time their value creation potential of the company moved to the investor's achievement.
Return on investment
Return rate of investment decision-making basis, any investment plan return on investment is less than the weighted cost of capital, in spite of the approach from the department managers, or from the company point of view, they should give up the investment at this time, department managers target and business objectives and vice versa.
Return on equity
Return on equity reflects the return on shareholder investment funds for the after-tax net income and equity capital ratio. The return on equity as a management indicator, managers may be replaced simply because with the debt equity capital, changes in the company's capital structure and get high bonuses, managers and therefore may accept debt financing program, and give up those who have to use equity financing of Item.
Earnings per share
Earnings per share are the share of a project during a certain performance (with after-tax net profit divided by the number of ordinary shares outstanding). After-tax earnings per share not only by the size of the impact of the performance, but also by the impact of differences in capital structure, while the capital structure of the company's headquarters rule, at the sectoral level is the manager of non-controllable factors, is not conducive to the performance of sector managers assessment.
Cash flow evaluation method
The main indicators of cash flow valuation method, including free cash flow, net present value and investment return on cash flow, these indicators in the venture the ability to generate cash flow to help business managers recognize the business of capital efficiency.
Evaluation the choice of indicators
Enterprises must favour an appropriate evaluation method. It must be based on firm features or evaluation of the objectives to be accomplished to make the final choice. If an enterprise just needs to improve balance sheet efficiency, control of working capital,
increased turnover, develop accounts receivable management, and then the basic evaluation methods, such as return on assets, or EVA are good enough, since all of these indicators are profits and assets sheet related. If the depreciation of the assets of enterprises should take out more, then the cash flow rate of return is the best method, because it is calculated to be definite and adjusted depreciation of the asset.
Those cost savings have been accomplished, the project enterprise restructuring, the current would like to stress growth, and those who just want access to further growth opportunities for businesses, should dump the rate of return methods, such as return on investment, return on equity, cash flow, return and so on, because these indicators for assessing the benefits of growth did not, it will allow managers tend to prefer not to increase the capital utilization was able to create revenue growth in investment programs. Such enterprises should use EVA evaluation.
It should be noted that the purpose of performance evaluation is to maximize shareholder wealth, if the valuation is complex and difficult to value, for the purpose of achieving that any assessment of effectiveness of the system will be weakened.
2.1.5: Economic Value Added: The Invisible Hand at Work
Durant, Michael (2000) in his article "Economic Value Added: The Invisible Hand at Work" has described that EVA is both a measure of value and also a measure of performance. The value of a business rest on investor's hopes about the upcoming profits of the enterprise. Stock prices track EVA far more thoroughly than they track earnings per
share or return on equity. A constant rise in EVA will bring an increase in the market value of the company. As a performance measure, Economic Value Added forces the organization to make the creation of shareholder value the number one priority. Under the EVA method, stiff charges are incurred for the use of capital. EVA focused companies focus on improving the net cash return on invested capital. EVA is changing the way managers run their businesses and the way Wall Street prices them. When business decisions are aligned with the interest of the shareholders, it is only a matter of time before these efforts are reflected in a higher stock price.
2.1.6: Study of Economic Value Added (EVA) and its Relationship with the Share Price
Anish Kumar (2009) explains the uses, benefits and limitations of EVA with the focus on decision making, performance evaluation, and incentive compensations.
The management decision-making procedure includes mainly the assessment of financial commitment and the allocation of the organization's resources. According to the authors the traditional procedure to make such choices is depending on income and it is termed as capital budgeting. EVA may be added now as an additional tool to make financial commitment choices that includes new projects, mergers and acquisitions. In this regard, EVA is close to net present value (NPV) technique. The use of cash flows as an important long-term signal of investor value is depending on discounting the money moves in the same way as used in financial commitment capital budgeting and perseverance of the worth of takeover targets. The use of EVA in the choice should response the concern of whether the organization being obtained will improve the value of the acquiring organization and whether it will make extra value to the current investors later on. One of the identifying functions of EVA is its application to areas where investor value is designed. As per the author one of the major benefits of using EVA as a decision tool is in the area of asset management. One of the major contributions of EVA is that management now pays greater attention to management of assets, allocation of resources and capital structure including the operating leverage. Furthermore, EVA according to author is appealing to developing companies that need to fund their projects through satisfying the value enhancement requirements of investors.
The author observed that the evaluation of management efficiency introduced about more use of economical and non-financial signs. The use of EVA in efficiency assessment introduced about a clean strategy as to how management should think. Citing an EVA Brochure of the Millennium Chemicals Inc., a Subsidiary of Hanson, the author states that the top professionals consider the development of value as their objective. Thus, the author perceives that the companies consider EVA, not only as a tool for calculating value development but a mind-set, and a behaviour. He also perceives that the company thinks EVA goes beyond conventional economical actions to demonstrate how they make value through upgrades in revenue and spending budget as well as through handling company resources. In evaluating efficiency through the use of EVA, a focus on EVA for the development of short-term and long-term success has to be recognized. The use of EVA could be prolonged to all stages of workers throughout the company. According to this author when these workers, especially the revenue workers, know that concentrating on EVA will offer them with information that shows edges on a particular products or client, then they will be vulnerable to give up calculating their efficiency by amount alone and become more relaxed with the economic value approach.
The author opinions that most companies that use the EVA approach tie management efficiency to professional compensation plans and to the objectives of investors. Regardless of the measure used for incentive compensation, management should affiliate it with efficient functions; value added products and services, on-going enhancement, cost reduction, and divestment of under-performing resources, innovation, customer satisfaction, and other non-financial actions.
2.1.7: EVA: The Right Measure of Managerial Performance
Reddy Irala, Lokanandha (2005) had conducted a research study entitled as "EVA: The Right Measure of Managerial Performance?" According to this study it is very essential to align the interests of the mangers and shareholders or at least lessen the difference in interests. In this regard Economic Value Added has been seen as better alternative to the traditional performance measures-Profits, EPS, ROCE and ROE etc. While successful EVA stories in the west are quite encouraging, empirical research is not adequate to establish the claim of EVA as a better measure. Nevertheless there is also not much study to prove it otherwise. In case of India both way research is very insufficient. Although not a panacea, EVA based compensation plans will drive managers employ a firm's assets more effectively and EVA should help lessen the difference in the interests of the managers and shareholders, if not perfectly align them.
2.1.8: The Development of Corporate Performance Measures: Benchmarks before EVA
Goetzmann, N. William and Garstka, J. Stanley (2005) had conducted a research study entitled, "The Development of Corporate Performance Measures: Benchmarks before EVA". The study reveals that EVA can be viewed as a modern effort to apply concepts that have been developed through the course of the 20th century by economists and managers. While it fairly reflects the basic concept of single-period residual income, it does not address the inter-temporal nature of the valuation problem. Without proper adjustments, EVA may even short-change future growth opportunities.
2.1.9: An Analysis of EVA and Other Measures of Firm Performance Based on Residual Income
Martin, D. John, Petty, J. William, and Rich, P. Steven (2003) in their research study entitled, "An Analysis of EVA and Other Measures of Firm Performance Based on Residual Income" reviews the theoretical foundations of residual income as a tool for evaluating a firm's interim performance for purposes of assigning incentive compensation. Consequently, paying for performance using residual income to measure wealth creation can have incentive effects that are inconsistent with wealth creation. The paper describes that recent efforts to address the limitations of residual income can efficiently address the wealth measurement issue; however, they give rise to serious execution problems connected to the necessity for predicting future firm performance. Furthermore, if internal predictions of future firm performance are used, this is a source of a potentially serious moral threat problem as the same managers whose performance is being assessed provide the forecasts.
2.1.10: EVA and Innovations in Decision Making and Financial Management
Prof. JHvH de Wet, Mr. FJ de Hart, (2001) state that economic value added (EVA) of an organization is currently recognized as the single, most suitable internal measure of business financial performance. Its attraction can be found in the fact that it is conceptually sound as it shows the true financial revenue of an organization after considering the full cost of capital, such as the (opportunity) cost of equity. This research analyzes how current control traditional and economical value methods can be modified to integrate the EVA viewpoint. It also is applicable these modified methods to an organization detailed on the JSE Investments Exchange South Africa.
The research goals of these authors are the following:
â€¢ Investigating the modification of the following control methods to incorporate EVA
â€¢ Cost-volume-profit decision-making and breakeven analysis;
â€¢ Leverage and understanding analysis;
â€¢ Target priced at and
â€¢ Share value.
Using the data of a detailed organization (Woolworths) to implement the methods modified for EVA and to recognize possible difficulties and stumbling blocks.
The study examined some current cost management and financial management methods and shown how these can be modified to integrate EVA. The realistic output of this is that organizations can implement these modified methods for day-to-day operating choices like cost/volume revenue choices or even long-term strategic decisions like valuations. This strategy will make sure that the concentrate continues to be on an all-encompassing strategy for the maximization of investor value. This research outlined a few of these possible improvements, namely in regard of cost-volume revenue decision-making, make use of, concentrate on priced at and discuss assessment. If EVA is within the choice model and maximization of EVA is desired, it guarantees that the value of the organization is also optimized (all other things being equal). This study examined some current spending budget and economical control methods and shown how these can be modified to integrate EVA. The realistic output of this is that organizations can implement these modified methods for day-to-day managing choices like cost/volume revenue choices or even long-term ideal choices like value. This strategy will make sure that the concentrate continues to be on an all-encompassing strategy for the maximization of investor value.
2.2: Empirical Review
2.2.1: Valuation through EVA and Traditional Measures an Empirical Study
Dr. N R V Ramana Reddy, M.Rajesh, Dr.T.Narayana Reddy(2011) the authors of this paper describe and compare the EVA with other measures like Return on Equity (ROE), Return on Net worth (RONW), Return on Capital Employed (ROCE) and Earnings per Share (EPS). Apart from this, taking the real financial data of a company, the paper shows how EVA calculations can be done to demonstrate whether the company is adding to shareholder value by generating profits over and above the capital charge.
Table 2.1: Comparison of different Traditional Performance Measures
Source: International Journal of Trade, Economics and Finance, (Feb - 2011)
From the above table 2.1, it is clear that traditional measure of corporate performance does not consider cost of capital in calculation of NOPAT whereas EVA includes the same.
Study tried to find out the following objectives:
1) To calculate the EVA and Traditional Performance measures like ROCE, EPS, and RONW of Hindustan Unilever Limited.
2) To compare EVA with the Traditional methods for evaluating a company's Financial Performance.
The secondary data has been collected from published annual reports of HINDUSTAN UNILEVER LIMITED
Tools of Analysis:
EVA = NOPAT - COCE
NOPAT = Net operating profits after tax
COCE= W1.Kd + W2. Ke+ W3.Kr
W1, W2, W.3 = Weights assigned to individual sources in the capital structure
Kd = I (1-t)
Kd= Cost of Debt
I = Interest rate
t = tax rate
Ke= Dividend + g
Ke= Cost of Equity
Po= Price of share
G = growth in a share
g = Ke X Retention Ratio (b)
b= Earnings per Share - Dividend per Share
Earnings per Share
Table 2.2: EVA VS ROCE AND EVA VS RONW AND EVA VS EPS
EVA as a %
a % of
EVA as a % of
No. of shares
Source: International Journal of Trade, Economics and Finance, (Feb - 2011)
ROCE was observed to be 61.8% i.e., for every Rs 100 investment the return is Rs 61.8, whereas EVA as a percent of Capital Employed is only 30.43 i.e., or every Rs 100 investment, the company has added value of Rs 30.43.On an average, the Return on Capital Employed during the study period is 62.4 % whereas average EVA as a % of Capital Employed is 33.25%. The assessment shows that difference exists between the performance results given by traditional methods and EVA. The traditional methods do not reveal the real value addition to shareholder's wealth.
Table 2.3: Coefficient of Correlation of different performance measures with SVA
Source: International Journal of Trade, Economics and Finance, (Feb - 2011)
In this study EVA is the measure that correlates the best by far with shareholder wealth creation and it would be fair to assume that a company that can constantly improve its EVA should be able to improve its shareholder value. It is also recognized that the comparatively weak correlation that was existing between SVA (Shareholder Value Added) and ROCE, RONW as well as EPS. The study concluded that growth in earnings is not adequate to generate value, except returns are higher than the cost of capital. From the study, it is evidently observed that EVA, when compared with traditional measures, it gives accurate figures how much actually the shareholder is going to get at the end of the accounting year by taking into account cost of capital like cost of equity, cost of debt, and cost of retained earnings. The study concludes that EVA is the best fitting measure for measuring the value of shareholders.
2.2.2: EVA or Traditional Accounting Measures; Empirical Evidence from Iran
Mehdi ArabSalehi and Iman Mahmoodi (2011) in their study tried to find out the superiority of EVA as a performance measure compared to traditional accounting measures. The study is done with 76 companies listed in Tehran Stock Exchange from 2001 to 2008. Here both relative and incremental information content approaches are employed.
Here stock return is taken as the dependant variable and the independent variables are EPS, ROA, ROE and EVA. EPS is measured by dividing net income by the average number of common shares outstanding. ROA is measured by dividing net income plus interest expenses by average total assets. ROE is measured by dividing net income by average equity.
EVA = NOPAT - (WACC Ã- CAPITAL t -1)
Adjusted NOPAT and invested capital are determined by:
NOPAT t = EBIT t -Tax+ Adjustments t
Invested Capital = equity + all interest-bearing short and long term liabilities + Adjustments
The cost of capital is defined as follows:
D is the book value of debts, E is the market value of equity, Kd is the return on debt, T is the rate of tax and Ke is the expected return of shareholders. The capital assets pricing model (CAPM) is used to estimate the cost of equity (Ke). The annual systematic risk (Beta) for each firm is estimated using 36-monthly returns of each stock (Ri) and returns of market (Rm). In addition, the three-month rate of government bonds, which is acquired directly from the website of Central Bank of Iran, is considered as the risk free interest rate (Rf). However, the cost of equity is calculated as follows:
In this study, to examine the superiority of EVA to traditional measures, a pooling panel data method is used. Relative and incremental information content tests of EVA and three traditional accounting measures (including EPS, ROE and ROA) using the following regressions:
Source: International Research Journal of Finance and Economics (2011)
Where; Rit is stock return of firm i in year t, MVit-1 is market value of firm i in year t âˆ’1, and Î± are the coefficients of regressions and it Ïµit is the error term.
The study shows the descriptive statistics of all variables. Mean statistics shows that all variables have a positive mean and also ROE (0.6033) has the largest and EPS (5.23E- 09) has the lowest mean among the variables. Moreover, the mean of ROE (0.6033) is greater than that of ROA (0.2175) which shows Iranian firms use a lot of debts in their capital structure.
Relative information content tests
Table 2.4: Test results of relative information content of EPS, ROE, ROA and EVA
Source: International Research Journal of Finance and Economics (2011)
As shown regression models (1), (2) and (3) are significant at 1-percent level, while regression (4) is not statistically considerable. The results indicate that stock returns are more connected with ROA (R2 =14.06 percent) than other performance measures, particularly EVA. The relative information content tests show that traditional accounting measures offer more information than EVA.
Incremental information content tests
Table 2.5: Test results of Incremental information content tests
Source: International Research Journal of Finance and Economics (2011)
The study shows F-test and Hausman tests are engaged to choose the most suitable pooling methods. The results of F-tests show that pooled models are suitable than fixed and random effects models for all of regressions (5 to 7). All regression models (5 to 7) are important at 1 percent level. The highest R2 (16.04 percent) is reported in regression (7), which combines ROA and EVA. EVA adds only a little information content further than EPS, ROE and ROA.
The relative information content tests shown that ROA has the highest explanatory control in explaining stock returns. EVA does not have significant association between stock return. As per the study in Iranian capital market traditional accounting measures are more associated with stock returns than EVA. As per incremental information content tests EVA adds only marginally to information content beyond EPS, ROE and ROA. The results show that traditional accounting measures, particularly ROA, do better than EVA.
2.2.3: A Recent Analysis With Respect To EVA and Share Price Behaviour of Indian Banks
Sivakumaran D and Saravanakumar. M (2011) conducted a study among the Indian banks to check the relationship between EVA and share price behaviour. In the study EVA is calculated and compared with the particular share prices of 39 banks of the BSE-BANKEX for a period of seven years starting from FY 2004-05 to FY 2010-11. The study is conducted to find out the relationship between Economic Value added and other financial variables like Return on Assets, Return on Owned Funds and Earnings per Share and also to study the relationship between share price and other financial variables like EVA, ROA, ROF and EPS.
In the paper Pearson's Coefficient of Correlation is used to find the connection between the EVA and other traditional measures. To demonstrate the relationship of EVA, EPS, ROA and ROF with share price Regression analysis has been used. The movement of growth of value addition in terms of EVA in the Indian Banking Industry, the research used statistical tools like mean, standard deviation, CV, LGR (Linear Growth Rate) and 't' statistic for analysing the financial data of the sample banks.
As per the research making an investment in the market is becoming more and more risky as the beta of the individual securities is rising year by year. The rise in beta is increasing weighted average cost of capital; it specifies that capital is becoming more and pricier. The banks share prices have showed a rising trend as the market is becoming more and more risky, investor's outlook are increasing for more or less all the years. In the study share prices of two banks shows high correlation of coefficient and coefficient of determination and the share prices of eighteen bank's shows low correlation of coefficient and coefficient of determination with EVA. This shows that there is no relation between EVA and share price.
This study explains the significance of using EVA as a means for measuring financial performance. It shows that there is no well-built outline of EVA of selected banks all through the period. Due to higher cost of capital the wealth earned by most of the banks in the year 2006 is negative. The concept of EVA is subtracting the cost of capital from the firm's profits to assess, the economic additional value produced by the firm to its owners over the cost of capital employed and the cost of debt has little effect on the EVA. However, as predicted EVA acts in a linear fashion with respect to the cost of equity. It is found that there is no strong relation between EVA and market prices of the banks. Thus, the investors do not give so much weight to EVA for its investment decision. It is also expected that the practice of EVA as a financial performance tool will also be more in India. According to the study EVA is the one of the measures, which can be used to compute the performance of the banks but it cannot be used to predict the share price of the company.
2.2.4: The Relationship between Stock Return and Economic Value Added (EVA): A Review of KSE-100 Index
Muhammad Asad Khan, Naveed Hussain Shah, Atta ur Rehman (2011) conducted the research in order to reveal the connection among stock return and economic value added (EVA) as evaluate to the connection with other variable such as net income (NI) and operating cash flow (OCF) with in Pakistani stock Market. The study is conducted during seven years from 2004 to 2010 for 60 firms. The study is conducted on non-financial firms registered on Karachi Stock Exchange.
The figures contain time series as well as cross-sectional data, so pooled regression model is utilize for the association. The general form of the model is
"Yit" is the stock return, "Î²0" is the intercept, and "Xit" are the independent variables where "eit" is the error term.
The Objectives of this research are
1. Providing independent empirical proof on the information content of EVA, Net income, and accounting earnings measures.
2. Increasing interest in EVA in the business press, increasing use of EVA by firms and among academics, and potential interest in EVA among accounting policy makers.
3. Introducing evidence about the information content of economic value added from the Pakistani market.
The study shows that eventually the EVA is not showing a greater involvement in predicting stock returns as clear from the lower value of its coefficient -53.83 as against to 96.2388 and 51.0941 coefficients of the cash flow from operating activities and net income respectively.
In the study variables are important as clear from the lower p-values but the R-square value shows the superior descriptive power of the cash flow from operating actions. Pearson correlation with the variables calculate that all of the variable are positively correlated excluding EVA which is negatively correlated and among net income it does not show any important relationship so it means none of rapport is found among net income and EVA. The negative correlation between Stock return and EVA is also predicting the dependency on each other.
From the study it is found that EVA is not contributing to the stock return as the investor dependence and trust is on the condition of dividends to the shareholder rather than increasing value of the business. Higher the payment of dividend will eventually add to stock return as investor are valuing it more as clear from the OCF importance and coefficient. Higher OCF means higher cash creation would-be from operation thus eventually predicting greater prospective of payout ratio as a result leading to rising stock return relatively better than the net income seeing that it do add up the noncash account receivable which is incapable to supply in the form of dividends.
In the study authors found that EVA too possesses various qualitative aspects such as the performance of the top management and board of governors and their awareness about the EVA and the mind-set of investors to this model which were not taken due to complexity in measuring these variables.
2.2.5: EVA versus Conventional Performance Measures - Empirical Evidence from India.
The main purpose of the study by A.K. Sharma and Satish Kumar (2011) is to check whether Economic Value Added (EVA) can be used as a tool of performance measures though investing in Indian market and present proof about its advantage as a financial performance measure as compared to traditional performance measures in Indian companies. To attain this, performance of the Indian listed manufacturing companies is compared with traditional financial performance methods used in investment analysis. To test the hypotheses and to know the efficiency of different performance measures Panel data regression was used. As per the Regression results about hypothesis 1 show that EVA is considerable association with MVA of the companies and there is positive connection between EVA and MVA of companies. Another examination from the results is that as EVA outperforms NOPAT, it can be used as substitute for market return (MVA). Only a little percentage of changes in MVA can be explained by EVA and NOPAT as calculated by adjusted r- square of EVA and NOPAT respectively. In order to make out whether EVA dominates traditional performance measures such as NOPAT, ROCE, ROE, and EPS etc. Hypothesis 2 was tested. The results show that EPS and RI lead than EVA in explaining the MVA. Pair wise combinations that most clarify MVA, in order of decreasing power, are EPS/NOPAT (26.54%), EPS/RI (25.98%), and EVA/EPS (29.89%). when combined with EPS, EVA is ranked third best measure, thus concluding that even though EPS is top measures of shareholder valuation however EVA also can be used by investors making investment decision and in firm assessment. Another conclusion from these results is that investor in India mainly focus on conventional measures while making investment decision and in assessment of companies. Incremental value relevance test also hold the same results, reflecting the superiority of traditional measures. The results regarding the value relevance of components of EVA along with traditional performance measures shows that EPS dominates, but components of EVA also add to the variations in shareholder value. Therefore from the mixed evidences from the study conclude that investor have to use EVA while planning investment strategy.
2.2.6: Analysis of Influence Economic Value Added (EVA) and Market Value Added (MVA) Return to Share in Manufacturing Company in Indonesian Stock Exchange
Saputra Agung T, 2005, this analysis is designed to figure out how far the impact of Economic Value Included (EVA) and Market Value Added (MVA) on the stock return. Studies using Regression technique, which is to know about using more than one different in impacting other factors. Objects that are used are manufacturing companies that have gone public and is registered as issuers on an on-going basis at the Indonesian Stock Exchange. The sample used is a manufacturing company which is authorized as providers in Indonesia Stock Exchange from the year 2008-2009 as many as 15 samples. Information analysis is done by using: Multiple Linear Regression, is used to describe the level of connection between independent variables with the dependent variable is expressed with varying degrees of relationship, coefficient of determination, used to measure how big the independent variables can explain the dependent variable, hypothesis testing by t-test , is used to determine whether or not a significant independent variable on the dependent variable individually for each variable and the f-count is used to find out together. T-test results showed that EVA and MVA have no significant relationship to the Return of Shares and based on the F test rejected Ho Ho be accepted and that means there is no significant effect simultaneously or together. On this basis, for investors who will invest their shares in manufacturing companies
2.2.7: An overview of the implementation of Economic Value Added (EVA) performance measures in South Africa
H.M. van der Poll, N.J. Booyse, A.J. Pienaar, S. Büchner & J. Foot,2011, Although Economic Value Added (EVA) might improve the statistic of organisations' efficiency, it seems not to be used commonly in South Africa. The need to evaluate economical efficiency and the different analytics that can be used should be examined to identify the best evaluate for each industry. The purpose of the revealed study was to figure out the level to which EVA is used by South African organizations. Furthermore, this research targeted on methods used by these organizations to determine EVA and targeted to figure out the South African business areas in which it is most likely to be applied. A focus group conversation was performed with specialists, which involved professionals, experts and statisticians, to talk about EVA and difficulties with regards to its execution. It was established that South African organizations will benefit from using EVA along with other analytics. Management needs to understand its own company to be able to apply the most appropriate efficiency statistic appropriate to the company. It is suggested that organizations do a thorough inner research of their organizations to assist them in making an informed decision regarding the appropriate efficiency statistic, such as EVA.
2.2.8: The Relationship between Economic Value Added (EVA) and Market Value Added (MVA) With Reported Earning: An Empirical Research of 40 Listed Companies in Indonesia Stock Exchange for the Year 2004-2007
Pratiwi Putri Wibowo and Ruben Garcia Berasategui (2008) conducted the study to examine the relationship between Economic Value Added (EVA) and Market Value Added (MVA) with the reported earnings. The purpose of the study was to gain better understanding in the use of EVA and MVA in relation to the reported earnings in certain purposes from different regression models.
Data and Research Methodology
The authors developed a number of hypotheses to be tested statistically and will make clear and describe the results. Thus it is descriptive and inferential (hypothesis testing). The nature of study is co relational study since the researcher is anxious with defining the relationship of the variables with the problem statement. The figures used in the study are secondary data, which are from 2003- 2007 financial reports of the listed companies from the database and internet and was put together by the author. The sample size is 40 listed companies and the author uses a purposive sampling design.
The study shows that Indonesian listed companies have negative average of EVA in 4 years of the research scope (year 2004 to 2007). It shows that normally, Indonesian listed companies still have not generated value-added from its operations.
The maximum correlation among EVA and Reported Earnings is achieved in model a, which correlates EVA and Reported Earnings. The regression analysis states that 30.90% of inconsistency in Reported Earnings can be explained by EVA in the same year. The result is reasonably clear since EVA is calculated from financial information of the company after the year-end.
The maximum correlation among MVA and Reported Earnings is achieved in model a, which correlates MVA and Reported Earnings. The regression analysis states that 80.60% of inconsistency in Reported Earnings can be explained by MVA in the same year. The result shows that the Reported Earnings is too affected from the value that companies have created from the market point of view in the same year.
In the multiple regressions, the model that shows highest correlation which correlates EVA, MVA and Reported Earnings in the same year. It shows that even though 80.60% of inconsistency in Reported Earnings can be explained by EVA and MVA in the same year, MVA is more important in explaining Reported Earnings than EVA. As a result, there is still not adequate proof that EVA can be used as efficiently as MVA in evaluating the Reported Earnings.
Based on the results, this study has proved that there are connections among EVA and MVA with Reported Earnings, particularly when it is used in valuation purposes. Whereas it can also be used for other purposes, the connections are not as high as in the evaluation purpose model mainly in the growth prediction model. Therefore, the author does not advise the growth prediction model to be used because it may create bias results.
2.2.9: Validity of the Economic Value Added Approach: An Empirical Application
Christos Anastassis and Dimitris Kyriazis (2007) had conducted a research study entitled "Validity of the Economic Value Added Approach: An Empirical Application". The objective of the study was to investigate the relative explanatory power of Economic Value Added (EVA) model with respect to stock returns and firms' market value, compared to established accounting variables (e.g. net income, operating income), in the context of a small European developing market, namely the Athens Stock Exchange. The study revealed that net income and operating income appeared to be more value relevant than EVA. EVA does not appear to have a stronger correlation with firms MVA than other variables.
2.2.10: MVA and EVA: Some empirical evidence
Dr. D.V. Ramana (2007) had conducted a research study entitled "MVA and EVA: Some empirical evidence". The study empirically examines the relationship between MVA and EVA of the Indian companies. Though the focus of the paper is the relationship between EVA and MVA, it also tries to understand the relationship between MVA and other common accounting numbers like NOPAT, PAT and PBIT. The study revealed that there is no strong evidence to support the claim that EVA is superior to the traditional performance measure in its association with MVA.
2.2.11: Value-based management, EVA and stock price performance in Canada
Athanassakos, George (2007) had conducted a research study entitled "Value-based management, EVA and stock price performance in Canada". The purpose of this paper is to determine the extent to which Canadian companies have embraced value-based management (VBM) methods and assess the stock price performance of the companies that use VMB vs. those that do not. The study finds that value-based management methods are widely used in Canada, with the likelihood of usage being higher for larger companies with younger and more educated executives with an accounting/finance background. The statistical analysis that follows the tabulation of survey results indicates companies that used EVA had a better stock price performance than those not using EVA. Moreover, our logit regression analysis shows that companies with better stock market performance exhibited higher likelihood of using EVA.
2.2.12: Is economic value added more associated with stock return than accounting earnings? The UK evidence
Ismail, Ahmad (2006) had conducted a research study entitled "Is economic value added more associated with stock return than accounting earnings? The UK evidence" The paper seeks to examine the claim of EVA advocates of its superiority as a financial metric compared with other measures. The paper uses a sample of 2,252 firm-year observations from the UK market and applies panel data regressions to test the relative information content of EVA and other accounting measures and the incremental information content of EVA components in explaining stock return. It is found that net operating profit after tax and net income outperform EVA and residual income in explaining stock return; it was also found that accruals and operating cash flow have significant incremental information content, while the accounting adjustments of EVA proponents have significantly less contribution in explaining stock return. Yet the paper concludes that other variables must be considered in order to capture the unexplained variation in stock return models.
2.2.13: Economic Value Added Application to Portuguese Public Companies
Peixoto, Susana (2006) had conducted a research study entitled as "Economic Value Added Application to Portuguese Public Companies". Based on a survey of Portuguese public companies listed on the Lisbon Stock Exchange, research was carried out on the awareness and the utilization of various performance measures. The results indicate that managers elect performance measures based on net income. Yet more sophisticated measures such as EVA or CFROI are being increasingly adopted. The major contribution of this study is the analysis of the information content regarding Operating Income, Net Income and EVA, based on a sample of 39 Portuguese public companies during the period from 1995 to 1998. The main results suggest that EVA does not have more information content than traditional performance measures in explaining Equity Market Value. The relationship between EVA and Market Value Added (MVA), however, is statistically significant.
2.2.14: A Fresh look at Economic Value added: Empirical study of the Fortune Five Hundred Companies
Abdeen, M. Adnan and Haight, G. Timonty (2002) had conducted a research study entitled as "A Fresh look at Economic Value added: Empirical study of the Fortune Five Hundred Companies". The research focuses on the uses, benefits and limitations of economic value added as a value creation measure. The study compares the performance of EVA user companies with non-user fortune 500 companies for the years 1997 and 1998. It shows that user's performance means profits as percentage of revenues, assets, and
stockholders' equity were higher than the non-users. However, the means for 1998 earnings per share (EPS), EPS change from 1997 and EPS growth for the years 1988-1998 were lower for the EVA user companies. EVA will become less popular in its use as an instrument of control and performance evaluation. The conclusion of this research is not in support of EVA use as a measure of value creation to stockholders.
2.3: Contextual Review
2.3.1: EVA Based Performance Measurement: A Case Study of DABUR INDIA LIMITED
Debdas Rakshit (2006) in his research paper EVA based performance measurement: A Case study of Dabur India Limited tried to study the effectiveness of traditional performance indicator like ROI with new performance measure EVA. The study has been conducted for the time period from 1998 - 99 to 2002 - 03.
DU - PONT MODEL
On the basis of accounting concepts financial performance of the company is measured in this model. ROI consider overall performance of the company and considered all the activities which contribute towards ROI. In this four aspects are considered in the ratio analysis such as Profitability, Leverage, Activity and Liquidity. ROI depends on mainly two ratios such as Capital Turnover Ratio and Net Profit Ratio. The different factor that affects ROI is explained in the DU - PONT Control Chart.
Source: EVA Based Performance Measurement: A Case Study of DABUR INDIA LIMITED, Debdas Rakshit (2006)
Economic Value Added Model
The three factors affecting EVA are
Adjusted earnings before interest after tax
Weighted Average Cost of Capital
These various factors affecting EVA are put in chart below. The management can easily identify the factors affecting the value of the organisation with the help of this Chart.
Source: EVA Based Performance Measurement: A Case Study of DABUR INDIA LIMITED, Debdas Rakshit (2006)
Table: 2.6 ROI versus EVA performance indicators of DIL