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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: synthesizes areas of conceptual knowledge that contribute to a better understanding of the issues. Empirical review is the literatures, or previous studies that relate or argue positively with your studies hypothesis and variables. Contextual review shows the studies which has been done previously on the particular topic.
2.1 Conceptual Review
2.1.1: Economic Value Added - A General Perspective
Asish K Bhattacharyya & B.V.Phani (2001) in their paper examine whether EVA is a higher performance measure both for corporate reporting and for domestic governance. It completed that though EVA does not offer additional information to investors, it can be modified as a corporate viewpoint for inspiring and educating employees to distinguish between value creating and value destructing actions. This would guide to direct all efforts in creating shareholder worth. The paper highlights the awareness of the dangerous movement of reporting 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 claimed as being advanced than the normal measures such as ROI, ROE and ROA, which are based on the accounting data. With respect to capital invested in the firm, these measures provide the rate of return earned by the firm. The main constraint of these measures is derived from limitations inherent in the measurement of accounting profit. EVA claims that because of these imperfections, the accounting based methods are not good proxies for value making. Whether EVA is an improvement over straight measures and serves the purpose of appealing the managers to pay thought to shareholders value even if that results in compromising present performance. The answer may be negative because all the above limitations are also related with EVA.
EVA as a Corporate Philosophy
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. A firm can generally estimate its WACC a problem rate that is being used by firms in capital budgeting 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 comprehend skill and theoretical clarity. 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 concept of EVA have gained considerable notice in the advanced economies, but implementation issues and its soundness is under debate all over the world. The paper presents a broad literature review and a significant analysis to move to the advances 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 known that EVA calculates the profitability net of cost of capital. EVA can be occupied as the net operating profit minus suitable charge for the opportunity cost of all the capital invested in a project. EVA is an estimation of true economic profit or the total by which earnings go beyond 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.
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 comparatively 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 evidences too state those EVA adopters earn increased profitability comparative 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 that addresses the changes made by EVA adopters is by Wallace (1997). 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)
They 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
In this view EVA is measured as better choice to the traditional performance method such as Profits, EPS, and ROE etc. EVA based performance drive managers to utilize firm's assets more effectively and it helps in lessening of differences 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 considerable commutation attempt and extensive guidance for both managers and their subordinates.
2.1.3: 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 ActÂ
Stock market law can inform managers how to look at the market is the company's management and value creation capability to the manager critical out over a longer period of time their value formation potential of the company transferred to the investor's achievement.Â
Return onÂ 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 angle 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.Â The return on equity as a management indicator, managers may be replaced simply because with the debt equity capital, changes in the company'sÂ capital structureÂ and get high bonuses, managers and therefore may accept debt financing program, and give up those who have to use equity financing of Item.Â
Earnings per share
Earnings per share are the share of a venture 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 inÂ capital structure, while theÂ capital structureÂ 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.Â
Cash flow evaluation methodÂ
The main indicators of cash flow estimation 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 helpÂ business managersÂ recognize the business of capital efficiency.
Evaluation the choice of indicatorsÂ
Enterprises must prefer an appropriate evaluation method. It should be based on firm features or valuation of the objectives to be achieved to make the final choice. If an enterprise just wants to progress balance sheet effectiveness, control ofÂ workingÂ capital, increased turnover, developÂ accounts receivableÂ 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 approach, because it is calculated to be definite and adjusted depreciation of the asset.Â
Â Â Â Â Those cost savings have been completed, 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.Â
Â Â Â Â 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 intention of achieving that any evaluation of effectiveness of the method will be weakened.Â
2.1.4: Economic Value Added: The Invisible Hand at Work
Durant, Michael (2000) in his article "Economic Value Added: The Invisible Hand at Work" has explained that EVA is both a measure of value and also a measure of performance. The value of a business depends on investor's expectations about the future profits of the enterprise. Stock prices track EVA far more closely than they track earnings per share or return on equity. A sustained increase 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 approach stiff charges are incurred for the use of capital. EVA focused companies concentrate 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.
2.1.5: 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 reduce 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 sufficient to establish the claim of EVA as a better measure. However there is also not much research to prove it otherwise. In case of India either way research is very inadequate. Although not a panacea, EVA based compensation plans will drive managers employ a firm's assets more productively and EVA should help reduce the difference in the interests of the managers and shareholders, if not perfectly align them.
2.1.6: 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 attempt to apply concepts that have been developed through the course of the 20th century by economists and managers. Is simplicity is both its attraction and its limitation. 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.
2.1.7: 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 explains that recent attempts to address the shortcomings of residual income can effectively address the wealth measurement issue; however, they give rise to serious implementation problems related to the necessity for forecasting future firm performance. Furthermore, if internal forecasts of future firm performance are used, this is a source of a potentially serious moral hazard problem as the same managers whose performance is being evaluated provide the forecasts.
2.2: Empirical Review
Â 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
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
Table2.2: EVA VS ROCE AND EVA VS RONW AND EVA VS EPS
EVA as a %
a % of
EVA as a % of
No. of shares
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
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:
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
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
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 show 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 study used statistical tools like mean, standard deviation, CV, LGR (Linear Growth Rate) and't' statistic for analyzing the financial data of the sample banks.
As per the study Investing 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 idea 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. On the other hand, as expected EVA behaves 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, "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 it is 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: 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.
2.2.7: 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.
2.2.8: 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.
2.2.9: 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.
2.2.10: 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.
2.2.11: 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.
2.2.12: 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 users 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: 2.7 ROI versus EVA performance indicators of DIL
Basic EVA on Capital Employed ( %)
(Weight based on book Value)
Basic EVA on Capital Employed ( %)
(Weight based on market Value)
Disclosed EVA on Capital Employed( %)
(Weight based on book Value)
Disclosed EVA on Capital Employed( %)
(Weight based on market Value)
The table shows the difference exists between the performance results given by traditional measure and EVA. The ROI does not show any value creation happens to the shareholder wealth so any efficient decision cannot be taken on the basis of ROI. But EVA measurement give a clear idea about the value addition as well as value destruction happens to the shareholders wealth.
As per the study, EVA based performance measurement system is the base on which the organisation have to take suitable decisions associated to the choice of strategy, capital allocation, merger & acquisitions, divesting business and goal setting. Even as deciding resource allotment it becomes essential to value the EVA impact of such decision. Management Accountants cover the full awareness regarding the company that would create value. They will be able to direct a company in its reform mission for value creation.
2.3.2: Economic Value Added (EVA) and Sector Returns
Nuttawat Visaltanachoti, Robin Luo and Yi Yi (2008) in this study they tried to consider the advantages of EVA by comparing with its information content in explaining 90 sector returns with three traditional accounting-based performance measures: cash flow from operations (CFO), earnings (EBIT), and residual income (RI).
This paper studies the connection between EVA and traditional accounting performance measures with sector returns. The study is conducted on 90 sectors in the US over the period 2003 to 2005. The study is conducted in order to check the relationship between EVA and sector returns and also to assess whether EVA is highly related performance measure than traditional accounting-based performance measures.
In the study the authors used Relative information content test to study which performance measures superior, explain sector returns by comparing the information content of EVA, CFO, EBIT, and RI, respectively and to check if EVA has closer relation with market-adjusted sector returns than CFO, EBIT and RI. The result of the test shows that EBIT are more highly linked with sector returns than RI, CFO and EVA. Thus the study proves that earnings are higher to EVA in explaining sector returns. In the study the authors further divided EVA into four components: cash flows from operations (CFO), operating accruals (Accrual), after tax interest expense (ATInt), and capital charge (CapChg), and this is done to check which factor of EVA contributes mainly toward the association of EVA with sector returns. This is done with the help of incremental information content test. As per the results from the test shows that Accrual contributes largely toward the information content of EVA, followed by CFO, CapChg and ATInt. Accrual and CFO contributes to traditional accounting-based to performance measures and it helps to describe sector returns further than that explained by components exclusive to EVA such as CapChg. It strengthens the results arising from the relative information content test that earnings take over EVA in explaining sector returns.
Some of the explanations for not finding stronger value-relevance for EVA are: First, in the study existing realisations slightly than future flows of each performance measure are used. Even though EVA is a good substitute for economic profits, realised EVA may not do better than the current realisations of other performance measures such as earnings in proxying for future cash flows. Second, earnings might be a superior measure to describe the sector returns since it does not need to be adjusted though EVA is calculated by adjusting net operating profits after tax (NOPAT) and capital considerably.
2.3.3: The ability of EVA (Economic Value Added) attributes in predicting company performance.
Issham Ismail (2011) conducted the study on ability of EVA attributes in predicting company performance. This study is done by exploratory designs and correlational method, and the purpose of the study is to find the relationship of EVA and company performance. In the study panel pool data regression models are used and the author has used time series and cross section analysis at the same time. The sample of the companies includes most of the public listed companies in Bursa Malaysia, and the study is conducted for over the period 1993 to 2002. For the period 1997 to 2002, 245 samples of Main Board companies were selected which involved 1440 observations. While for the period 1993 to 2002, 75 Main Board companies were selected this involved 750 observations.
The study is using, regression analysis between value creator and destroyer covering stock return over a period of 10 years that involves 750 observations, and studies for a period of 6 years which involves 1468 observations, indicates that neither value creator nor value destroyer had a connection with stock returns, as both models are statistically irrelevant. This finding is contrary to findings by Turvey et al. (2000).
According to the study regression between value creator and value destroyer with earnings (represent by EPS and NOPAT), value creators had a better connection with earnings than value destroyers. The findings show that, value creators are superior multipliers of earnings than value destroyers and this study indicates that, value creators have better earnings multiplier than value destroyers (such finding are consistent with findings from Stewart (1994), Turvey et al. (2000), and Isa and Lo (2001). It indicates that the increments of EVA value in value Creator Company tend to increase accounting profit at a higher rate than in value destroyer companies
The study concludes that for regression with frequent or period particular coefficients, the longer period of EVA had a better connection with the stock return than shorter period. It shows that EVA had a better association with stock return over a longer period of the study. These conclusion are reliable with finding from O'Byrne (1997) but are contradicted by findings by Isa and Lo (2001).
2.3.4: Dissecting EVA: The Value Drivers Determining the Shareholder Value of Industrial Companies.
This study aimed to address the problems of shareholder value creation. The study is conducted on 20 industrial companies to know how is EVA is contributing towards shareholder value creation. The analysis was conducted for 20 industrial companies for the period of 1991 to 2000. Hypothesis was done to deal with the variables of EVA and six step wise regression analysis were done.
In the study when the regression analysis was conducted on the sample, the total regression coefficients not only increased, but more significantly, there was a move away from the profitability ratios to the balance sheet ratios. The study shows that at first profitability (income statement) ratios are the key value drivers in dominant shareholder value creation. Though, as companies become established wealth creators and get better on their performance, profitability ratios become less important. Efficient financing of the balance sheet, efficient fixed asset and working capital management become top priorities in driving shareholder value.
It is found from the study that to improve profitability margins in a company, it is suggested that the subsequent activities be undertaken: increase the gross profit margin by lowering the cost of sales through more efficient production; optimising inputs and substituting inputs without affecting product quality; reduce operating expenses by calculating and monitoring (reducing) the ratios of various operating costs to output (sales); achieve relevant economies of scale for each of the value activities; introduce mechanisms to improve the rate of learning and eliminate overheads that do not add value to the product.
According to the results of this study, balance sheet ratios or variables become increasingly significant as a company becomes an established value creator. Therefore, the efficient management of both working and fixed capital investment contribute towards more overall efficiency in operations and improved shareholder value. The subsequent actions are recommended by the study for working capital investment: minimize cash balances; manage accounts receivable to reduce the average number of day's debt outstanding; increase inventory turnover and make maximum use of non-interest-bearing current liabilities such as creditors and taxes.
The following actions are recommended from the study for fixed capital investment: promote policies to increase utilization of fixed assets; obtain productivity-increasing assets by means of prudent project or investment evaluation techniques, such as net present value; sell unused or underutilized fixed assets if possible and set levels of utilization or returns on assets employed.
The study recommends that key variables which were recognized by means of the statistical analyses, those value drivers need to be broken down to operating level. Value drivers depend on each company's exclusive situation and identifying them can be a process that requires some trial and error. Operating margins can be split up according to product, geography or consumer segment. If a company is struggling to match the skills of its sales force against a given customer segment, better results might be obtained if such a ratio is measured on a geographic basis.
The study suggests that the key value drivers are not static so they must be reviewed at regular intervals. The value drivers can also not be considered in isolation. A price increase might have a large impact on value through an increased profit margin, but not if it results in a considerable loss of market share.
In most cases it is to the advantage of shareholders that management have an incentive scheme to induce them to adopt value-based management and actively manage those variables that determine shareholder value. Such an incentive scheme can be based on value created as measured by the EVA of a company over a period of time. Management can be remunerated (or penalised) on the basis of value created (or destroyed).
2.3.5: EVA versus Traditional Accounting Measures of Performance as Drivers of Shareholders Value - A Comparative Analysis
Dumitru Andreea Paula and Dumitru Cristina Elena (2005) in their article tried to study the connection between EVA and other traditional accounting measures relative to market value added (MVA). The authors used data from listed companies and the study investigate the strength of EVA has been verified excellent performance measure to motivate management and employees in any company due to its highest correlation with the MVA, the theoretically best performance measure and EVA adopting companies' superior performance compared with peer non-EVA adopting companies.
The study is based on the data of companies listed for the period from 1994 to 2004. It revealed that EVA did not show strongest correlation with MVA. Though the performance indicators selected for the study, the changes in the standardized cash flow from operations explained the biggest percentage of changes in standardized MVA (38%). ROA came second best (15%) and standardized EVA (8%) third.
When data in the years when spreads were negative were left out, the results were only slightly better, with no difference in the ranking of the indicators. The results shows that MVA is actually equal to the present value of all future expected EVAs. Therefore one can anticipate there not necessarily to be a strong correlation between MVA and EVA on a year-on-year basis. The study has reaffirmed the significance of cash flow management. The findings suggest that some caution is merited when focusing only on EVA as the measure of choice for internal company performance.
Another finding of the study was the insignificant correlation between MVA and EPS and DPS. The fact that both earnings and dividends are still often used as the basis for share valuations, one can infer that, at least for locally listed companies, these valuation methods are unreliable in the extreme.
2.3.6: The Relationship between EVA and Stock Return
Mohammad Fawzi Shubita (2010) in his study tried to find out the connection between EVA and Stock return. In the beginning of the study he tried to explain the meaning of EVA and tried to explain it in theoretical way. There he states that EVA is a performance metric that calculates the creation of share value, but it differ from the traditional financial performance metrics such as net profit and earning from share.
This study aims to achieve the following objectives:
1. Providing independent empirical evidence on the information content of EVA, residual 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 Jordanian market.
Research Models and Variables
The relative information content test of EVA and other measures is based on examining the explanatory power of all the measures and testing which one the higher information content as compared to the others.
Equation - Rit= b0i+ Î² 1Xit-1+ eit
The dependent variable in equation is Rit, which is a measure of the annualized compounded rate of return to the shareholders2. This variable has been extensively used for studying the information content of profit measures (see, for example, Lev, 1989; Easton and Harris, 1991). b0i is the intercept, and eit is a random disturbance term.
The independent variables3 are as follows:
NI, net income available for shareholders;
OCF (operating cash flow);
RI (residual income), calculated as Net income - (cost of capital * total capital) (Ismail, 2006).
EVA (economic value added).
EVA =Net Operating Profit After Taxes âˆ’Capital Charges
EVA =NOPAT âˆ’WACC* EA, (2)
NOPAT = Net Operating Profit after Taxes
WACC =Weighted Average Cost of Capital
EA = Economic Asset or Invested Capital4
EVA is the difference between Net Income (Net Profit) and Cost of Equity. If the cost of equity is zero, the Net Profit is equal with EVA.
All industrial shareholding companies that satisfy the following conditions will be included in the study sample:
1. Share prices data are available during the study period (2000-2008), and there is an availability of data required to calculate study variables.
2. The company didn't enter in a consolidation process or allocated free shares because these events affect the company figures such as earnings. (39) Companies will represent the study sample.
Table 2.8: Correlation Matrix
In the study the stock return has the largest mean followed by NI, OCF, RI and EVA. In the correlation matrix all the independent variables are positively correlated with one another. EVA has a lower correlation with stock return compared to NI.EVA and RI under perform standard accounting profit measure NI.
Table 2.9: Test Results
In the study four separate regressions for each performance measure (EVA, RI, NI, and OCF) is conducted. NI significantly outperforms EVA and RI in explaining stock return. NOPAT was more associated with stock return (R2 25.78 percent) than EVA (R2 20.20 percent), EBEI (earnings before extraordinary items) was more associated with stock return (adjusted R2 9.04 percent) than either RI (adjusted R2 6.24 percent) or EVA (adjusted R2 5.07 percent), but all three measures dominate CFO (cash flow from operations; adjusted R2 2.38 percent).Operating income measures outperformed RI and EVA. The results of the panel data regressions direct to the conclusion that EVA does not significantly outperform NI and NOPAT, and sometimes it does not even outperform RI. The results pointed out that NI outperforms EVA and RI in their association with stock return.
2.3.7: Economic Value Added and Traditional Performance Measures: A Review of Academic and Empirical Literature
Dr. Karam Pal and Jasvir S. Sura (2007) had conducted a research study entitled "Economic Value Added and Traditional Performance Measures: A Review of Academic and Empirical Literature". This paper attempts to provide a review of research studies on EVA's conceptual underpinnings and its empirical and theoretical analysis and traditional performance measures with the aim of finding the relationship between shareholders value and various performance measures and plugging the gap, if any. The result of this paper offer that according to practitioners EVA dominates traditional measures in explaining stock return and firm value; but academician found traditional measures too