The fundamental objective of any business is maximization of shareholders’ wealth



The fundamental objective of any business is maximization of shareholders' wealth. The realization of this prime objective should be accompanied by efficient allocation and management of scarce resources, and the business should generate a return greater than the investor's required return on invested capital. It is necessary to understand how the overall added value of the firm is created for building a successful business. In other words, it is important for the management to identify those performance drivers that impact significantly on the added value of the company. The management of the company can use the particular measures for corporate planning and executive compensation, when the abovementioned performance drivers are identified. The idea of corporate performance measurement has been developed over the twentieth century.

In recent years, new financial performance measures have been getting a lot of attention as substitutes for traditional measures based on accounting earnings per share. However, the popularity of such measures as earnings per share and the return on equity has decreased over the last two decades. This has happened because modern value based management measures of performance (residual income and Economic Value Added for example) have been widely debated in the existing literature to be superior measures of value creation. This study is focused on the role of EVA as a performance measure.

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Economic Value Added is a relatively new performance measure which has received substantial attention. It has been widely promoted and discussed in the financial press and in the academic literature. The term 'Economic Value Added' was copyrighted by the consulting firm Stern Stewart & Company (Stewart III, 1994).

The process of creating a company's development strategy is directly linked to the interests and needs of its shareholders. These interests affect managerial decisions. Nowadays the fundamental idea of financial management is following: the goal of business is the maximization of the value of shareholders' invested capital. It means the maximal increase in economic value of the company. Shareholders invest in projects with the best returns because they want to maximize their profits.

The idea of maximization of the value of shareholders' invested capital is not a new one. Marshall (1890) in his 'Principles of Economics' developed the concept of economic profit, he wrote that if the firm aims to create wealth its earnings must be higher than its equity capital and cost of debt. The concept of residual income has been implemented in the 20th century. Residual income is defined as a difference between after-tax operating profits (NOPAT) and charge for invested capital. 'Residual income has been recommended as an internal measure of business-unit performance (Solomons, 1965) and as an external performance measure for financial reporting (Anthony, 1973, 1982a,b)' (Gary C. Biddle, Robert M. Bowen, James S. Wallace, 1996, p. 302).

'EVA is based upon something we have known for a long time: What we call profits, the money left to service equity, is usually not profit at all. Until a business returns a profit that is greater than its cost of capital, it operates at a loss. Never mind that it pays taxes as if it had a genuine profit. The enterprise still returns less to the economy than it devours in resources… Until then it does not create wealth; it destroys it' (Peter Drucker, 1998, p. 14).

In the 1980s and 1990s Stern Stewart & Company has advocated that EVA, which is a variation of residual income, can measure both internal and external performance. These claims of Stern Stewart & Company attracted a lot of attention within the corporate managers as a tool of strategic planning and investment appraisal. 'EVA stands well out from the crowd as the single best measure of wealth creation on a contemporaneous basis [and] is almost 50% better than its closest accounting-based competitor [including EPS, ROE and ROI] in explaining changes in shareholder wealth' (Stewart, 1994, p. 75).

EVA is used by a large number of companies, including such successful corporations as Coca-Cola, Quaker Oats, Herman Miller Inc., CSX Copr., Briggs & Stratton, AT & T, Hewlett - Packard Co. There have been made a number of empirical studies to examine the efficacy of EVA compared to other measures of corporate performance. Some studies are focused on evaluation traditional earnings and EVA by finding out which measures have higher correlation with stock returns. Other studies are devoted to investigating the correlation between EVA and Market Value Added. The results of these studies are mixed and a brief description of their finding is in the next Literature Review section. However, the debate over performance measures is not resolved to date. Some studies have shown that EVA can be implemented successfully within the organization as an internal and external performance measure, whereas others didn't find significant advantages of this measure compared to traditional financial success measurements.

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EVA is classified as a non-financial measure, and being a performance measure it focuses on economic profit which is different from accounting profit. 'It is important to note that EVA is more just a performance measurement system. It is also marketed as motivational, compensation-based management system that facilitates economic activity and accountability at all levels of the firm' (Cordeiro, James J. and Jr., D. Donald Kent, 2001, p. 58). The purpose of using this measure is getting shareholders and management to think about economic profits. Thus they evaluate new business opportunities, because assets have opportunity costs in terms of Economic Value Added. The application of Economic Value Added allows to identify those areas of business that are more profitable for the purpose of allocation funds there, and to have positive impact upon return of investment as a result.

EVA versus traditional accounting measures in determining corporate financial performance

Comparison of Accounting versus Economic based performance measures

There are two methods to calculate share price drivers, which are accounting and economic based methods.

The traditional accounting method of performance measurement is a model according to which the firm's share prices are defined when a firm's earnings per share are capitalized by the market at a certain price/earnings ratio. The accounting based measures of financial performance also include Return on investment (ROI), Return on invested capital (ROIC), Return on capital employed (ROCE), Return on net assets (RONA), Return on assets (ROA) and other earnings based ratios. The weaknesses of these measures are following: the earnings can be manipulated by means of book entries that are not reflected in the cash flow of a firm; the cost of capital is not taken into consideration by these accounting measures. For example, the calculation of return on equity ignores the cost of equity, and the calculation of return on assets ignores the cost of assets.

Economic models, in its turn, don't ignore the cost of capital, but take into account both the return on capital and its cost. This valuation method proposes that share prices are set by the cash flow and the risk associated with it generated during the life of a firm. According to these economic models it is important to generate such a profit from firm's operations that is greater than the required return on the amount of capital employed to generate that profit. This means that the profit in terms of economic models is the amount that is greater or lower than the required minimum rate of return that shareholders and lenders could obtain by investing their funds in other firms which have the same risk.

EVA is based on economic methods of valuation, which is defined further in this section.

Economic Value Added vs. traditional performance measures.

'Conceptually, EVA is superior to accounting profits as a measure of value creation because it recognizes the cost of capital and, hence, the riskiness of a firm's operations' (Lehn & Makhija 1996, p.34). The difference between Economic Value Added and traditional measures is that it is constructed so that maximizing this measure can be set as a target.

'The usefulness of traditional accounting measures, such as earnings per share (EPS), return on assets (ROA) and return on equity (ROE), and their effect on shareholder (market) value, have been discussed for some time. Since the 1990s, strong arguments have been raised in favour of economic value added as an accounting measure, mainly by the Stern Stewart Consulting Company and Associates (Stewart 1991:215; Stern 1993:36)' (de Wet, JHvH, 2005, p.1).

Return on capital is conventional and relatively good performance measurement. It is also called Return on investment (ROI), Return on invested capital (ROIC), Return on capital employed (ROCE), Return on net assets (RONA), Return on assets (ROA) etc, and can be calculated differently by different firms. The main drawback of these rates of return is that maximization of these figures doesn't necessarily lead to maximization of shareholders' wealth. ROI doesn't recognize that the rate of return shouldn't be less than the cost of capital and that owners' wealth is not maximized when the rate of return is maximized.

Shareholders want company to increase the absolute return above the cost of capital rather than to increase the percentage. The Economic Value Added tells us the impacts to owners' wealth, while the ROI tells us the rate of return. Thus, the Economic Value Added should be in the leading role of corporate control and ROI should give the additional information.

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Return on Equity has the same drawbacks as Return on investment. There is no risk component in this measure, and owners are not told by the level of ROE whether the company is creating their wealth or not. This is an informative measure as well as ROI.

Economic Value Added vs. other Value-based measures.

Besides EVA there are other Value-based measures such as Cash flow return on investment (CFROI), Cash Value Added (CVA), Shareholder value Added (SVA), Adjusted Economic Value Added (AEVA) and Refined Economic Value Added (REVA).

Many of these measures are based more on cash plows than EVA, and don't have the EVA's imperfections. But these measures are complicated to calculate. 'CFROI is growing in use by potential investors, SVA is often chosen for corporate planning decisions, but EVA appears to offer the simplest and most consistent overall solution' (Weaver, S., 2006, p.60).

'EVA is the most widely used Value-Based performance measure' (Myers, 1996, p.42) probably just because it is easier to understand. 'In implementing EVA, one of the most important things is to get the people in organizations to commit to EVA and thereby also to understand EVA' (Klinkerman 1997). It is most widely used also because other metrics require additional costs for their implementation, which are often more than the information achieved with them. In other words they don't pass a cost-benefit analysis.

EVA Defined

EVA measures a firm's economic value taking into account both the cost of equity and the cost of debt. Thus it takes the total cost of capital into consideration. The conventional accounting measures of performance in its calculation only take an interest expense that is only the debt part. Therefore, some companies seem to be profitable under traditional accounting performance measures, but at the same time these companies don't generate a profit higher that its cost of capital.

EVA is not a new concept and it is a variation of already known residual income measure of performance. The difference between these two measures is discussed further in the sub-section called 'The difference between Residual Income and EVA'.

'Economic Value Added' is an internal measure of performance that determines MVA (Market Value Added)' (de Wet, JHvH, 2005, p. 3), while MVA is the best cumulative measure of a company's performance from an investor's point of view.

'Economic Value Added' is a financial performance measure based on operating income after taxes, the investment in assets required to generate that income, and the cost of the investment in assets (or, weighted average cost of capital)' (Brewer, C.P., Chandra, G. & Hock, A.C.,1999, p. 4).

The main idea of EVA as a measurement of corporate performance is that the value of a firm is created when the total cost of capital (the cost of debt and the cost of equity) is lower than the return on investment. Therefore, EVA is calculated as the NOPAT (Net operating profit after tax) less an adequate charge for the opportunity cost of the total capital that was invested in a business.

The calculation of Economic Value Added is very similar to the calculation of the 'residual income, and is calculated as:

EVA = Net Operating Profit After Tax (NOPAT) Less Economic Profit multiplied by Weighted Average Cost of Capital (WACC), where Economic Profit = Fixed Assets (such as machinery and equipment) + Net Current Assets (such as cash, inventory, and receivables),

EVA is also equivalently expressed as:

EVA = (NOPAT / Invested Capital (IC) - WACC) * IC = (Return on Investment (ROI) - WACC) * IC.

'NOPAT is obtained by adding interest expense after tax back to net income after-taxes, because interest is considered a capital charge for EVA' (Prober, L.M., 2000, p.2). WACC is the weighted average of the firm's equity and debt, where the cost of debt is calculated as the interest charged on a loan of a company. The following factors should be taken into consideration while calculating the equity portion: the riskiness of the market where the company operates, the industry to which a particular company belongs.

Thus, 'EVA is defined as the excess of the dollar amount of net operating profit after tax (NOPAT) over the dollar charge for capital (both debt and equity) obtained by multiplying the percentage weighted-average cost of capital (WACC). This arguably approximates economic performance better than traditional accounting measures such as return on assets since it measures the dollar return in a given year above the minimum rate required to compensate investors for risk on capital investments' (Cordeiro, James J. and Jr., D. Donald Kent, 2001, p.57-58).

If the EVA is positive, the company has created wealth, because it has earned more NOPAT than the cost of the invested assets to generate that income. If the EVA is negative, there is no generation of profit, and company is just consuming capital. Thus, a company's goal is to achieve a positive and growing EVA. 'The fundamental notion is that the return from using funds must exceed the cost of those funds in order for value to be created' (Dillon, D.R. & Owers, E.J., 1997, p. 33).

If the ROI minus the WACC is positive, it means the company is creating extra returns comparing to its cost of capital, and thus a higher MVA is achieved. Lehn and Makhija (1996:34) describe EVA as follows: 'EVA and related measures attempt to improve on traditional accounting measures of performance by measuring the economic profits an enterprise - after-tax operating profits less the cost of the capital employed to produce those profits.'

Two basic steps to calculate EVA by Stern Stewart & Company are: (1) adjusting NOPAT for accounting 'distortions'; and (2) subtracting the opportunity cost of equity capital and opportunity cost of debt from this adjusted NOPAT. Therefore, there are two main differences of EVA from accounting earnings:

GAAP income is redefined by EVA;

traditional earnings deduct only interest expense of debt capital, while EVA takes into account opportunity cost of both debt and equity capital.

The information obtained from accounting data to calculate EVA is gone through a number of adjustments. These adjustments are made to decrease the existing 'distortions' in accounting information due to the accounting rules (Stewart, 1994).

Stern Stewart has determined 164 items for potential adjustment, but to have a good measure of Economic Value Added company can make only a few adjustments. 'Adjustments include such items as: additions for interest expense after-taxes (including any implied interest expense on operating leases); increases in net capitalized R&D expenses; increases in the LIFO reserve; and goodwill amortization. Adjustments made to operating earnings for these items reflect the investments made by the firm or capital employed to achieve those profits' (Prober, L.M., 2000, p.1).

There are four criteria to be considered for adjustment which are given by Stern Stewart. These criteria are: materiality, manageability, definitiveness, and simplicity. If the item has all of above mentioned criteria, it can be considered for adjustment.

First, as it was mentioned above Economic Value Added the profit of the firm is defined on an after-tax basis, while such measures as Return on investment is calculated on before-tax basis. This means that Economic Value Added always has a lower value in comparison with Return on investment. This concept helps to distinguish units of the company, whether these units create value or destroy it.

Second, the adjustment to generally accepted accounting principle (GAAP) is made. The argument for this adjustment is that 'what makes good sense for general purpose financial reporting does not necessarily make sense for profitability comparisons' (Parkinson, J., 2004, p. 38).

Third adjustment is made to the research and development (R&D) expense. While GAAP expenses it all immediately, Economic Value Added 'capitalizes successful R&D efforts and amortizes the amount over the period benefiting the successful R&D effort' (Prober, L.M., 2000, p.2).

There are other common adjustments which are usually made, such as non-recurring gains and losses, deferred taxes, provisions for warranties and bad debts, operating leases. In summary, some of Economic Value Adjustments increase the reported surplus, but some of them decrease it at the same time. Thus this approach leads to creation of its own levels of uncertainty and subjectivity.

The Strengths and Limitations of Economic Value Added.

'The primary strengths of Economic Value Added is that it provides a measure of wealth creation that aligns the goals of divisional or plant managers with the goals of the entire company' (Brewer, C.P., Chandra, G. & Hock, A.C.,1999, p. 7). Investment option with positive Economic Value Added is viewed favorably both by managers and the company.

However, this measure has four limitations. The first is 'Size Differences'. Economic Value Added doesn't control for size differences across the company units. The second is 'Financial Orientation'. Economic Value Added relies on financial accounting methods connected with revenues and expenses. Managers can manipulate these accounting numbers by changing their decision-making process. Managers can make choice to their own personal gain over company's. The third is 'Short-Term Orientation'. 'In an influential Harvard Business Review article entitled "Managing Our Way to Economic Decline" the authors state: "Although innovation, the lifeblood of any vital enterprise, is best encouraged by an environment that does not unduly penalize failure, the predictable result of relying too heavily on short-term financial measures - a sort of managerial remote control - is an environment in which no one feels he or she can afford a failure or even a momentary dip in the bottom line" (Hayes & Abernathy, 1980)' (Brewer, C.P., Chandra, G. & Hock, A.C.,1999, p. 8). Economic Value Added is that form of managerial remote control that makes managers to put excessive accent on the short-term bottom line. The last limitation is 'Result Orientation'. Economic Value Added is aggregated, results-oriented measure, and is accumulated at the end of an accounting period. Therefore, limited useful information is given by this measure to people charged with the responsibility of managing business process.

Advantages and Costs of Economic Value Added.

'EVA provides a more comprehensive measure of profitability than traditional measures because it indicates how well a firm has performed in relation to the amount of capital employed' (Prober, L.M., 2000, p.1).

The main advantage of Economic Value Added concept is a definition of the goal: to compensate cumulative expenses on the invested capital, i.e. an effective utilization of resources, unlike a standard goal of profit maximization which can be reached without taking into accounts the efficient use of resources. The use of this concept does not call for any new, especial systems of the account and the financial reporting, it is enough to use the standard report on profits and losses and accounting balance with some adjustments made.

The Economic Value Added determines the most successful areas of business. Thus, firms are given the information for evaluation of the performance of particular units or divisions of the firm, and the managers who are responsible to those businesses. In comparison with Return on capital employed Economic Value Added gives the correct incentives for capital allocation.

EVA-based compensation plans reduces the conflict of interest associated with managers and measurement of profitability. It promises to ease communication between shareholders and management. It also helps to align firm's objectives with those of the manager. Economic value Added 'better aligns performance evaluation with project selection based on Net Present Value' (Bowen M.R. & Wallace S.J., 1999, p.540). Economic Value Added 'provides a decision-making and performance measurement framework which is aligned with the strategic analysis and makes strategy come alive within an organization as opposed to remaining an ivory tower top-level annual activity' (Booth, R., 1997).

However the Economic Value Added has its lacks, for example its application is limited to an estimation of already existing business which prospects can be predicted with a high degree of accuracy. First, the method becomes less useful to an estimation of the fast-growing and new businesses where revenue calculations would be inaccurate. This means that this measure is not suitable for certain types of businesses. Second, managers can reject the projects with negative Economic Value Added in a short-term perspective, but with positive Market Value Added over the longer term. This problem seems to be the main problem with Economic Value Added. Third, Economic Value Added is based in historical data, therefore it is not clear whether it can successfully predict corporate success or not. Fourth, the calculation of Economic Value Added is difficult in those industries where intangibles assets, such as brand names, are large. Finally, according to Gary Hamel "the efficient use of capital is not the be all and end all for successful companies. Strategy and innovation count for more". He states "in the emerging knowledge economy, capital efficiency is even less of a wealth driver. In the industrial economy capital was everything. In the knowledge economy it often means nothing especially to companies like Microsoft and Amgen whose assets walk out the door every night" (Hamel, G, 1997).

How to improve Economic Value Added.

It is important to understand the basic ideas how Economic Value Added and thus the shareholders' wealth can be improved. The Table below shows the three methods to increase the Economic Value Added:

The evaluation criterion

The methods

The application of the method

The Economic Value Added increase

1. Rate of return increases with the existing capital employed.

a) Development of new types of products/services;

b) Development of new markets.

2. Additional capital is invested in business earning more than the cost of capital.

Making NPV-positive investments.

3. Capital is withdrawn from business that fail to earn return greater than the cost of capital

Reducing access inventories and receivables and thus the capital costs caused by them are reduced without corresponding decreases in revenues.

These are the only ways in which value can be created. Economic Value Added catches all of these three methods.

There are countless ways to increase revenues which are included in the first method. Companies usually do investments in new products and new markets. Those companies, which use the methodology of weighted average cost of capital (WACC) and Net Present Value (NPV) in their investment calculations, have to know that the shareholders' wealth increase when the second abovementioned method is applied. The last method is not widely applied as the previous two. For example, by reducing access inventories and receivables and thus the capital costs caused by them are reduced without corresponding decreases in revenues.

'From an EVA perspective, operations will be more efficient by investing in value-adding projects and withdrawing from value-destructive projects' (Dodd, L.J. & Johns J., 1999, p. 14).

The difference between residual income and EVA

It was mentioned in the previous sections that EVA is not a new concept and it is based on the valuation model which is called residual income. Residual income was adopted by General Electric in the 1950s as a divisional measure of performance and it is believed that residual income was developed as a performance measurement by this adoption. Later in 1965 Solomons published his book on the control of divisionalized businesses, where he argues that residual income is an adequate performance measurement. Nevertheless, residual income remained relatively unpopular by practitioners over a long period of time. This concept was revitalized by Stern Stewart & Company with their variant EVA.

Residual income and EVA fundamentally have the same equations for the calculation. EVA differs from residual income in accounting adjustments that are made for capital and profit. Stern Stewart has identified 164 possible adjustments and it is argued by this consultant company these adjustments are made for a production of a better measure of residual income. However, according to Stern Stewart in practice the application of only 10 to 15 adjustments is enough for estimation of EVA. The most important adjustments are following: depreciation, amortization, R&D, leases, goodwill, and income taxes. Some of these main adjustments are described in the previous sub-section.

Review of Literature


Stern Stewart & Company has advocated that 'Earnings, earnings per share, and earnings growth are misleading measures of corporate performance' (Stewart, 1991, p. 66). Since 1990s they have been advocating to use EVA for measurement of corporate performance instead of earning based measures. They have raised strong arguments in favor that the use of EVA has given a new life to financial performance of such big companies like Coca-Cola, CSX, SPX Corp, GE, and Chrysler (Tully, 1993; Walbert, 1994). 'Forget EPS, ROE and ROI. EVA is what drives stock prices' (Stern Stewart advertisement in Harvard Business Review, November-December, 1995, p. 20). Stern Stewart also state that EVA creates wealth and has higher explanatory power to the changes in shareholder wealth than other existing performance measures.

Many companies all over the world are the clients of Stern Stewart & Company and are using EVA as internal and external measure of performance.

There have been numerous studies the aim of which was to determine whether the above mentioned claims about the superiority of EVA as measurement of performance are adequate. Recent academic studies are mainly focused on finding out which performance measurement Economic Value Added or traditional Earnings per Share has a stronger relationship with stock market returns, and less on evaluating the EVA adopted companies' performance. However the results of the empirical studies regarding the claim that EVA is has a superior explanatory power to shareholder wealth creation are mixed. Some studies have shown that EVA is a strong management incentive tool; at the same time other studies show that it is even less useful measurement than traditional measurements of financial performance. There is no final conclusion in existing literature whether there is a correlation between EVA and shareholders' wealth creation. The debate over the 'best' single financial performance measurement is not resolved to date.

EVA is promoted by Stern Stewart & Company as 'the internal measure of year-to-year corporate operating performance that best reflects the success of companies in adding value to their shareholders' investment' (Stern, 1994).

The literature review is divided into the following sections:

1) Empirical reviews supporting EVA® as a measure of financial performance;

2) Empirical reviews criticizing EVA® as a measure of financial;

Empirical reviews supporting EVA as a measure of financial performance

The concept of EVA is close to the concept of residual income, which was described in a monograph by Solomons in 1965. It is proposed by the author that residual income, which is calculated as the difference between the net earnings and the cost of capital invested, is the measure which can be successfully used for the purpose of performance evaluation and to encourage managers to maximize the value of the firm. There are number of adjustments made to the firm's accounting results by Stern Stewart & Company for the calculation of EVA. These adjustments are the key differences between EVA and residual income.

Stern Stewart & Company provide the empirical evidence on the performance of EVA® as a financial measure regularly in their publications. The in-house researches show that EVA is a best performing metric.

Lehn and Makhija (1996) based their study on the data of 241 firms over the period 1987-1993. The main focus of their study is on investigating the performance measures which are the best predictors of CEO turnover. There is a discussion on the correlation between measures of performance and stock returns. They examined EVA and MVA and documented that both of these measures have significant positive correlation with stock price performance. The study also says that this correlation is higher than with traditional measures of performance such as Return on Equity and Return on Assets. The correlation of EVA with stock returns is 59%, while MVA's correlation with stock returns equals 58%. The results of this empirical study indicate that both of these measures outperform the relationships between stock returns and return on equity (46%) and return on assets (46%). The results of this study are following: the higher levels of EVA and MVA are led by a greater focus on business activities; both EVA and MVA are adequate measures of performance that provide information about the quality of strategic decisions, and thus they can be used as signals of strategic change.

Milunovich and Tseui (1996) in their study 'EVA in the Computer Industry' found that MVA has higher correlation with EVA than with such measures as Earnings per Share, Earnings per Share growth, Return on Equity, Free Cash Flow or Free Cash Flow growth. They investigated the correlation of traditional performance measures and EVA with MVA of US companies working in computer industry for the period of time from 1990 to 1995. Their research shows that a new fast growing technology firm which has positive EVA investment opportunities can have negative cash flows similar to those of a loss making company which is close to the bankruptcy. Milunovich and Tseui have made a conclusion that growth in earnings creates value when the cost of capital is less than returns. According to their opinion EVA sometimes works when other measures don't, and that it is a good supplement to other measures for the purpose of evaluating shares.

O. Byrne in his study "EVA and Shareholder's return" (1997) compared the data from 1985 to 1993 for EVA divided by the cost of capital, NOPAT and FCF relative to market value divided by invested capital. They obtained the following results: EVA and NOPAT had almost the same explanatory power; EVA explained 31% of the change in the market value divided by the capital ratio and NOPAT - 33%, while FCF explained 0%. He concluded that the measure which is linked to the market value systematically is EVA, not NOPAT and other traditional earnings. Another conclusion of this study is that EVA can be used as a key to understanding the expectations of the investor which are included in a firm's current share price.

Garvey, Milbourn and Todd in their study "EVA versus Earnings: Does it matter which is more highly correlated with stock return" (2000) suggest that EVA can be used as a guide to the firm value. They find a simple correlation between EVA and stock returns.

Robert Kleiman's study 'Do companies adopting EVA add more value for their industry competitors?' (1999) supported EVA as a superior performance measure. He studies 71 companies which adopted EVA in the period from 1987 to 1996. He compares the total stock market returns for EVA adopted companies and the closest-matched peer and the median peer for the time period - three to + three years from the year companies began to adopt EVA. The result of this study conclude that there is a strong evidence that the stock market performance of EVA companies was much better that of peer companies at a studied period of time.

Other studies focused on this question did not find a significant relationship between EVA and stock price performance.

Empirical reviews criticizing EVA as a measure of financial performance

Biddle, Bowen and Wallace wrote one of the first independent papers 'Does EVA® beat earnings? Evidence on associations with stock returns and firm values' on this topic. They examined a sample of US companies over the period from 1984 to 1993.

According to Gary C. Biddle, Robert M. Bowen, and James S. Wallace research (Journal of Accounting and Economics 24, 1997) EVA being an effective tool of performance measurement and managerial compensation doesn't outperform traditional earnings in relation with stock market returns. They have made a fully study regarding performance measure. This study suggests that traditional earnings generally give better explanation for firm value and stock returns than EVA. They used each EVA component to find out the correlation between performance measure and stock return. The results of their study say that the correlation of the earnings with market adjusted stock returns (24.7%) is higher than EVA's (15.3%), residual income's (15.5%) and cash flow from operations (13.8%).

In addition to their research on the correlation of the above described metrics with the stock returns, the authors examined the role EVA's unique components in the explanation of contemporaneous stock returns beyond that explained by cash flow from operations and earnings. These unique EVA components are the accounting adjustments to income and capital. They evaluate the role of each EVA's components, such as cash from operations, operating accruals, capital charge and accounting adjustments in explaining contemporaneous stock returns. Biddle et al (1999) results suggest that examined components unique to EVA contribute only marginally to the explanation of contemporaneous stock returns beyond that explained by earnings.

Biddle et al (1997, 1999) compared EVA with such measures as net income and residual income. Contrary to Stern Stewart claims the results of this study give evidence that traditional earnings dominate EVA in explaining stock returns. For example, according to this research net income and residual income have higher explanatory power to stock returns than EVA. In general they had the following results: traditional earnings dominate EVA in association with stock returns; EVA is not superior performance measure in explaining company values compared to earnings; EVA components don't give a significant contribution to the market participants in terms of information which is already given by net income.

Kramer and Pushner (1997) have made 'An Empirical Analysis of EVA as a Proxy for MVA' using the Stern Stewart 1000 [1] companies for the ten years period of 1982-1992. The correlation between these two measures was studied in their work. They didn't find a clear evidence of EVA's superiority as the best internal measure of shareholder value creation. This study suggests that compensation schemes must depend not on EVA, but to profits. According to their studies it seems that profits are closer to market's focus than EVA.

Kramer and Peters (2001) examined strength of relationships between EVA and NOPAT with MVA. NOPAT showed higher explanatory power than EVA in 42 of the 53 industries that were studied. They also have made a conclusion that EVA is not better suited to particular industries compared to others, whether it is manufacturing or knowledge-based industries.

Hamel and Lieber (1993) argue that EVA is not a good tool of measurement of company's wealth creation, but they agree that it is an adequate place to start. According to Gary Hamel "the efficient use of capital is not to be all and end all for successful companies. Strategy and innovation count for more". He states "in the emerging knowledge economy, capital efficiency is even less of a wealth driver. In the industrial economy capital was everything. In the knowledge economy it often means nothing especially to companies like Microsoft and Amgen whose assets walk out the door every night" (Hamel, G, 1997).

Dodd and Chen examined the data for the period of time from 1983 to 1992 using Stern Stewart 1000 database and some additional data. They tested the claim that EVA is a superior performance measure of shareholder value. They found that correlation between share returns and ROA was higher than a correlation of share returns and EVA. They also investigated the correlation for the other accounting measures, and it was very low for such measures as ROE and EPS. EVA didn't show a strong relationship to share returns for a selected large number of firms in a selected long period of 10 years. In this study, EVA didn't appear to have a better explanatory power than ROA had. Dodd and Chen also tested residual income, which is similar to EVA, but it doesn't have any adjustments which are usually made by Stern Stewart & Company to decrease accrual accounting distortions. They found that residual income and EVA both gave the same results.

These prior studies try to find the answer to the question whether EVA is more highly correlated with stock market returns than traditional financial measures.


Economic Value Added is important for firm as a performance measurement and controlling tool. Economic Value Added is superior to such performance measures as Return on Investment, because it is theoretically in line with maximizing shareholder's wealth. Economic Value Added, when it is effectively applied, it encourages managers and employees to think and behave like owners. It makes company to pay attention to capital employed.

One of EVA's strong characteristics is its befitting to management bonus systems. This kind of bonus system is favorable both to the shareholders and the management. As a result of implementation this kind of bonus system, the performance level is likely to rise.

Economic Value Added only measures changes of wealth and helps to asses quantitatively different strategies. It is a short-term performance measure as well as other performance measures.

'Economic Value Added can provide a valuable measure of wealth creation and can be used to help align managerial decision making with firm preferences: however, it is only one piece of the performance measurement puzzle and it must be used in conjunction with a balanced set of measures that provide a complete picture of performance' (Brewer, C.P., Chandra, G. & Hock, A.C.,1999, p. 11). It has such positive attributes as that it facilitates understanding the value-creation process by those who are not strong in economics, finance and accounting.