Maximizing
shareholders value has become the new corporate paradigm in recent years. The
Corporates, which gave the lowest preference to shareholders curiosity, are now
bestowing the utmost preference to it. Shareholder’s wealth is measured in
terms of returns they receive on their investment. It can either be in forms of
dividends or in the form of capital appreciation or both. Capital appreciation
depends on the changes in the market value of the stocks. The market value of
stocks depends upon number of factors ranging from company specific to market
specific. Financial information is used by various stakeholders to assess
firm’s current performance and to forecast the future as well.
The
empirical studies highlight that there is no single accounting measure which
explains the variability in the shareholders wealth (Chen and Dodd, 1997;
Rogerson, 1997). Any financial measures used in assessing firm’s performance
must be highly correlated with shareholders wealth and on the other hand should
not be subjected to randomness inherent in it. Traditional performance measures
such as NOPAT, EPS, ROI, ROE etc. have been criticized due to their inability
to incorporate full cost of capital thereby accounting income is not a
consistent
predictor
of firm value and cannot be used for measuring corporate performance. Value
based management system has gained popularity in academic literature in last
two decades. One such innovation in the field of internal and external
performance measurement is EVA. (Note 1)
Pioneered
and advocated by US based business consultant Stern Stewart and company argue
that EVA can be used instead of earnings or cash from operations as measures of
both internal and external performance. “Abandon earnings per share”,
“Earnings, earnings per share, and earnings growth are misleading measures of
corporate performance” and “The best practical periodic performance measure is
EVA” (Stewart 1991). Further to support his hypothesis that EVA is a better
performance measures than other performance measures Stewart (1994) cites
in-house research indicating that “EVA stands well out from the crowd as the
single best measures of value creation on continuous basis”. He further remarks
that ‘EVA is almost 50% better than accounting based measures in explaining changes
in the shareholders wealth”.
Apart from
this popular study, support for EVA has been acknowledged from other sources,
Fortune, which regularly publishes EVA performance rating since 1993 has
acknowledged EVA under different notations “today’s hottest financial idea”,
“The Real way to creating wealth” and “A new way to find Bargains”. Proponents
of EVA have made following principles claims about EVA:
1) EVA helps
in reducing Agency conflict and improve decision making (Costigan & Lovata,
2002; Biddle et al. 1999 )
2)
EVA is more strongly associated with stock return than other measures.
(Maditinos et al., 2006; Lehen and Makhija,1997)
3)
EVA Improves Stock Performance (Ferguson et al., 2005)
4)
EVA adds more informational content in explaining stock returns (Erasmus, 2008;
Chen and Dodd, 1997; Kim, 2006; Palliam, 2006)
5)
EVA and Market Value are correlated (Lefkowitz, 1999; O’Byrne, 1996; Uyemura,
1996; Peterson and Peterson, 1996). Before proceeding further on the concept,
let us first understand the concept of EVA.
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