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Incentives and Investor Expectations

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  • Stephen F. O'Byrne
  • S. David Young

Abstract

This article argues that the Expectations‐Based Management (EBM) measure proposed by Copeland and Dolgoff (in the previous article) is essentially the same measure that EVA companies have used for years as the basis for performance evaluation and incentive compensation. After pointing out that the analyst‐based measures cited by Copeland and Dolgoff do not provide a basis for a workable compensation plan, the authors present the outline of a widely used expectations‐based EVA bonus plan. In so doing, they demonstrate the two key steps in designing such a plan: (1) using a company's “Future Growth Value”—the part of its current market value that cannot be accounted for by its current earnings— to calibrate the series of annual EVA “improvements” expected by the market; and (2) determining the executive's share of those improvements and thus of the company's expected “excess” return. One of the major objections to the use of EVA, or any single‐period measure, as the basis for a performance evaluation and incentive comp plan is its inability to reflect the longer‐run consequences of current investment and operating decisions. The authors close by presenting a solution to this “delayed productivity of capital” problem in the form of an internal accounting approach for dealing with acquisitions and other large strategic investments.

Suggested Citation

  • Stephen F. O'Byrne & S. David Young, 2006. "Incentives and Investor Expectations," Journal of Applied Corporate Finance, Morgan Stanley, vol. 18(2), pages 98-105, March.
  • Handle: RePEc:bla:jacrfn:v:18:y:2006:i:2:p:98-105
    DOI: 10.1111/j.1745-6622.2006.00090.x
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    Cited by:

    1. Magni, Carlo Alberto, 2009. "Splitting up value: A critical review of residual income theories," European Journal of Operational Research, Elsevier, vol. 198(1), pages 1-22, October.
    2. Magni, Carlo Alberto, 2007. "Measuring performance and valuing firms: In search of the lost capital," MPRA Paper 5850, University Library of Munich, Germany.
    3. Magni, Carlo Alberto, 2010. "Residual income and value creation: An investigation into the lost-capital paradigm," European Journal of Operational Research, Elsevier, vol. 201(2), pages 505-519, March.
    4. Nicolas Mottis & Jean-Pierre Ponssard, 2009. "Création de valeur, 10 ans après..," Revue française de gestion, Lavoisier, vol. 0(8), pages 209-226.
    5. Mottis, Nicolas & Ponssard, Jean-Pierre, 2009. "Création de valeur, 10 ans après…," ESSEC Working Papers DR 09013, ESSEC Research Center, ESSEC Business School.
    6. François Larmande & Jean-Pierre Ponssard, 2007. "The lack of controllability of EVA explains its decline a field study," Working Papers hal-00243065, HAL.

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