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EVA, Economic profit and cash value added do NOT measure shareholder value creation

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  • Fernández, Pablo

    () (IESE Business School)

Abstract

We analyze 582 American companies using EVA, MVA, NOPAT and WACC data provided by Stern Stewart. For each of the 582 companies, we have calculated the 10-year correlation between the increase in the MVA (Market Value Added) each year and each year's EVA, NOPAT and WACC. For 296 (of the 582) companies, the correlation between the increase in the MVA each year and the NOPAT was greater than the correlation between the increase in the MVA each year and the EVA. There are 210 companies for which the correlation with the EVA has been negative! The average correlation between the increase in the MVA and EVA, NOPAT and WACC was 16%, 21% and -21.4%. The average correlation between the increase in the MVA and the increases of EVA, NOPAT and WACC was 18%, 22.5% and -4.1%. We also find that the correlation between the shareholder return in 1994-1998 and the increase in the CVA (according to the Boston Consulting Group) of the world's 100 most profitable companies was 1.7%. We have also analyzed the relationship between shareholder value creation and various other parameters, including Economic Profit and EVA, during the period 1991-1997. In this case, the sample consisted of the 28 largest Spanish companies. Economic Profit had the highest correlation with shareholder value creation in only 4 companies (EVA in only 2), while in 18 companies the highest correlation was found for the interest rate. A firm's value and the increase in the firm's value over a certain period are basically determined by the changes in expectations regarding the growth of the firm's cash flows and also by the changes in the firm's risk, which lead to changes in the discount rate. However, accounting only reflects the firm's history. Both the items of the income statement, which explain what has happened during a certain year, and those of the balance sheet, which reflect the state of a firm's assets and liabilities at a certain point in time, are historic data. Consequently, it is impossible for accounting-based measures, such as those we have seen (EVA, economic profit, cash value added), to measure value creation. We finish the paper with an anecdote about EVA: an e-mail written by an analyst at Stern Stewart & Co. in response to an article, written by me, questioning the ability of EVA to measure shareholder value creation.

Suggested Citation

  • Fernández, Pablo, 2002. "EVA, Economic profit and cash value added do NOT measure shareholder value creation," IESE Research Papers D/453, IESE Business School.
  • Handle: RePEc:ebg:iesewp:d-0453
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    File URL: http://www.iese.edu/research/pdfs/DI-0453-E.pdf
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    References listed on IDEAS

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    1. Robert T. Kleiman, 1999. "Some New Evidence On Eva Companies," Journal of Applied Corporate Finance, Morgan Stanley, vol. 12(2), pages 80-91.
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    Cited by:

    1. Saadet Kasman & Adnan Kasman, 2011. "Efficiency, Productivity and Stock Performance: Evidence from the Turkish Banking Sector," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 58(3), pages 355-372, September.
    2. Herciu, Mihaela & Ogrean, Claudia & Belascu, Lucian, 2009. "La dynamique du binôme capital financier – capital intellectuel dans la création de la valeur de l’entreprise dans une société basée sur la connaissance
      [The dynamics of the financial capital – int
      ," MPRA Paper 16305, University Library of Munich, Germany.
    3. Akalu, M.M. & Turner, J.R., 2001. "The Practice of Investment Appraisal," ERIM Report Series Research in Management ERS-2001-77-ORG, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
    4. Akalu, M.M. & Turner, J.R., 2002. "Adding Shareholder Value through Project Performance Measurement, Monitoring & Control," ERIM Report Series Research in Management ERS-2002-38-ORG, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
    5. Elena Shakina & Maria Molodchik, 2013. "Intangible-driven value creation: supporting and obstructing factors," HSE Working papers WP BRP 24/FE/2013, National Research University Higher School of Economics.
    6. Akalu, M.M. & Turner, J.R., 2001. "Investment Appraisal Process," ERIM Report Series Research in Management ERS-2001-78-ORG, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.

    More about this item

    Keywords

    Economic Profit; correlations;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • M21 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics - - - Business Economics

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