Economic Value Added

ABSTRACT

Economic value added (EVA™) is a financial performance measure that is increasingly becoming popular. 

A better performance measure is important for investors and managements. Economic Value Added (EVA™) has gained considered attention all over the world. The purpose of this paper presents a comprehensive review from the aspects of financial, divisional, decision making and incentive system to critically discuss if EVA™ outperform traditional measures such as Return on Investment (ROI) or Residual Income (RI), etc. It may be a source of information for management to understand which metric is appropriate for its situation to best measure performance.

1.0 INTRODUCTION

With increasing pressure on firms to deliver shareholder value, there has been a renewed emphasis on devising financial performance measures that encourage managers to increase shareholder wealth (Worthington & West, 2001). Traditional metrics for measuring financial performance such as Return on Investment (ROI), Residual Income (RI), etc. are sometimes criticized for failing to measure shareholders’ true value (Mäkeläinen 1998). In the last two to three decades, Economic value-added (EVA™) has been getting plenty of attention as a new form of internal and external financial performance measurement. In contrast with other traditional metrics, EVA™ focuses more on wealth or value creation for the shareholders rather than just the accounting profits. This paper attempts to evaluate the advantages of EVA™ over other traditional measures. The conceptual underpinnings of EVA™ are reviewed first. Then, this paper will examine the effectiveness of EVA™ vis-a-vis traditional measures with respect to four issues – corporate financial performance measure, divisional performance appraisal, investment decision making, and incentive compensation. Finally, the limitations of EVA™ will be reviewed.

2.0 DEFINITION OF TERMS

2.1 Return on Investment (ROI)

ROI, a...