Question 6
Lecture Discussion Question
In striving to increase performance and ultimately the value of the company, EVA is
often presented as the best mechanism, however it may not provide the required
incentives to increase managerial interest in improving performance.
Discuss in light of the published research discussed in class.
ANSWER
In the current business context, companies are seeking for an economic framework
which better mirrors their value and profitability. Performance measurement is
defined as regular measurement of outcomes and results, which generates reliable
data on the effectiveness and efficiency of programs (ECA, 2015). Relative
performance measures include Return on Investment (ROI), Residual Income (RI),
Economic Value Added (EVA).
An organisation should not use only financial measures to monitor performance
(CIMA, 2008). First, no single financial measure captures all performance aspects of
an organisation. Second, financial measures have reporting time lags that could
mislead and hinder timely decision making.
ROI is a ratio of operating income to average operating assets. ROI may influence a
divisional manager to select only investments with high rates of return. Also, while
comparing ROI of different companies, it is necessary that they use similar
accounting policies and methods (Agar, 2009).
RI is the excess earning over the minimum expected return on operating assets. It is
an absolute measure and does not foster comparison of different size projects. Profit
ignores the cost of equity capital. Companies only generate wealth when they
generate a return in excess of the return required by providers of capital – both
equity and debt. It also does not discourage myopic behaviour (Flower, 1971).
EVA is a variant of RI marketed by Stern Stewart & Co., with the purpose of
promoting value-maximising behaviour in corporate managers. Zimmerman (1997)
defined EVA as an accounting-based measure of periodic operating performance
that is directly linked to shareholder wealth. EVA is the difference between
accounting earnings – with possible adjustments for interest and some accounting
methods – and the cost of invested capital used to generate those earnings. EVA is
an absolute measure and has overcome the problems of ROI. EVA helps to manage
both long term and short-term value (Kaplan, 2010).
Many supports Stewart’s (1999) claim for the superiority of EVA as a performance
measure. A study of Malmi and Ikaheimo (2003) found that EVA has an impact on
Lecture Discussion Question
In striving to increase performance and ultimately the value of the company, EVA is
often presented as the best mechanism, however it may not provide the required
incentives to increase managerial interest in improving performance.
Discuss in light of the published research discussed in class.
ANSWER
In the current business context, companies are seeking for an economic framework
which better mirrors their value and profitability. Performance measurement is
defined as regular measurement of outcomes and results, which generates reliable
data on the effectiveness and efficiency of programs (ECA, 2015). Relative
performance measures include Return on Investment (ROI), Residual Income (RI),
Economic Value Added (EVA).
An organisation should not use only financial measures to monitor performance
(CIMA, 2008). First, no single financial measure captures all performance aspects of
an organisation. Second, financial measures have reporting time lags that could
mislead and hinder timely decision making.
ROI is a ratio of operating income to average operating assets. ROI may influence a
divisional manager to select only investments with high rates of return. Also, while
comparing ROI of different companies, it is necessary that they use similar
accounting policies and methods (Agar, 2009).
RI is the excess earning over the minimum expected return on operating assets. It is
an absolute measure and does not foster comparison of different size projects. Profit
ignores the cost of equity capital. Companies only generate wealth when they
generate a return in excess of the return required by providers of capital – both
equity and debt. It also does not discourage myopic behaviour (Flower, 1971).
EVA is a variant of RI marketed by Stern Stewart & Co., with the purpose of
promoting value-maximising behaviour in corporate managers. Zimmerman (1997)
defined EVA as an accounting-based measure of periodic operating performance
that is directly linked to shareholder wealth. EVA is the difference between
accounting earnings – with possible adjustments for interest and some accounting
methods – and the cost of invested capital used to generate those earnings. EVA is
an absolute measure and has overcome the problems of ROI. EVA helps to manage
both long term and short-term value (Kaplan, 2010).
Many supports Stewart’s (1999) claim for the superiority of EVA as a performance
measure. A study of Malmi and Ikaheimo (2003) found that EVA has an impact on
