DOES EVA REALLY HELP LONG TERM STOCK PERFORMANCE?

Transcription

1 DOES EVA REALLY HELP LONG TERM STOCK PERFORMANCE? Wesley M. Jones, Jr. The Ciadel George Lowry, Randolph Macon College ABSTRACT Economic Value Added (EVA) as a philosophy is no new. Many economics sudens have sudied i as economic profi or he excess reurn o capial over a fair, required reurn for aking risk. Is use as a managerial performance measure, however, is relaively new. Indusrial companies began adoping he mehod in he early 1980's. The purpose of he proposed sudy is o examine he long-erm effecs of adoping EVA as a performance meric by empirically examining he long erm sock performance of adoper s of he pracice relaive o heir performance prior o adoping he sysem. The resuls sugges ha firms adoping EVA as a performance measure realize posiive cumulaive excess reurns over he hree-year period subsequen o adopion. INTRODUCTION Shareholders monior managerial behavior so ha managers ac in a manner consisen wih maximizing shareholder wealh. To ha end, companies pu ino place sysems of managerial performance incenives ha help o beer align he ineress of managers wih he ineress of shareholders. These have generally aken he form of incenive compensaions ied o an accouning measure for which a minimum accepable sandard is esablished. An incenive sysem of his ype may be manipulaed by managers acing on he goal of maximizing heir incenive compensaion o he exclusion of shareholder s value. The search for an effecive, performance meric agains which o judge managemen performance is one ha should be of ineres for shareholders and managers alike. To ha end, Sern, Sewar and Company

2 developed a managerial performance incenive sysem ha i markes as Economic Value Added or EVA 1 for shor. BRIEF DISCUSSION OF EVA LITERATURE Economic Value Added is defined as he value generaed by a company s operaions ne of he cos of he capial employed in generaing ha value. The mahemaical definiion of Economic Value Added according o Sewar (1994) is EVA = NOPAT k C (1) a NOPAT is he firm s ne operaing profi afer axes calculaed as EBIT(1-T), k a is he firm s overall cos of capial, and C is he dollar value of he capial employed by he company. Since is inroducion in he early 1980's as a performance meric, EVA has been praised, disseced, and challenged. [See Gran (1996), Dierks and Pael (1997), Lehn and Makhija (1996), and Ferguson and Leisikow (1998) for examples of aricles supporing EVA as a performance measure and Dodd and Johns (1999), Kramer and Pushner (1997), Chen and Dodd (1998) and Jones and Lowry (2005, 2006, 2006(1)) for examples of aricles challenging EVA s usefulness as a performance meric] The purpose of his sudy is o examine he long-erm performance of a company s sock subsequen o adoping EVA as a performance meric. If he asserion abou EVA being a superior performance measure and conribuing more o he creaion of value for shareholders is rue, hen one would expec ha he long erm rend in adoper s sock reurns would be posiive. DATA AND METHODOLOGY The Sern Sewar websie liss approximaely 80 EVA companies, bu, as noed in Dodd and Johns (1999), he populaion of U. S. EVA adopers is unknown and no publicly 1 EVA is a regisered rademark of he Sern Sewar Company, a New York based consuling firm.

3 disclosed. To obain a lising of EVA adopers and heir adopion daes, Sern Sewar was conaced and hey provided a lising of 27 EVA adopers along wih heir EVA sar daes. The Compusa daabase was accessed o obain for each company daa on monh end sock price and he value of he S&P 500 for he period beginning 37 monhs prior o he firm s EVA sar dae and ending 37 monhs afer he sar dae. Prices were used o calculae monhly reurns, and a porfolio of he EVA companies was consruced. Using a mehodology similar o Brown and Warner (1980), he cumulaive average abnormal reurn of he EVA porfolio was esimaed. The model for esimaing expeced reurns subsequen o adopion was found by regressing he reurns of he companies on he reurns of he marke for he 26 monh period beginning a =-36 and coninuing o = -11 prior o he adopion monh of he EVA sandard. The esimaed equaion was hen used o predic he expeced reurn for he 46 monhs period beginning a = -10 and coninuing o = +36 subsequen o adopion of he sandard. The difference beween he acual and prediced reurn was hen calculaed as he abnormal reurn (AR) for each period according o equaion 2 below. AR i i ( R ) = R E (2) i The abnormal reurns were hen averaged across all securiies for each monh o formulae he monhly average abnormal reurn (AAR) as noed in equaion 3 below.. AAR N ARi i= = 1 (3) N The average abnormal reurns were hen accumulaed over he even period from = -10 o = +36 o formulae a series of cumulaive average abnormal reurns (CAAR) as noed in equaion 4 below. CAAR = CAAR 1 + AAR (4)

4 This series of cumulaive abnormal reurns is hen esed for significance during he even period; he resuls of he significance es graphically presened in Figure Cumulaive Average Abnormal Reurn Figure 1 The graph illusraes ha he firm s adoping EVA as a performance meric appear o experience a long-erm negaive impac subsequen o adopion. The negaive cumulaive abnormal reurns become significan afer approximaely 21 monhs subsequen o adopion of EVA as a performance meric. CONCLUSIONS AND IMPLICATIONS Economic Value Added has been presened as one of he mos imporan performance measures ha a company can implemen. While he measure does have some inuiive appeal in ha is seems o sugges ha managers should ac more enrepreneurial, he evidence of is effeciveness in acually posiively impacing share prices remains mixed. This sudy has indicaed ha firms adoping EVA acually experience negaive cumulaive abnormal reurns over ime subsequen o adopion. Perhaps, as suggesed by Chen and Dodd (1998), he marke prefers a performance measure ha is independenly audied o a performance measure ha is

5 boh somewha difficul o undersand and unaudied. If firms choose o adop he EVA meric, hey should be aware ha i may no be as beneficial as perhaps i appears on firs glance, and perhaps hey would be well counseled o use i in conjuncion wih some oher acceped and independenly audied performance meric or merics REFERENCES 1. Brown, Sephen J. and Jerold B. Warner. Measuring Securiy Price Performance. Journal of Financial Economics. V.8 (1980) p Chen, Shimin and James L. Dodd. Usefulness of Operaing Income, Residual Income and EVA : A Value-Relevance Perspecive. Working Paper presened a 1998 MBAA Conference, Chicago, IL, 3/28/98. Absrac published in conference proceedings. 3. Dierks, Paul A., and Ajay Pael. Wha is EVA, and How Can I Help Your Company? Managemen Accouning. November Dodd, James L., and Jason Johns. EVA Reconsidered. Business and Economic Review. V45.N3. April/June Ferguson, Robern and Dean Leisikow. Search for he Bes Financial Performance Measure: Basics are Beer. Financial Analyss Journal. V54. N1. Jan/Feb Gran, James L., Foundaions of EVA for Invesmen Managers. The Journal of Porfolio Managemen. Fall Jones, W.M., and G. Lowry, An Examinaion of he Effec of Size on Differences Beween Hisorical Measures of Risk and The Risk Implied by Economic Value Added Virginia Economic Journal, V. 11, 2006, pp Jones, W.M., and G. Lowry, An Examinaion of he Business Secor Differenials Beween Hisorical Measures of Risk and he Risk Implied by Economic Value Added, Journal of Business and Economic Research, V.4, N.12, December 2006, pp Jones, W.M., and G. Lowry, An Examinaion of he Consisency of Risk Differenials Beween Hisorical Measures of Risk and The Risk Implied by Economic Value Added, Journal of Business & Economics Research, V. 3, N. 12, December 2005, pp Kramer, Jonahan K., and George Pushner. An Empirical Analysis of Economic Value Added as a Proxy for Marke Value Added. Financial Pracice and Educaion. Spring/ Summer Lehn, Kenneh, and Anil Makhija. EVA & MVA as Performance Measures and Signals for Sraegic Change. Sraegy and Leadership. Many/June Sewar, G. Benne, III. EVA : Fac and Fanasy. Journal of Applied Corporae Finance. V.7. N.2. (1994)