Evidence on EVA

27 Pages Posted: 20 Sep 1999  

Gary C. Biddle

The University of Hong Kong - School of Economics and Finance

Robert M. Bowen

University of San Diego - Department of Accountancy; University of Washington - Foster School of Business

James S. Wallace

Claremont Colleges - Peter F. Drucker Graduate School of Management

Abstract

Economic Value Added (EVA) has attracted considerable attention as an alternative to traditional accounting earnings for use in both valuation and incentive compensation. With a host of consultants now marketing related metrics, numerous claims have been made - most based on anecdotal evidence or in-house studies. This paper summarizes independent evidence regarding EVA's alleged advantages. We begin by reviewing the theory that links the underlying concept of residual income to shareholder value. Second, we discuss how Stern Stewart modifies residual income to produce its proprietary EVA metric and show how median EVA compares with residual income, net income and operating cash flows over the period 1988-97. Third, we examine the claim that EVA is more closely associated with stock returns and firm value than is net income. The evidence indicates that EVA does not dominate net income in associations with stock returns and firm values. Fourth, we examine a second claim that compensation plans based on residual income motivate managers to take actions consistent with increasing shareholder value. Here, the independent evidence suggests that managers do respond to residual income-based incentives. Finally, we discuss how a metric such as EVA can be useful for internal incentive purposes even if it conveys little news to market participants regarding the firm's valuation.

JEL Classification: M41, M46, G12, G14, G30, M33

Suggested Citation

Biddle, Gary C. and Bowen, Robert M. and Wallace, James S., Evidence on EVA. Journal of Applied Corporate Finance, Vol. 12, No. 2, Summer 1999. Available at SSRN: https://ssrn.com/abstract=178168 or http://dx.doi.org/10.2139/ssrn.178168

Gary C. Biddle

The University of Hong Kong - School of Economics and Finance ( email )

8th Floor Kennedy Town Centre
23 Belcher's Street
Kennedy Town
Hong Kong
+852 3917-4388 (Phone)
+852 2858-5614 (Fax)

HOME PAGE: http://www.fbe.hku.hk/Aboutus/Staff_Detail.cfm?StaffID=315

Robert M. Bowen

University of San Diego - Department of Accountancy ( email )

223 Olin Hall
5998 Alcalá Park
San Diego, CA
United States
619.260.2385 (Phone)

HOME PAGE: http://www.sandiego.edu/business/directory/biography.php?id=1232

University of Washington - Foster School of Business ( email )

Box 353226
University of Washington
Seattle, WA 98195-3226
United States

HOME PAGE: http://faculty.washington.edu/rbowen/

James S. Wallace (Contact Author)

Claremont Colleges - Peter F. Drucker Graduate School of Management ( email )

The Drucker School of Management
1021 North Dartmouth Avenue
Claremont, CA 91711
United States
(909) 607-6063 (Phone)

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