Economic Wealth Added, the Relevant Economic Measurement for Profit Maximization
29 Pages Posted: 24 Jun 2011
Date Written: July 31, 2010
The rational behavior of financial investors is defined by the preference to obtain more wealth, whether from more value or higher dividends. The indicator which represents this main concern, which we shall name Economic Wealth Added, EWA, has neither been characterized, nor explained directly by the control levers which pilot it.
While the classic economy presented earnings after tax amortization and depreciation as the major economic stream, economists concentrated their attention on value as the main paradigm, presenting it first by its distribution side by the means of discounting free cash flows, often omitting the creation side, which must distance the previous ones. Actually, an investment contributes to the value, a long time before the distribution of the cash flow which it will generate: if its expected profitability decreases, the value of the company will decrease immediately, thereby decreasing financial profit. This will also have an impact on the possibilities of economic development. Faced with this economic and financial reality, the Copernican revolution is to make the created wealth, EWA, the first subject of interest.
We are therefore going to define the economic wealth added, both in static and in dynamic terms, and we will show how much this concept, allows to understand the aptness of investment policy, the optimization of financial structure, by distancing itself from naive visions of a classical and traditional economy without financial markets, where the wealth created by a company was not sufficiently anticipative. This paradigm, also leads to repositioning the notion of accounting capital and the related classic ratios, and questions the notion of profit maximization. EWA offers a multidimensional vision of wealth creation, namely, by showing the economy as whole or by stakeholder, gross or net of the risks, expected or realized, over a period or accumulated.
Economic Wealth Added must be considered the reference measurement for the management of the economic and financial performance of companies as well as a main concern for the economy.
Keywords: profit maximization , corporate finance, EWA, EVA
JEL Classification: G30, G31, G32, D04, D58, D84
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