A Look Back at the Beginnings of EVA and Value‐Based Management: An Interview with Joel M. Stern

10 Pages Posted: 8 Apr 2014

See all articles by Joel M. Stern

Joel M. Stern

Columbia University - Columbia Business School

Joseph T. Willett

Merrill Lynch & Co.

Date Written: Winter 2014

Abstract

One of the pioneers of value‐based management discusses his life's work in converting principles of modern finance theory into performance evaluation and incentive compensation plans that have been adopted by many of the world's largest and most successful companies, including Coca‐Cola in the U.S., SABMiller in London, Siemens in Germany, and the Godrej Group in India. The issues covered include the significance of dividend payouts (are dividends really necessary to support a company's stock price and, if so, why?) as well as the question of optimal capital structure (whether and why debt might not be cheaper than equity). But the most important focus of the interview is corporate performance measurement and the use of executive pay to strengthen management incentives to increase efficiency and value. According to Stern, the widespread tendency of public companies to manage “for earnings” - or in accordance with what he refers to as “the accounting model of the firm” - often leads to value‐destroying decisions. As one example, the GAAP accounting principle that requires intangible investments like R&D and training to be written off in the year the expenses are incurred is likely to cause underinvestment in such intangibles. At the same time, the failure of conventional income statements to reflect the cost of equity almost certainly encourages corporate overinvestment. Stern's solution to this problem is an executive incentive compensation plan in which rewards are tied to increases in a measure of economic profit called economic value added, or EVA, which research has shown to have a significance relation to changes both in share value and the premium of market value over book value. Moreover, by combining such a plan with a “bonus bank” that pays out annual awards over a multi‐year period, boards can ensure that management will be rewarded not for good luck but rather for sustainable improvements in performance.

Suggested Citation

Stern, Joel M. and Willett, Joseph T., A Look Back at the Beginnings of EVA and Value‐Based Management: An Interview with Joel M. Stern (Winter 2014). Journal of Applied Corporate Finance, Vol. 26, Issue 1, pp. 39-46, 2014, Available at SSRN: https://ssrn.com/abstract=2422149 or http://dx.doi.org/10.1111/jacf.12052

Joel M. Stern

Columbia University - Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

Joseph T. Willett (Contact Author)

Merrill Lynch & Co.

World Financial Center - North Tower
19th Floor
New York, NY 10281-1319
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
1
Abstract Views
935
PlumX Metrics