Economic Value Added: Candide or Optimism – A Panglossian and Empirical Study

Posted: 2 Dec 2018

See all articles by Ralph Palliam

Ralph Palliam

American University of Kuwait

Date Written: November 5, 2003

Abstract

Managerial finance literature is replete with intellectually stimulating hypotheses about Economic Value Added (EVA). Upsurges in EVA optimism can be contrasted with Voltaire's attitude toward virtue and other such abstractions. The near unanimity among some researchers reflect the omnipotence of EVA. It has been designed and fashioned the best among “all possible worlds”. Correlation between EVA and stock prices may provide reasonable and reliable guide to EVA’s value as an incentive-contracting tool. Theoretically the best of all possible tools would have a correlation of 1 with the best of all that is best in the “best of all possible worlds”. This would be the case if all is well in the “metaphysico-theologo-cosmolonigology” reporting of financial data. As with most of the theories of finance and economics, EVA is also based on numerous assumptions. This study tests assertions that Economic Value Added (EVA) is more highly associated with stock returns and firm values than accrual earnings, and evaluates which components of EVA, if any, contribute to these associations. Relative information content tests reveal earnings to be more highly associated with returns and firm values than EVA, residual income, or cash flow from operations. Incremental tests suggest that EVA components add only marginally to information content beyond earnings. Considered together, these results do not support claims that EVA dominates earnings in relative information content, and suggest rather that earnings generally outperform EVA. The findings of the study suggest that EVA is a relatively poor predictor of stock performance and enhanced shareholder value.

Keywords: Economic Value Added, EVA, Synthetic Price, Accounting Profit, Cost of Capital, Earnings, Performance Measurements, CAPM, Earnings Manipulation

Suggested Citation

Palliam, Ralph, Economic Value Added: Candide or Optimism – A Panglossian and Empirical Study (November 5, 2003). Indian Institute of Capital Markets, 10th Capital Markets Conference, Indian Institute of Capital Markets. Available at SSRN: https://ssrn.com/abstract=3278619

Ralph Palliam (Contact Author)

American University of Kuwait ( email )

P.O. Box 3323
Safat, 13034
Kuwait

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