The Utilization of Value-Based

Management: An Empirical
Analysis

Harley E. Ryan, Jr. and Emery A. Trahan

The objective of this paper is to provide information on how value-based management is perceived,
implemented, and utilized in leading industrial corporations in the US, and to examine factors that influence
the decision to utilize it. We gather data through a survey of the chief financial officers (CFOs) of a large
sample of US industrial corporations, in order to ascertain their opinions of and experiences with value-
based management systems and metrics. The results suggest that there is room for improvement in the
design and implementation of value-based management systems. If value-based management is to have an
impact on corporate strategy and value and reduce intra-firm agency costs, then its scope within the firm
may need to be expanded. [JEL: G30, M10, G34]

n Increased competition in the managerial labor and The objective of this paper is to fill the gap in the
capital markets has led to heightened pressure on literature by providing information on how value-
corporations to focus on maximizing shareholder value. based management is perceived and implemented in
Hostile takeovers, institutional investors with large leading industrial corporations in the US. We ascertain
equity positions in corporations, more active boards the types of systems being studied and implemented,
of directors, and increasingly competitive global capital how and when the corporation implements a value-
markets have all contributed to this increased pressure. based management strategy, and gain information on
In response, companies are searching for ways to better the perceived success or failure of these strategies.
manage shareholder value, and numerous consulting We also examine the factors that influence the
firms have developed models designed to help adoption of value-based management methods.
corporations implement value-based management To the best of our knowledge, this paper represents
systems. Outside of reports in the financial press, there the first independent study of the popular value-
is little evidence on the awareness, use, and scope of based management models and how they are
value-based management in US corporations. There is utilized. 1 The results provide new information on
a gap in the academic literature in that no scientific how the CFOs of major corporations perceive
evidence reports how value-based management is different value-based management models and the
perceived by financial managers, which methods are services of numerous consulting firms that offer
used, and how they are used. value-based management advice. They also provide

1
Harley E. Ryan, Jr., is an Assistant Professor at Lousiana State Several studies of specific methods have been conducted or
University, Baton Rouge, LA 70803-6308. Emery A. Trahan commissioned by sponsoring consulting firms. See, for
is an Associate Professor at Northeastern University, Boston, example, Stewart (1994). Dillon and Owers (1997) discuss
MA 02115. the debate over EVA as a performance metric. Also, Peterson
and Peterson (1996) evaluate several value-based management
The authors acknowledge helpful comments received in methods from an investment perspective. While these
developing the survey instrument from financial executives methods may be useful to corporate financial managers,
Milton Glass, Linton Molding, Don Peters, and Sam Weaver. Peterson and Peterson question their value to equity analysts.
Jim Owers, Ernie Swift, two anonymous referees, and the Editor, We are interested in value-based management in terms of its
Raj Aggarwal, also provided useful comments. use in corporate financial management.

46
RYAN & TRAHAN—THE UTILIZATION OF VALUE-BASED MANAGEMENT 47

new insights into this growing area of corporate articles profile several corporations that have adopted
strategy and provide data on the motivations of firms a variety of value-based management methods in an
utilizing value-based management systems. effort to increase their value.
Numerous consulting firms have developed and
popularized metrics designed to help corporations
I. Value-Based Management Systems
implement value-based management systems. Some
and Shareholder Wealth Maximization examples are:
Value-based management refers to management
Discounted Cash Flow (DCF) popularized by
adopting a corporate strategy of maximizing
LEK/Alcar Consulting Group. DCF recognizes
shareholder value. Value-based management is, in
that the market value of a company can be
theory, all-encompassing and includes corporate
expressed as the present value of its expected
strategy, management compensation issues, and
future cash flows discounted back to the present
detailed internal control and reward systems, all
at the company’s cost of capital. Alcar
designed to link employee performance to shareholder
popularized DCF a s a m e t r i c l i n k e d t o
value. A comprehensive value-based management
shareholder value, and the notion that cash
system can span all levels of the corporation and have
flows may be broken down into a number of
an impact on all employees.
value drivers. See Rappaport (1986) for a more
Recent surveys of a variety of public companies
detailed discussion of DCF and its application
indicate a high degree of interest in issues related to
to value-based management.2
managing for value. Ramirez, Waldman, and Lasser
(1991) survey Fortune 500 CFOs and middle managers
on the importance of 26 topics in corporate finance. Cash Flow Return on Investment (CFROI)—
The item receiving the highest ranking from both CFOs popularized by BCG-HOLT. CFROI represents the
and middle managers is investor reactions towards cash flow a company generates in a given period
firms concentrating on short-term performance and as a percentage of the cash invested in the
ignoring long-term benefits. A major issue raised in company’s assets. Both cash flow and assets are
write-in comments was the prevailing “myopic” vision stated in current dollars to adjust for inflation.
of Wall Street. Cooper and Petry (1994) survey a sample The asset base is also adjusted to include the
of CFOs, from the 1990 Business Week 1,000 firms, on capitalization of operating leases. The cash flow
their use of a variety of sophisticated financial to cash invested ratio is then converted to an
management decision methods. They conclude that internal rate of return measure over the normal
there is considerable interest in empirical evidence on economic life of the assets involved. See Peterson
maximizing shareholder value. Trahan and Gitman and Peterson (1996) for a more detailed discussion
(1995) survey Fortune 500 and Forbes 200 Small of CFROI.
Company CFOs regarding their desire to know more
about several corporate finance topics grouped into
Return on Invested Capital (ROIC)—
ten decision areas. The impact of financial decisions
popularized by McKinsey & Co. ROIC is the ratio
on stock price is an area that CFOs of both groups of
of a company’s net operating profits less adjusted
firms express a desire to know more about. The impact
taxes (NOPLAT) to its invested capital. NOPLAT
of cash flow on stock price, impact of institutional and
is the company’s earnings before interest and
managerial ownership on stock price, and impact of
taxes less cash taxes. Invested capital is the
short-sighted management are all topics within this
amount invested in the operations of the
area that the CFOs would like to know more about.
company. It is computed as the sum of operating
Davis (1996) interviews executives at 12 companies
working capital, net fixed assets, and net other
regarding their focus on cash flow and performance
assets. See Copeland, Koller, and Murrin (1994)
measurement. He finds that, while the executives at
for a more detailed discussion of ROIC.
the companies used different financial performance
measures, all were concerned with creating shareholder
Economic Value Added (EVA®)—popularized by
value by generating earnings and cash flow greater
Stern Stewart & Co. The EVA metric, which has
than the cost of the capital entrusted to them.
been trademarked by Stern Stewart, is a residual
Value-based management has captured the interest
income type measure of economic profit. Stern
of the corporate and investment communities. Recent
articles in Fortune (see Lieber, 1996; and Fisher, 1995) 2
DCF is a factor in all of the metrics discussed, since they all
include a list of 1,000 companies ranked by how much derive from a present value model. For Alcar, DCF is also the
market value they added during the past decade. These main metric utilized to measure performance and to link to value.
48 FINANCIAL PRACTICE AND EDUCATION — SPRING / SUMMER 1999

Stewart computes EVA as net operating profits survey questionnaire lists the more popular value-
after taxes (adjusted for a variety of factors, e.g., based management metrics and notes the consulting
capitalizing and amortizing R&D expenditures) firms that popularized them, although respondents may
minus a capital charge, computed as the use a metric without employing the consulting firm
company’s adjusted book value of capital times that popularized it, or they may use their own variation
its market-determined cost of capital. EVA of the metric. In developing the survey instrument, we
measures the excess of earnings over the consulted with several financial executives to gather
minimum return that shareholders could get by their feedback on the instrument and ensure that the
investing capital in companies of similar risk. See design was effective and would gather information that
Peterson and Peterson (1996) and Stewart (1991) is of interest to financial executives.
for a more detailed discussion of EVA. The surveys were numbered to allow second
requests to be mailed and to allow us to ascertain the
All of these firms link their metrics upwards to characteristics of responding companies. Anonymity
shareholder value and link them downwards to a series was promised to each respondent. Responses were
of value drivers. BCG-HOLT defines value drivers as subjected to statistical analysis to examine differences
operating decisions that have a high impact on value in how these competing systems are used. Finally, firm-
and are manageable by the business unit. Ideally the specific determinants of value-based management
performance of many employees can be tied to usage are analyzed by estimating a logit model. Firm-
shareholder value by measuring their impact on a specific data is obtained from Compustat.
particular value driver.
A detailed discussion of value-based management
III. Results
and a description of the firms’ models and value drivers
may be found in several books written by consultants The questionnaire was mailed to the CFOs of the
at these firms. See for example: Copeland, Koller, and 977 sample firms in November 1996. Second requests
Murrin (1994), Rappaport (1986), and Stewart (1991). were mailed in February 1997. A total of 204 (21%)
The competition among these firms and the debate responses were received. This response rate compares
over which model works best is illustrated in articles favorably to many other surveys of this population; (see
by Myers (1996, 1997) and Stewart (1994). for example, Ramirez, et al., 1991; and Trahan and Gitman,
1995). Of the 202 responses, 18 indicated that it was
II. Methodology company policy not to complete survey questionnaires.
The remaining 184 completed the questionnaire.
To gain information on how value-based
management is perceived and utilized in US A. Characteristics of Respondents and
corporations, we begin with a survey of the CFOs of a Responding Firms
large sample of firms. The 1,000 largest publicly-owned
Two tests are conducted for response bias. Because
US industrial and non-financial service companies are
questionnaires may be forwarded upon receipt by the
included in the sample. The list was obtained from
CFO to others within the company, each respondent
Walbert (1995), which ranks the 1,000 companies based
was asked to write in his or her corporate title. All of
on their Market Value Added for 1993.3 Addresses and
the respondents are high-level corporate personnel.4
CFO names were obtained from Compact Disclosure,
To further check for response bias, we gather firm-
Standard & Poor’s, and Moody’s Industrial Manual. A
specific information for the firms responding to the
total of twenty-three of these firms were not surveyed
survey and for firms not responding. The variables are
because they either merged or went out of business.
similar to those utilized by Ramirez, et al. (1991). The
A two-page (one-page, double-sided) survey
mean values of these variables for responding and
instrument, available from the authors, was designed
non-responding firms are reported in Exhibit 1. Only
to obtain information on the respondent’s title,
the ratio of operating income before interest, taxes,
familiarity with value-based management, use of value-
and depreciation to sales is significantly different for
based management, areas where it is used, scope of
responding versus non-responding firms. It is possible
use, timing of adoption, and employee education. The
that response is biased toward firms that are interested
survey also gathers information on how value-based
in and using value-based management, overstating
management is used in determining compensation.
these percentages in our results relative to the
Space for write-in comments was also provided. The
3
Market value added (MVA) is a measure popularized by Stern 4
Of them, 88% hold the title of CFO, Treasurer, Controller,
Stewart and Co. MVA is the difference between a company’s and/or Vice-President. The remainder are in Planning and
total market value and its total book value of capital invested. Budgeting, Investor Relations, or assistants to officers.
RYAN & TRAHAN—THE UTILIZATION OF VALUE-BASED MANAGEMENT 49

Exhibit 1. Financial Characteristics of Surveyed Firms

Figures for assets, sales, equity, shares and volume are in millions.

Firms Responding Firms Failing to Respond t-Statistic

(N=186)a (N=791)b for
Mean Mean Differencec
Total Assets $4,583 $3,821 0.78
Sales $4,165 $3,474 0.36
Market Value of Equity $3,596 $3,288 0.58
Long- Term Debt to Assets Ratio 20.9% 23.1% 1.43
Operating Income Before Interest, Taxes, and 18.0% 15.4% 2.38**
Depreciation to Sales Ratio
Net Profit Margin 1.6% 3.1% 0.65
Tax Rate 32.3% 35.5% 0.48
Number of Shares Outstanding 92 85 0.56
Trading Volume (Shares per Year) 71 76 0.60

a
Observations for individual variables differ from total observations due to the unavailability of data.
b
Accounting data was available for 183 responding firms and 780 non-responding firms.
c
Determined by a difference in means test.

**Significant at the 0.05 level, determined by a difference in means test.

population of firms. Our main objective, however, is to presentation on the method. Of the respondents
provide information on how responding firms perceive, familiar with the methods, a high of 82% report that
use, and implement value-based management systems. they use DCF,6 and a low of 46% report that they use
Hence, this response bias, if it exists, would not impact CFROI. The percentage of firms using DCF is
our main results. statistically significantly higher than for the other
methods. Eighty-three percent of the other methods
B. Familiarity and Use of Value-Based written in by respondents are reported as being used.
Management Overall, a majority of the respondents are familiar with
many of the value-based management methods, many
Of the 186 executives completing the questionnaire,
have seen presentations on these methods, and many
24 (13%) said that they were not familiar with value-
use the methods. Details are shown in Exhibit 2.
based management. The remaining 162 (87%) said they
Many respondents indicate that they have
were familiar with value-based management.
developed a value-based management method, either
Respondents were generally familiar with the listed
internally or with the assistance of a consultant. DCF
methods (DCF, CFROI, ROIC, and EVA). Of the 162
is the most common method with 52% of the
respondents who indicated that they were familiar with
respondents who are familiar with it developing it
value-based management, a high of 94% were familiar
internally. This is statistically higher than the other
with EVA and a low of 72% were familiar with ROIC.
methods. EVA is the most common method being
The percentage familiar with EVA is statistically
developed with outside assistance, with 18% of the
significantly higher than all other methods, and the
respondents who are familiar with EVA developing it
percentage familiar with DCF is significantly higher
with outside assistance. This is statistically higher
than CFROI and ROIC. Additionally, 19% indicated that
than for the other methods. For those familiar with
they were familiar with other value-based management
other methods, 50% developed the method internally,
methods. 5 Of the respondents familiar with the
and 27% developed it with outside assistance. 7
methods, a high of 83% have seen a presentation on
Overall, many of the responding companies are using
EVA, while a low of 38% have seen a presentation on
ROIC. Of the respondents familiar with other value-
6
based management methods, 43% have seen a This is not surprising given the fact that DCF is a method
widely taught in business schools and covered in all well-known
financial management textbooks as the predominant method
5
These include: Amp Value Added, KPMG Critical Factors, for analyzing investment decisions. See for example, Brealey
IRR, Total Enterprise DCF, LBO Base, Towers Perrin Value Based and Myers (1996).
7
Management, Cash Flow Return with Cost of Capital Threshold, Some companies indicated that they developed the methods
Marakon DCF, Shareholder Value Added, and Braxton. both internally and with outside assistance.
50 FINANCIAL PRACTICE AND EDUCATION — SPRING / SUMMER 1999

Exhibit 2. Familiarity and Use of Value-Based Management Systems

Responses are given for 162 respondents who indicated that they were familiar with value-based management. Respondents
were presented with a statement regarding their familiarity and use of value-based management systems and asked to indicate all
systems to which the statement applied. DCF indicates discounted cash flow, CFROI indicates cash flow return on investment,
ROIC indicates return on invested capital, EVA indicates Economic Value Added, Other indicates any other value-based
management system. See footnote 3 for a summary of other methods listed by respondents. Letters indicate that the proportion
responding positively for a particular method is statistically greater than the method indicated by the letter.

Familiarity
an d U se DCF (D) CFROI (C) ROIC (R) EVA (E) Other (O)
Familiar with 140/162 86% 121/162 75% 116/162 72% 152/162 94% 30 of 162 19%
Method C*** R*** O*** O *** O *** D** C*** R*** O***
At Presentation 78/140 56% 55/121 45% 44/116 38% 126/152 83% 13 of 30 43%
on Method C* R** D*** C*** R*** O***
Use Method 115/140 82% 56/121 46% 59/116 51% 76/152 50% 25 of 30 83%
C*** R*** E*** C*** R***
Developed 73/40 52% 40/121 33% 41/116 35% 42/152 28% 15 of 30 50%
Internally C*** R* E*** O*
Developed with 9/140 6% 4/121 3% 6/116 5% 28/152 18% 8 of 30 27%
Assistance D*** C*** R*** D*** C*** R***
Satisfied with 83/140 60% 46/121 38% 45/116 39% 64/152 42% 18 of 30 60%
Method C*** R*** E*** C*** R*** E*

***Significant at the 0.01 level, determined by a difference in proportions test.

**Significant at the 0.05 level, determined by a difference in proportions test.
*Significant at the 0.10 level, determined by a difference in proportions test.

a variety of value-based management methods, with Exhibit 3. Generally, the most common area where value-
the majority of those utilizing a method developing it based management methods are applied is investment
internally. Details are shown in Exhibit 2. decisions, with a high of 97% of DCF users employing
Respondents were asked whether or not they were it for these purposes, and a low of 63% using EVA for
satisfied with the method. For those familiar with a investment decisions. This difference is statistically
method, the answers ranged from a high of 60% significant, although 63% for EVA is still substantial.
indicating they were satisfied with DCF to a low of The next most common area is long-term planning, with
38% being satisfied with CFROI. The percentage a high of 70% using EVA in this area and a low of 54%
satisfied with DCF is statistically higher than the other using ROIC, although the difference is only
methods, while the differences across the other significantly different for EVA over CFROI and ROIC.8
methods are not statistically significant. Of the In the area of performance measurement, a high of 76%
respondents familiar with other value-based of users employ EVA, and a low of 16% use DCF. A
management methods, 60% are satisfied with them. high of 58% of users employ EVA for annual-budgeting
With the exception of DCF and methods listed by purposes, while a low of 17% use DCF for annual
respondents as “other,” the majority of respondents budgeting. EVA is the most commonly used method for
familiar with a value-based management method do compensation, while 49% of those using EVA employ it
not indicate that they are satisfied with the method. for compensation decisions, although the percentage
There is room for improvement in the design and
implementation of value-based management systems. 8
The percentages discussed in this section are based on the
Details are shown in Exhibit 2. percentage of respondents who use a particular method.
Generally the number of respondents is consistent with the
C. Areas Where Value-Based Management percentages, however, as the numbers in Exhibit 2 show, some
areas may have different usage in terms of number of
Methods are Used respondents. For example, 68 (59%) users of DCF use it for
long-term planning, whereas 53 (70%) users of EVA use it for
Respondents were asked to indicate the areas of long-term planning. The difference in ranking, based on
financial management where they utilize value- number of users versus percentage, stems from the fact that
based management methods. The results are shown in 115 respondents report using DCF, while 76 report using EVA.
RYAN & TRAHAN—THE UTILIZATION OF VALUE-BASED MANAGEMENT 51

Exhibit 3. Areas Where Value-Based Management Methods are Used

Responses are given for respondents who indicated that they use a particular value-based management method. Respondents
were presented with a statement regarding the areas in which they use value-based management systems and asked to
indicate all systems to which the statement applied. DCF indicates discounted cash flow, CFROI indicates cash flow
return on investment, ROIC indicates return on invested capital, EVA indicates Economic Value Added, Other indicates
any other value-based management system. Percentages are based on the number of respondents who indicated that they
use a particular method. Letters indicate that the proportion responding positively for a particular method is statistically
greater than the method indicated by the letter.

DCF (D) CFROI (C) ROIC (R) EVA (E) Other (O)
112 Users 56 Users 59 Users 76 Users 25 Users
N % N % N % N % N %
Long- Term 68 59% 31 55% 32 54% 53 70% 14 56%
Planning C* R*
Annual 20 17% 23 41% 30 5 1% 44 58% 13 52%
Budgeting D*** D*** D***C* D***
Investment 111 97% 46 82% 40 68% 48 63% 15 60%
Decisions C*** R***E*** O*** R* E***O**
Performance 18 16% 16 29% 34 58% 58 76% 15 60%
Measurement D* D***C* D*** C***R** D*** C***R**
Compensation 7 6% 6 11% 23 39% 37 49% 17 68%
D*** C***E*
Othera 5 4% 0 0% 2 4% 3 4% 1 4%
a
Other includes seven acquisitions (5 DCF, 1 ROIC, and 1 EVA), education (Other), reference only (EVA), pricing (EVA), and ad hoc use (ROIC).
*** Significant at the 0.01 level, determined by a difference in proportions test.
** Significant at the 0.05 level, determined by a difference in proportions test.
* Significant at the 0.10 level, determined by a difference in proportions test.

is not significantly different than for the other methods. differences are significantly different at the divisional
Of those who subscribe to DCF, a low of 6% utilize it level. A high of 20% use DCF on a departmental basis,
for compensation decisions. while a low of 7% use ROIC and EVA on a departmental
Overall, value-based management is applied mainly basis.9 The percentage of DCF users at the departmental
in the areas of investment decisions, long-term level is significantly higher than for ROIC and EVA.
planning, and performance measurement. The DCF Overall, all methods are used primarily at the
method is the most widely used method for investment corporate level, to a lesser extent at the divisional level,
decisions, while the EVA method is the most commonly and to an even lesser extent at the departmental level.
used method for long-term planning, annual budgeting, This is not surprising given that it is easier to
performance measurement, and compensation. implement value-based management methods at the
corporate level than at lower levels of the company
D. Scope of Use of Value-Based Management where additional value drivers need to be developed
and additional employee education is required.
To ascertain how far value-based management
However, these results indicate that responding
methods are being pushed down in their companies,
companies are not implementing value-based
respondents were asked to indicate the scope of
management systems to span all levels of the company
utilization: Corporate (the whole company), Divisional
and to impact employees at all levels.10
(major business units), or Departmental (functional
areas within major business units). The results are 9
Again (see footnote 8) these percentages are based on the
shown in Exhibit 4. The most common scope of percentage of respondents who use a particular method. In terms of
numbers of respondents, DCF has the highest number of respondents
application for all methods is at the corporate level. A reporting usage at the corporate, divisional, and departmental level.
high of 84% of those companies using EVA utilize it at 10
Myers (1996) argues that the EVA metric is more easily
the corporate level, while a low of 73% of the pushed down in the organization to a company’s line managers and
companies using DCF utilize it at this level. EVA is is easily communicated to operating people, while CFROI is more
suitable for defining targets at the corporate level. Our results do not
only statistically significantly higher than DCF. A high support this contention in that we find EVA to be more popular at
of 54% use CFROI on a divisional basis, while a low of the corporate level. This may reflect the costs associated with a
42% use ROIC on a divisional basis. None of the higher level of training associated with EVA. See Exhibit 5.
52 FINANCIAL PRACTICE AND EDUCATION — SPRING / SUMMER 1999
Exhibit 4. Scope of Use of Value-Based Management Systems
Responses are given for respondents who indicated that they use a particular value-based management method. Respondents
were presented with a statement regarding their scope of use of value-based management systems and asked to indicate all
systems to which the statement applied. DCF indicates discounted cash flow, CFROI indicates cash flow return on
investment, ROIC indicates return on invested capital, EVA indicates Economic Value Added, Other indicates any other
value-based management system. Percentages are based on the number of respondents who indicated that they use a
particular method. Letters indicate that the proportion responding positively for a particular method is statistically
greater than the method indicated by the letter.

D C F (D ) C FR OI (C ) R OIC (R ) EVA (E) Other (O)

112 U sers 56 U sers 59 U sers 76 U sers 26 U sers
N % N % N % N % N %
Corporate Level 84 73% 46 80% 44 75% 64 84% 22 88%
D* D*
Divisional Level 55 48% 30 54% 25 42% 40 53% 14 56%

Departmental Level 23 20% 9 16% 4 7% 5 7% 2 8%

R*** E***O * E*
O thera 11 10 % 4 7% 1 2% 6 8% 1 4%
R* R*
a
Other includes nine projects (seven DCF and two CFROI), six headquarters (CFROI, four EVA, and Other), two country (DCF,
EVA), three finance department (DCF, CFROI, ROIC), operating unit (DCF), consolidated level (EVA), and subsidiary (DCF).

***Significant at the 0.01 level, determined by a difference in proportions test.

*Significant at the 0.10 level, determined by a difference in proportions test.

E. Timing of Adoption of Value-Based F. Employee Education

Management Methods
Respondents were asked about training of
Respondents were asked whether they adopted a employees on value-based management. The results
value-based management method all at once or are shown in Exhibit 6. The majority of firms did train
gradually, to list the year(s) that they adopted the employees, with a high of 87% for EVA and a low of
method, and abandoned the method if applicable. 82% for DCF and CFROI. Firms do not indicate a
The results are shown in Exhibit 5. There does not preference for training employees prior to
seem to be a clear preference for adopting methods implementation, with approximately as many firms
all at once or for a gradual implementation. Slightly waiting until after implementation to train as those who
more firms adopted the methods gradually, with the train before. Several firms offer training both prior to
exception of DCF where 53% of adopters and after implementation. The majority of firms
implemented the method all at once. The median conducted the training internally, as opposed to using
year of adoption is 1988 for DCF and ROIC, 1990 for an outside firm. Some firms conducted training both
CFROI, 1995 for EVA, and 1994 for methods listed internally and by an outside firm. A high of 97% of the
b y r e s p o n d e n t s a s “ o t h e r. ” T h e m o r e r e c e n t firms using ROIC did the training internally, with a low
adoption of EVA is statistically significant. Four of 63% for firms using EVA.
firms responded that they abandoned DCF, two firms Overall, firms view training as an important part of
abandoned CFROI, one firm abandoned ROIC, three implementing a value-based management system, but reveal
firms abandoned EVA, and two firms abandoned no clear preferences for the timing of employee training.
other methods. The majority of the firms conduct the training internally.
Overall, many respondents indicate that adoption
of value-based management methods occurs all at once, G. Use of Value-Based Management for
while many other respondents indicate that the Compensation
adoption takes place gradually. EVA is the most popular Respondents using value-based management
method being adopted recently.11 methods to determine compensation were asked about
the level of employees covered and how the
11
This is consistent with Myers (1996) reporting that all but
compensation was determined. The results are shown
25 of 250 companies that have hired Stern Stewart to install in Exhibit 7. Not surprisingly, value-based management
EVA systems have done so in the last three years. compensation systems were applied most frequently
RYAN & TRAHAN—THE UTILIZATION OF VALUE-BASED MANAGEMENT 53

Exhibit 5. Timing of Adoption of Value-Based Management Systems

Responses are given for respondents who responded to questions regarding the adoption of value-based management
systems. DCF indicates discounted cash flow, CFROI indicates cash flow return on investment, ROIC indicates return on
invested capital, EVA indicates Economic Value Added, Other indicates any other value-based management system.
Percentages and statistics are based on the number of responses to a particular question. Letters denoted by the symbol
* indicate that the median response for a particular method is statistically greater than the method indicated by the letter,
determined by a Wilcoxon test.

Timing of DCF (D) CFROI (C) ROIC (R) EVA (E) Other (O)
Adoption 79 Adopters 45 Adopters 40 Adopters 66 Adopters 21 Adopters
N % N % N % N % N %
Adopted All at Once 42 53% 21 47% 19 47% 27 41% 12 57%
Adopted Gradually 37 47% 24 53% 21 53% 39 59% 9 43%
N M e dian N M e dian N M e dian N M e dian N M e dian
Year Adopted 49 1988 28 1990 31 1988 69 1995 18 1994
Method E*** O* E*** O*** E*** O***
Year Abandoned 4 1994 2 1995 1 1991 3 1994 0 n/a
Method
***Medians are significantly different at the 0.01 level.
*Medians are significantly different at the 0.05 level

Exhibit 6. Employee Education on Value-Based Management Systems

Responses are given for respondents who responded to questions regarding training that employees received on value-
based management systems. Percentages and statistics are based on the number of responses to a particular question.
DCF indicates discounted cash flow method, CFROI indicates cash flow return on investment, ROIC indicates
return on invested capital, EVA indicates Economic Value Added, Other indicates any other value-based management
system. Percentages are based on the number of respondents who indicated that they use a particular method. Letters
indicate that the proportion responding positively for a particular method is statistically greater than the method indicated
by the letter.

DCF (D) CFROI (C) ROIC (R) EVA (E) Other (O)
N Yes % N Yes % N Yes % N Yes % N Yes %
Trained Employees on 80 65 82% 45 37 82% 43 36 84% 69 60 87% 21 19 90%
Method
Prior to Implementation 53 20 38% 31 13 42% 28 12 43% 56 27 48% 15 6 40%
After Implementation 53 24 45% 31 14 45% 28 11 39% 56 19 34% 15 4 27%
Both Prior to and After 53 9 17 % 31 4 13% 28 5 18 % 56 10 18% 15 5 33%
Conducted Training Internally 57 42 74% 33 29 88% 30 29 97% 60 38 63% 18 15 83%
D* E*** D*** E***
Utilitized Outside Firm for 57 8 14 % 33 2 6% 30 0 0% 60 10 17% 18 1 6%
Training R*** R***
Both Internal and External 57 7 12% 33 2 6% 30 1 3% 60 12 20% 18 2 11%
Training C ** R***
***Significant at the 0.01 level, determined by a difference in proportions test.
**Significant at the 0.05 level, determined by a difference in proportions test.
*Significant at the 0.10 level, determined by a difference in proportions test.

to CEOs, followed by other executives, professional employees.12 Stock options were also fairly popular,
employees, and non-professional employees in
descending order. The most common form of this 12
The bonus information is consistent with the percentage of
compensation was in bonuses, with 94% of the relevant companies offering bonuses, for executive, salaried, and hourly
employees, reported by Lubin (1997). Based on data for 383
companies responding that CEO bonuses were
major companies, she reports that, in 1995, 27% offered
affected, 95% for other executives, 70% for bonuses to hourly workers, 57% to salaried employees, and
professionals, and 20% of non-professional approximately 90% to executives.
54 FINANCIAL PRACTICE AND EDUCATION — SPRING / SUMMER 1999

Exhibit 7. Use of Value-Based Management Systems for Compensation and Promotion

Responses are given for 83 respondents who provided information about how their firms use value-based management
systems for compensation and promotion purposes. Percentages are based on 84 responses.

Merit Increases B o n u ses Stock Options Promotions

L evel o f U se N % N % N % N %
CEO 14 17% 79 94% 25 30% 3 4%
Other Executives 14 17% 80 95% 25 30% 5 6%
Professional 10 12 % 59 70% 13 16% 5 6%
Non- Professional 6 7% 19 20% 3 4% 3 4%

with 30% of the relevant companies responding that research and development expenditures have long
CEO stock options and 4% of non-professional expected payoff periods, or for mature heavy-
employees’ stock options were affected by value- manufacturing industries. Consistent with Ramirez, et.
based management systems. al. (1991) we represent industry with a set of three
Overall, when used to determine compensation, dummy variables representing light manufacturing
value-based management systems are most frequently (LMAN, 2000<SIC code<3400), heavy manufacturing
applied to the CEO and other executives, and most (HMAN, 3400<SIC code<3600), high technology
often affecting the bonus calculation. (HITECH, SIC code=3600), and other.
Firm performance may influence the utilization of
H. Write-in Comments value-based management methods. Firms with good
financial performance may be more likely to utilize
Respondents were given space to write in any other
value-based management methods either because the
comments they had about value-based management
methods are working, or because the firms are
or their company’s experience with it. Sixty write-in
committed to continuing strong performance. On the
comments were received. Comments made by multiple
other hand, poor performing firms may be more likely
respondents are summarized in Exhibit 8. The most
to utilize value-based management methods in order
frequent comments deal with the importance of
to improve performance. We use market value added
customizing the value-based management system
divided by total assets (MVAA) to measure firm
(VBM) to the individual company and the need for a
performance. Market value added is obtained from
relatively simple system that is easy to communicate.
Walbert (1995). We also include the variables that drive
Other frequent comments mention that the company is
return on equity in the du Pont equation as performance
currently in the process of selecting and implementing
measures. The du Pont variables are: profit margin (net
the system, and that there is a need for a system that
income divided by sales—PM), total asset turnover (sales
will change employee behavior.
divided by total assets—TATO), and the equity multiplier
(total assets divided by equity—EM).
I. Determinants of Value-Based Management
Cooper and Petry (1994) find evidence that large firms
Usage
are more likely to adhere to shareholder wealth-
The results gathered from the survey instrument maximizing principles. They argue that as firms grow,
provide information on the respondents’ perceptions the number of potentially profitable investment
of value-based management and how their firms are opportunities increases, and staffing levels and
using value-based management. The information on computing power must also grow to evaluate them as
which firms are utilizing different value-based departments are created or expanded. They find a
management methods also provides the opportunity positive correlation between firm size and financial
to explore the determinants of usage. The following sophistication. We use firm size as a proxy for
factors are examined as potential factors that influence sophistication, which may influence the utilization of
the utilization of value-based management methods: value-based management methods. The log of total
industry, performance, sophistication, level of sales is used to measure firm SIZE.
operating assets, and level of fixed assets. Finally, the utilization of different value-based
Utilization of value-based management methods may management systems may be influenced by the nature
vary across broad industry groups. For example, one of a firm’s assets and the areas where it uses value-
popular criticism of EVA is that it may not be based management. Since short-term assets are more
appropriate for high technology firms where current likely to be influenced by performance in the current
RYAN & TRAHAN—THE UTILIZATION OF VALUE-BASED MANAGEMENT 55

Exhibit 8. Most Frequent Write-in Comments

This exhibit presents the write-in comments that occurred more than once. There were a total of 61 write-in comments
(some respondents made more than one) and 5 that were mentioned by one respondent (not reported).

Write-In Comments Number Percentage

Details on/Importance of a Customized System 14 23%
Need for Simplicity/Ease of Communication 13 21%
Currently in the Process of Selecting/Implementing a System 10 16%
Necessity for a System to Change Behavior 8 13%
Questioned the Suitability of VBM Systems for Their Industry 3 5%
No System is Perfect 2 3%
Use Multiple Systems 2 3%
Listed Results that were Achieved After Implementing VBM System 2 3%
Pitfalls of Employees Attempting to "Manage the Metric" 2 3%

period than are long-term investments, firms concerned all value-based management methods, and is
about performance measurement can utilize value- statistically significant for firms indicating that they
based management methods to help reduce use at least one value-based management method,
investment in accounts receivable and inventory. DCF, other, and multiple systems. Larger firms are
The results reported in Exhibit 3 show that firms more likely to use several of the value-based
report low usage of DCF and CFROI, medium usage management methods, suggesting that these
of ROIC, and high usage of EVA for performance methods are employed by more resource-rich,
measurement purposes. We would expect that, since sophisticated firms. 14 Industry effects are negative
EVA is heavily used for performance measurement, but not significant for high tech, and mixed for light
its utilization would be positively related to the and heavy manufacturing. There is not a strong
intensity of short-term operating assets. A negative industry relationship, although the negative signs
relation is expected for DCF and CFROI, since they are for HITECH are consistent with the notion that high
not heavily utilized for performance measurement. We research and development expenditures and long-
measure the intensity of short-term operating assets term payoffs may discourage the use of value-based
as the sum of inventories and accounts receivable management. Performance, measured by market
divided by total assets (OPASSET). value added divided by assets, is positive for all
Firms concerned about long-term planning and methods except other, and is statistically significant
investment decisions can utilize value-based for VBM, DCF, and multiple systems. The du Pont
management methods to help manage fixed assets. We variables for total asset turnover and leverage are
measure the intensity of fixed assets as net property mixed and not statistically significant. Profit margin
plant and equipment divided by total assets (PPE). is negatively related to the utilization of all methods
The results in Exhibit 3 show those firms that report except for CFROI, and is statistically significant for
relatively high usage of DCF, CFROI, ROIC, and EVA VBM, DCF, and EVA. The performance results
for investment and long-term planning decisions. We indicate that firms with high MVA performance and
would expect that, since all of these methods are heavily low profit margins are more likely to use value-based
used for long-term decisions, their utilization would management. Profit margins seem to be more of a
be positively related to the intensity of fixed assets. factor than asset utilization in driving the use of
Logit regression is utilized to examine the relation value-based management. A possible interpretation is
between the use o f v a l u e - b a s e d m a n a g e m e n t that firms facing strong competition, but that have
methods and the firm-specific characteristics adopted value-based management, may be perceived
discussed above. 13 The results are shown in Exhibit as having a value added strategic advantage in the
9. Firm size is positively related to the utilization of
14
Cooper and Petry (1994), extending Hirshleifer (1993), note
13
The influence diagnostics for binary response data developed that size may reflect a reputation bias, where managers at
by Pregibon (1981) were used to identify observations that large firms use more advanced decision making techniques to
were a poor fit to the model and to identify outliers. Two avoid appearing unsophisticated. We find a positive relation
observations were identified as outliers and were dropped from between firm size and the use of multiple methods, suggesting
the sample, along with three firms for which accounting data that managers at large firms may use multiple value-based
was unavailable from Compustat. management methods to avoid appearing unsophisticated.
56 FINANCIAL PRACTICE AND EDUCATION — SPRING / SUMMER 1999

Exhibit 9. Determinants of Value-Based Management Usage (N=181)

Logistic regressions are estimated where the independent variable is 1 if a firm uses a method and 0 otherwise. VBM
indicates the use of any value-based management system, DCF indicates the use of a discounted cash flow method, CFROI
indicates the use of cash flow return on investment, ROIC indicates the use of return on invested, EVA indicates the use
of Economic Value Added, OTH indicates the use of any other value-based management system, and MUL indicates the
use of multiple methods. LMAN is 1 if the firm is classified as light manufacturing and 0 otherwise, HMAN is 1 if the firm
is classified as heavy manufacturing and 0 otherwise, HITECH is 1 if the firm is classified as high technology and 0
otherwise, MVAA is the firm’s Market Value Added divided by total assets, PM is net income divided by sales, TATO is
sales divided by total assets, EM is total assets divided by total debt and liabilities, SIZE is the natural logarithm of the
firm’s sales, OPASSET is the sum of the firm’s inventories and receivables divided by total assets, and PPE is net property
plant and equipment divided by total assets. Chi-square statistics are in parentheses.
VB M DCF CFROI ROIC EVA OTH MUL
Intercept - 1. 6 0 7 - 1. 2 7 2 - 1.756 - 1.728 - 3.420 - 2.676 - 1.860
(0.94) (1.04) (2.03) (1.92) (6.66)*** (1.90) (2.39)
LMAN 12.865 0.743 - 13.555 1.645 0.965 - 12.237 0.459
(0.00) (0.77) (0.00) (4.61)*** (1.65) (0.00) (0.54)
HMAN - 0.234 0.226 0.719 0.112 0.304 - 1. 0 6 0 0.241
(0.12) (0.16) (1.56) (0.83) (0.291) (0.36) (0.66)
HITECH - 0.644 - 1.014 - 0.305 - 13.514 - 0.530 0.011 - 1.278
(0.71) (1.88) (0.13) (0.98) (0.40) (0.99) (2.36)
MVAA 0.608 0.289 0.181 0 . 15 1 0 . 10 6 - 0.271 0.261
(4.56)** (2.75) (1.67) (1.12) (0.54) (0.50) (2.72)*
PM - 8.311 - 3 . 9 10 0.341 - 2.563 - 4.297 - 3.506 - 3.105
(5.97)** (2.90)* (0.03) (1.59) (3.93)** (0.87) (2.24)
TATO - 0.098 0.031 0.019 - 0.511 0.235 - 0.277 - 0.094
(0.06) (0.01) (0.32) (2.12) (0.66) (0.26) (0.11)
EM - 0.147 0.000 - 0.098 - 0.073 - 0.092 - 0.683 - 0.095
(2.05) (0.00) (0.11) (0.41) (0.78) (1.59) (0.31)
SIZE 0.385 0.283 0.167 0.218 0.197 0.341 0.305
(3.77)* (4.05)** (1.55) (2.66) (2.16) (3.64)* (5.13)**
OPASSET 0.505 - 1.751 - 1.582 - 0.055 1. 7 7 0 - 0.315 - 0.806
(0.11) (1.87) (1.27) (0.00) (1.79) (0.02) (0.43)
PPE 1.506 0.169 0.422 0.028 2.320 0.427 0.614
(1.72) (0.03) (0.20) (0.00) (5.16)** (0.77) (0.46)
Concordant 73.4% 66.2% 63.7% 66.7% 69.2% 73.8% 64.8%
Users 14 7 111 55 57 70 21 97
Non- Users 34 70 126 124 111 160 84
***Significant at the 0.01 level.
**Significant at the 0.05 level.
*Significant at the 0.10 level.

future. 15 Exploring the nature of these performance measurement; negative and insignificant for ROIC, a
relationships in more detail may be an interesting topic method that is utilized at a medium level for
for future research. performance measurement; and positive and not quite
The operating assets coefficient is negative, as significant for EVA, a method that is used heavily for
expected, but not quite significant for DCF and CFROI, performance measurement. The property plant and
methods that are not utilized heavily for performance equipment coefficient is positive, as expected, for DCF,
CRROI, and EVA, and is statistically significant for
15
Using industry-adjusted profit margin results in coefficients EVA. These results provide some support for the notion
that are generally positive but not significant (CFROI is that metrics used for performance measurement are
positive and significant). This lends additional support to
the notion that firms in competitive industries (with low
more likely to be used by firms with high operating
profit margins) are using value-based management to gain assets, and metrics used for investment and long-term
competitive advantages. planning decisions are more likely to be used by firms
RYAN & TRAHAN—THE UTILIZATION OF VALUE-BASED MANAGEMENT 57

with high fixed assets. value-based management systems are most frequently
These results suggest that financial resources and applied to the CEO and other executives, and most
sophistication, MVA, and profit margin are the key often affect the bonus calculation; and 10) firm size
variables related to the usage of value-based management. and performance impacts the decision to utilize most
The resulting concordant percentages in Exhibit 9 value-based management methods.
indicate that all models do perform substantially better Most respondents are familiar with value-based
than chance in classifying firms based on their usage of management and use a variety of value-based
value-based management. However, there is room for management methods. In theory, value-based
further explanation of these relationships and for future management systems should span all levels of a
research that examines why and when firms adopt company and be used across all decisions. In practice,
value-based management systems. we observe that it is currently used primarily at the
corporate level and mainly for investment planning. A
IV. Summary and Conclusions number of recent articles (Dillon and Owers, 1997;
Kramer and Pushner, 1997; Myers, 1997; and O’Byrne,
Maximizing shareholder value has become an area 1997) question the scope of the impact that utilizing
of increased interest at US corporations. Value-based various value-based management metrics has on
management models have been developed that offer shareholder value. Our findings that indicate room
options to corporations for operationalizing the for improvement in the design and implementation
management of shareholder value. These techniques of value-based management systems, coupled with
impact corporate strategy, management compensation, the fact that firms are not extending the use of these
and internal control and reward systems. There is metrics to lower levels of the organization and
strong competition and debate over the impact and across more management decision areas, may
effectiveness of these models. However, little explain the lack of impact.
independent study of the models has taken place. Finally, value-based management needs to be
We survey the CFOs of a large sample of public examined beyond financial implications, in terms of its
corporations in order to ascertain their opinions of implications for the firm’s overall business strategy.
and experiences with a variety of value-based Lehn and Makhija (1996) examine the relationship
management systems. The key findings are: 1) a between performance metrics and strategic change.
majority of the respondents are familiar with many They argue that the increased interest in value metrics
value-based management methods and many have seen such as EVA and MVA reflects an increased awareness
presentations on these methods; 2) the responding by corporate managers that their task is to create
companies are using a variety of value-based shareholder value. These performance metrics are
management methods, with the majority of those found to be more correlated with measures of business
utilizing a method developing it internally; 3) with the strategy (CEO turnover and corporate focus) than
exception of DCF and other methods, the majority of accounting-based performance metrics. Aggarwal
respondents familiar with a value-based management (1997) argues that value-based management metrics
method do not indicate that they are satisfied with the can be useful in reducing intra-firm agency costs by
method, indicating that there is room for improvement transforming corporate strategies into metrics useful
in the design and implementation of value-based in making operating decisions. These metrics can add
management systems; 4) value-based management is to shareholder value if they reduce the inefficiencies
applied mainly in the areas of investment decisions, associated with the use of accounting-based metrics
long-term planning, and performance measurement; 5) to measure managerial performance. Aggarwal notes
all methods are used primarily at the corporate level, that the understanding of strategic vision declines
to a lesser extent at the divisional level, and to an even rapidly with the individual’s level in the organizational
lesser extent at the departmental level; 6) adoption of hierarchy, and that it is critical that corporate strategy
value-based management methods occurs all at once be translated, unit by unit, to concrete, measurable,
in some companies and gradually in others; 7) firms and widely understood goals and tactics. Our results
view training as an important part of implementing a suggest that value-based management systems
value-based management sys t e m , a n d t r a i n need to be more fully integrated into the organization
employees either prior to or after implementation or if they are to meet the objectives of reducing intra-
both; 8) the majority of firms conduct the training firm agency costs and better relating operating
internally; 9) when used to determine compensation, decisions to corporate strategy. n
58 FINANCIAL PRACTICE AND EDUCATION — SPRING / SUMMER 1999

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