Journal of Asian Business Strategy

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Corporate Governance through the EVA Tool: A Good Corporate Performance Driver

Twinkle Prusty
Associate Professor; Faculty of Commerce Banaras Hindu University Varanasi-221005, India

Abstract
The appraisal of the effect of Corporate Governance (CG) to the performance of the firm measured by
Economic Value Added (EVA), is the essence of the study from the gaining importance of motivating
managers’ i.e. enabling good governance for getting rid of destructive activities and investing in those
projects that are expected to enhance shareholder value. The implications of the practices of corporate
governance on the economic value added, of the sample companies are being explored and assessed to
find out whether its conformance will improve corporate performance enthused by valuation reporting,
EVA, which is important for investment decision making and consistent internal governance. It
necessitates establishing whether the components of corporate governance viz., equitable treatment of
shareholders, transparency and disclosure influences the economic value added, an superior
performance metric, by raising the consciousness of their relationship thereby, without relying on the
bland accounting results flaunted by the corporate.
Keywords: corporate governance, economic value added, value creation

Introduction1 enormous wealth through the EVA (Economic

Value Added) tool have an impact on the
Good corporate performance is very much company’s trust, credibility and reputation and
intertwined in good corporate governance hence, the ethical dimensions of a company’s
which shall ultimately maximize long-term operations would be reflected by the inclination
shareholder value in a more ethical manner by and incentive to pursue such governance
ensuring fairness, transparency, integrity and practices. As proclaimed by the Kumar
accountability of the management. A well- Mangalam Birla Committee Report (2000), it is
performed corporate implies well-functioning imperative for the companies to maximize the
and well-managed governance principles which shareholder’s value and wealth. Thus, the
leads to corporate excellence in all productive, quintessence of corporate governance lies in
economic and social pursuits. In the globalized considering the financial aspect, apart from
business environment, when companies are fulfilling the accountability aspect, implying the
driven by market forces and competitive company as a performing asset. It is required
pressures, they are mainly judged by enthused that to achieve the wealth creation function as
investors with the help of financial indicators the objective, the companies must perform
namely profits, earning per share, market value within an economic framework that keeps the
per share etc. Moreover, good corporate management accountable for their actions.
governance practices as measured by creating Many companies try to adopt better corporate
governance practices as a way to improve
economic dynamism and thus enhance overall
Corresponding author’s economic performance.
Email address: twinkle.prusty@gmail.com

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Journal of Asian Business Strategy, 3(12)2013: 340-348

This paper further dwells upon the following Taxes

aspects of corporate performance in terms of Net operating profit after tax (NOPAT)
creation of shareholders wealth as well as
managing for a higher stock price: Capital charges (Invested capital x cost of
capital)
 Using the EVA tool, as a measure of good Economic value added (EVA)
corporate performance.
 The superior dimensions of the EVA tool From the above formula in the EVA
over the traditional measures. calculation, it can be observed that unlike the
 Some related studies with the observations accounting profit, expressed as EBIT, Net
on the usefulness of EVA, towards value Income and EPS, which measures only the
creation. profitability, EVA on the other hand,
 Some Indian Corporate Philosophy on overcomes this stage of illusion by explicitly
EVA Approach. recognizing that the company employing the
 Some limitations on using the EVA tool, shareholders capital must bear a charge for the
as a performance measure. inherent risk that is borne by the later in the
 EVA: Setting up a good corporate process of profit generation by the former.
governance system. Thus, it has been realized that EVA is a
sophisticated tool which produces highly
EVA: A measure of good corporate accurate estimates of both capital used and a
performance: firms true cost of capital. Unlike the traditional
Economic value added is a financial measure measures like EPS or ROE, the advantage of
that gives the true economic profit produced by using EVA is that the decisions can be clearly
the company and thus has a direct link with the modeled, monitored and communicated by way
creation of shareholders' wealth over time. The of value added to the shareholder's investment.
concept was derived from the work done in
1961 by the Nobel Prize winner economist This exerts pressure on the movement of the
Franco Modigliani and Merton Miller, corporate governance ideals giving impact on
formalized by the consultancy firm Stern overall economic performance, market integrity
Stewart(2001) and followed by the accounting and the incentives that it creates for market
firm KPMG International(2004) which has participants and the promotion of transparent
recently won international acceptance as the and effluent markets.
standard of corporate governance and
performance for the reason that business EVA as mentioned by Maurya (2004), is based
organizations has made a paradigm shift in their on the shareholder’s approach that is concerned
focus from `managing earnings' to `managing with maximizing the wealth of customers,
value' for the shareholders i.e. from EPS/ROE employees, suppliers, society and also the
to EVA. Thus the measure of EVA is made in shareholders. The framework of EVA has better
terms of the residual income meaning that, it is reflected value and profitability which can
the true economic profit calculated as net withstand the challenge from the increasing
operating profit after tax minus a charge for the efficient capital markets and owners. As since
opportunity cost of the capital invested. The today industry is shifting from the product
calculation of EVA is made as follows: centric world of the past to a value centric
world of the future, the need of using EVA has
Net Sales got wide acceptance as a key indicator of
corporate performance.
Operating Expenses
According to Hax and Majluf (1984). “It is
Operating Profit (EBIT) economic and not accounting profitability, that
determines the capability of wealth creation on

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the part of the firm. It is perfectly possible that a CMIE's prowess during the period 2007-08 to
company is in the black, and yet its market 2011-2012, the following analysis has been
value is way below its book value, which means made.
that, from economic point of view, its resources
would be more profitable if deployed in an On the basis of EVA it was found that only
alternative investment of similar risk”. 31% representing 47 nos. of companies resulted
in value addition with the increasing trend. Out
Thus, the Economic Value Added, if adopted as of the remaining 69%, 17% i.e. 27 nos. of
a corporate philosophy can be very useful in sample companies destroyed value to
improving productivity of a firm measured in shareholders in five years while the balance
terms of creation of shareholder’s wealth. This 52% i.e. 80 companies had no regard for value
approach of corporate philosophy results in goal addition. While inter-firm analysis carried on
congruence and channelizes all efforts of the with average yearly computed values of EVA
management and employees towards a common revealed value in case of 71%, i.e. 110 nos. of
goal. Over the years, the management experts companies and only 29% i.e. 44 nos. of
and consultants have been advocating many companies gained values for their shareholders.
tools and techniques such as Management
Information System (MIS), Business Process On the basis of RONW (Intra-firm), only 6%
Reengineering (BPR), and Enterprise Resource representing 9 nos. of companies showed
Planning (ERP) etc for improving productivity increasing trend of value and out of the
in physical terms but these tools have failed to remaining 94%, 8% i.e. 13 nos. of companies
distinguish between value creating and value failed to create value to shareholders and the
destroying activities because they do not balance 86% i.e. 132 nos. gave no regard for
measure the economic surplus being generated value addition. While the results of inter-firm
by different activities. analysis showed 87% i.e. 134 nos. of companies
added value for their shareholders indicating
Hence, the successful implementation of these that these are profitable ones over the study
tools and techniques across the firm is a long period. Only 13% i.e. 20 nos. of companies
drawn process and the possibility of success has resulted in value destruction.
not been very high. In contrast, EVA when used
as a tool to measure corporate performance On the basis of ROCE, only 13% representing
helps to improve the business literacy in 20 nos. of companies revealed value addition
understanding the value enhancing capacity of over the study period and out of the remaining
any activity by getting return more than the cost 87%, 14% representing 12 nos. of companies
of capital employed for that activity. The one failed to add value to shareholder's wealth and
component consideration of the cost of capital balance 73% i.e. 112 nos. had no regard for
sets EVA apart from the other tools and value addition. The inter-firm analysis showed
techniques and thereby helps in building the (ROCE), 95% i.e. 147 nos. Of companies added
EVA culture in an organization. It can aptly be value over the study period and just 5% i.e. 7
realized that the use of EVA improves the nos. of sample companies resulted in value
financial corporate governance as it motivates a erosion.
manager to get rid of the value destroying
activities and to invest only in those projects EVA basis is superior in terms of examining
that are expected to enhance the shareholder shareholders' value addition as compared to
value. RONW & ROCE and also indicates that more
profits don’t necessarily create more economic
From the sample test conducted for 154 value added.
companies of India and database obtained from

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Journal of Asian Business Strategy, 3(12)2013: 340-348

Sample test conducted for 154 companies

in India during the period
2007-08 to 2011-12

EVA BASIS

RONW BASIS

ROCE BASIS

Source: CMIE’s Prowess database

The superior dimensions of the EVA tool financial performance measurement but their
over the traditional measures utility as true indicators of corporate financial
Although the traditional profit based performance or as facilitators of shareholder’s
performance measures such as ROI, EPS, NPV, value creation can hardly achieve success and
IRR etc have dominated the area of corporate has proved futile in the corporate value system.

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Many researchers and writers have also managers are more inclined in maximizing
recognized the superiority of EVA over the shareholder's wealth which is ultimately their
traditional performance measures like Stern goals too.
(1997) & Stewart (2003), Rappaport (1999), viii) The resultant effect of measuring value by
Teitelbaum (1997), Bacidore (1997), Banerjee EPS is that neither business risks nor financial
& Jain (1999) etc and placed the EVA tool in risks are accounted for in annual accounts by
new heights as a motivational, compensation- which returns cannot be judged unless it, be
based management system facilitating commensurate with the level of risks and gives
economic activity and accountability in the unreliable indicator of corporate value.
performance based management system. Thus, ix) Furthermore, investment considerations as
EVA can be considered to be superior to well as dividend policy matters are excluded in
accounting profits as a measure of value the valuation of EPS which makes the
creation that can be targeted to be maximized measurement criteria unreliable for determining
for better results while the traditional measures the economic value of the firms.
do not work in such a way. x) EVA can be perceived as an important
contribution to modern business conscience as
The several benefits of using EVA over the
it measures the true economic profit that is
traditional measures are:
greater than its cost of capital and indicates
whether the enterprise is creating wealth or
i) The measure of profitability with EPS is
destroying it. While, on the other hand, EPS
susceptible to manipulations in accounting or
gives regard to the return on income after tax
reported earnings.
only, which doesn't give a true picture of value
ii) The EPS measure can be made up to
creation, as in reality the enterprise having a
reflect the financial statements in such a manner
negative EVA may provide the managers more
as to enhance the company's reputation in the
inclination to remain static and not reap better
short run and play accounting or management
performance in removing any deficiency.
game for the purpose of enabling restructuring,
xi) EVA could better assess decisions that
mergers and acquisitions.
affect balance sheet and income statement or
iii) The present value of all the future cash
tradeoffs between each by charging capital cost
flows expected to be earned from any financial
against NOPAT.
asset is ignored in the calculation of reported
xii) The need for the increase of EVA has
earnings while in this regard, EVA has been an
been a useful guide for both strategic and
efficient tool in bearing a dramatically higher
operational decisions by which the knowledge
correlation to stock price change.
along with the use of capital and assets could
iv) The consideration of the cost of capital
efficiently and effectively be made.
which entails the calculation of economic profit
xiii) The EVA tool helps to integrate the
has very strong underpinnings in the practice of
planning and control functions within an
business ethics as it manages the value creation.
organization.
v) The measure of EVA is not constrained by
xiv) EVA works as a powerful decision
the generally accepted accounting principles
making tool on a long term perspective as well
(GAAP) which otherwise have impact on EPS
as links performance to value creation or value
with any voluntary adjustments.
destruction in an objective way.
vi) The value creation from intangible assets
have gained momentum with the onset of
The arguments in favor of the above
knowledge capital which do not appear as
contentions have also been propounded by
positive asset values on financial statements and
various academic researchers like Drucker &
hence the traditional measures EPS or ROE
Peter (1995), Bowen (1997), Chandra & Dyal
does not represent them in a meaningful format.
(1999), Booth (1997) and Chen & Dodd (1996)
vii) The use of EVA enables to measure value
through various literatures. Thus the utility of
and performance by alignment of the interest of
EVA simply does not en by indicating the
managers and shareholders and thus the

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degree of wealth creation but it also helps the Option Analysis, Balanced Score Card, Activity
management to assess the likely impact of Based Costing etc, thereby earmarked as the
competing strategies on shareholders wealth best corporate governance system.
with the help of other effective tools like Real

Table 1: The level of profitability and value creation-a comparison

Companies ONGC RIL IOC HLL VSNL MTNL ITC GAS WIPRO BPCL
NOPAT
(Rs in crores) in 6198 3243 2885 1640 1407 1301 1190 1186 866 850
year 2011-12
EVA
(Rs. In crores) 17 -318 355 1003 339 1089 591 180 235 139
in year 2011-12
Source: Reports and annual accounts of various companies

Review of related studies both for corporate reporting in U.S.A and other
Studies regarding the usefulness of EVA advanced economies.
towards value creation and the corporate
performances have been summarized as below. The Indian corporate philosophy on EVA
 Bacidore (1997) observed that EVA approach
performs quite well in terms of its correlation The companies that adopt the EVA tool by
with shareholder value creation while the identifying it as a measure of performance to
Refined EVA (REVA) is a theoretically relate to value creation and that the managers
superior measure for assessing the firms can directly observe and see the influence of
operating performance. their actions over it. In operational terms, the
 Nicholas (2000) observed that EVA is companies focus on the measurement and
more than just an internal business performance maximization of EVA for shareholder value
measure or a basis for determining incentive creation which is considered to be more
pay. relevant rather than the conventional measures
 Salmi et al. (2001) evaluated and compared such as earnings capitalization, market
EVA with the traditional profitability measures capitalization and present value of estimated
within a controlled simulation framework. future cash flows.
 Stern (1997) observed that EVA is the
financial performance measure that comes Oil and Natural Gas Corporation: Value
closer than any other to capture the true creation (by EVA) can be achieved through
economic profit of an enterprise. the focused internal efficiencies.
 Mayfield (1997) observed that the  The Coca Cola Co.: Business
shareholder value is enhanced by investing in managers need to increase
all those projects which give a positive NPV shareholder value through EVA
and by harvesting all those existing products only.
and projects whose return on capital is less than  Indian Oil Corporation: EVA
encouraging management and employees to methodology can cultivate high
create long term value. standards of business ethics and
 Booth (1997) observed that economic Total Quality Management for a
profit should be a part of company’s strong corporate identity and brand
performance measurement framework. equity.
 Teitelbaum (1997) observed that EVA is a  AT & T Corp.: EVA, the lead
performance measure, an analytical tool and a indicator of a performance
management discipline. measurement system gives humane
 Bhattacharya and Phani (2000) observed value added and customer value
that EVA is a superior performance measure added.

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 IBM: Outsourcing IT often lead to  Godrej: EVA's used as structural

short-term increases in EVA – by a performance-linked variable
study with Stern Stewart. remuneration along with, as a
 Wipro: Value drivers necessary for financial tool.
global talent markets and global  Dr. Reddy's Laboratories: EVA
products. used as a criteria to grant rewards
 Infosys: Value creation is greater such as variable pay, stock options
than what is received from and performance bonuses.
customers – EVA, an efficient  HLL : EVA, need to measure the
measurement tool for achieving performance of each of its divisions
excellence. Source: From the financial reports of the above
 Marico: Consideration of capital is companies
very essential to know value
creation.
 TCS: EVA'S link to compensation
is important and has been
implemented.

Table 2: Indian company’s response to EVA in the year 2011 & 2012
Dr. Satyam
Nestle Ranbaxy
Year HLL ITC Reddy's Infosys Wipro CIPLA Comp. RIL
India Lab
Lab Services
2011
(Rs. In 765 420 36 224 111 69 43 160 -97 328
Crores)
2012
-
(Rs. In 1003 591 350 242 235 100 71 33 -94
318
Crores)
Source: Reports and annual accounts of the various companies

Limitations on using EVA tool as a financial 5. EVA based on historic cost data may be
performance measures distorted due to inflation to estimate the actual
1. The inconsistency in adopting the profitability.
methodology to compute the cost of capital to 6. EVA which is dependent on the cost of
report on EVA and the various related capital calculations favors large firms but low
assumptions may not be useful to compare the return investments.
performance with the other companies. 7. EVA could be artificially low in case of
new assets where depreciation is charged to
2. The use of EVA has been used very
lower the profits and the vice versa.
casually for external reporting purposes only.
3. The information on EVA approach in terms
In this regard, the noted researchers and
of shareholder value creation does not form part
academicians like Chandra and Dyal (1999),
of the annual reports which are audited; rather
Chen & Dodd (1996), Biddle et al., (1997),
they are reflected as the unaudited additional
Mayfield (1997) and O’Hanlon & Peasnell
information that is given to the shareholders.
(1996) have also observed that EVA is not a
4. The use of EVA alone may not explain
complete performance measure due to some of
appropriately the changes in a firm’s value
the aforementioned limitations in its adoption
under the conditions of value depending on
and thus may not prevent the managers from
future expected cash flows.
engaging in dysfunctional behavior. However,
like other financial measures, the limitations
that are observed could be minimized by

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Journal of Asian Business Strategy, 3(12)2013: 340-348

supplementing EVA with other measures and (Higher Consciousness) and allowing it to act
efforts of the top management is indispensable through them and letting the overall handling of
to empower the lower level managers and economic value added to begin and to improve.
employees in implementing such a valuable If only more corporate could accept the
long term vibrant measure which can actually economic truth of value creation, and carry this
add value to the corporate shareholder wealth. knowledge from their inception, then the people
of the world could finally be at peace with one
EVA: Setting up of a good corporate another and no business will ever be
governance system condemned to Hell.
The creation of value, as understood by the
Global ethical business people is in regard to The spirit of demonstrating the best practices of
create value through integrated and sustainable corporate governance will be awakened only by
relationships with the primary corporate realizing the measureless benefits that is
constituencies of shareholders, lenders, manifested in the primary mission of creating
customers, employees, suppliers and the value and providing service to others. This
communities in which the firm does business. requires the heart energy to understand the
The value created many not always reflect in acute seriousness for the economic and social
financial statements, as they may also be from transformation and strive for corporate
the non-financial assets and it is to be realized excellence. Wherever corporate live or work,
by the companies as an integral part of fully they can make a difference and hence it is up to
understanding the performance of their each of their corporate management to accept
business. Companies are under pressure from this fact and act accordingly as the corporate
the investors to report all the value drivers of values are directed from within only when they
their performances which includes the various seek guidance from their self. Thus, the ultimate
intangibles too, such as the intellectual capital, truth underlying in the principles of corporate
requiring transparency in their measuring and governance is the sheer regulation of the self
reporting also. Much of the discussions about and the conscience to attain highest satisfaction
value creation through already existing and value while creating value with satisfaction
corporate governance standards with well- for others i.e. for those whose precious
developed regulatory and financial reporting resources are employed that could be used
framework couldn't hold back the American and elsewhere in a better way.
London corporate by an unprecedented string of
corporate collapses from early to recent times – Conclusion
Maxwell, BCCI and Polypeck in UK and
followed after 20 years are Worldcom, Xerox, The study has observed that good corporate
Enron, to name a few. governance will improve corporate performance
by adopting EVA reporting which is important
Hence, the genesis of corporate governance for investment decision making and internal
must be imbedded in a free market economy governance. It necessitates establishing whether
and excessive governmental regulations the components of corporate governance viz.,
sticking to the structural form impedes the value equitable treatment of shareholders,
creation process and always leads to unethical transparency and disclosure influences the
corporate practices. economic value added for consistent internal
governance and value creating of companies. It
There is so much of widespread of the values of calls for a professional exercise by the corporate
corporate governance that can increase the to make considerable progress in raising
business's market capitalization, but hardly awareness of the value of good corporate
there is increase in the number of corporate who governance by way of establishing relationship
look upon their performance as a form of between corporate governance and economic
worship by dedicating it to their inner Hi C value added, an superior performance metric of

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Journal of Asian Business Strategy, 3(12)2013: 340-348

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