Further evidence on the information content of economic value added

Ralph Palliam

Review of Accounting and Finance, 2006, vol. 5, issue 3, 204-215

Abstract: Purpose - The purpose of this paper is to test 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, contribute to these associations. Design/methodology/approach - Thirty three non‐EVA users and 75 EVA users were selected at random. Variables used in this study were revenues, profits, assets, stockholders’ equity, market value, earnings per share, total return to investors, and percentage cost reduction over time. Data were collected on several metrics. Findings - The study suggest that the common and widely accepted metrics used by analysts and calculated for EVA users are not necessarily superior to that of non‐EVA users. The evidence support that EVA is somewhat invalid, unreliable, and questionable. Research limitations/implications - The first limitation deals with the measurement of capital invested in assets. The second limitation was the use of an accounting definition of the return on equity. The operating income was not cleansed of any expenses which are really capital expenses (in the sense that they create future value). The operating income was adjusted if any cosmetic effects were identified. The third limitation is the determination of cost of capital (estimate). Discounted cash flow valuation assumes that cost of capital is calculated using market values of debt and equity. Practical implications - This study raises serious doubts about the capacity of EVA to deliver superior metrics. EVA users may be placing themselves at unnecessary risks and costs. Study shows that EVA is not a satisfactory descriptor of the real world and, therefore, it should be used with caution by management consultants, practitioners, and investors. Originality/value - The movement in stock prices reflects something other than EVA.

Keywords: Economic value added; Accounting; Profit; Cost of capital; Earnings; Performance measures (search for similar items in EconPapers)
Date: 2006
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Persistent link: https://EconPapers.repec.org/RePEc:eme:rafpps:14757700610686417

DOI: 10.1108/14757700610686417

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