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The Effects of Economic Value Added On Managerial Decision-Making and Corporate Profitability
Pauly, Christian
Pauly, Christian
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2015
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2015-05-01
Abstract
Many financial and accounting experts have questioned traditional tools that measure economic profit. The result of these questions led to the development of Economic Value Added (EVA), which by many is considered to give a more accurate picture of a company's financial performance. EVA is essentially an adaption of the Residual Income Measure. The term, Economic Valued Added, was coined by the consulting firm Stern Stewart in the mid 1980's and has been employed by some of the largest corporations in the world including Coca-Cola, General Electric, and, Briggs & Stratton. Peter Drucker, a leader in development of management education, once said, "until a business returns a profit that is greater than its cost of capital, it operates at a loss. Never mind that it pays taxes as if it had a genuine profit. The enterprise still returns less to the economy that it devours in resources . . . it does not create wealth; it destroys it." Economic value added effectively addresses Drucker's comment by adjusting the GAAP financial statements to more accurately reflect how the company allocates its capital. These adjustments, combined with a calculation of the cost of capital through debt and equity, can provide management with better information before deciding to take on certain projects. My thesis will attempt answer the questions of whether EVA truly affects managerial decision-making as well as whether it increase firm profitability, otherwise commonly addressed as firm value. By analyzing various case studies, it's my hope that I can provide readers with a solid explanation of these questions.
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Accounting