An Analytical Study of Economic Value Added and its Industry Implications

I had made an attempt to write a few research papers some time back. Some were presented, published and appreciated; some didn’t either due to me not meeting the required deadlines or my boss not being interested. I take the opportunity to share some of the abstracts with my readers here. .

The object of the company, the object of the finance manager and the object of the subject, Financial Management all are the same. It is maximization of shareholder’s wealth. This is measured by the returns they receive on their investment. Certain value for shareholders is now widely accepted as the governing corporate objective. We need to understand that the attention in value creation has been inspired by several developments which are briefly mentioned here.

Institutional investors, which traditionally were passive, have begun to put forth influence on corporate managements to create value for shareholders, Many top companies like GE, Coca Cola, Hindustan Lever, Reliance Industries, and Infosys which have given value creation a fundamental place in their corporate planning serve as role model for others. Business press is highlighting upon shareholder value creation in performance rating exercises. More attention is now being paid to link top management compensation to shareholder returns.

To help firms value based management approaches have been developed. Value based management represents a fusion of various business disciplines. From finance, it has taken up the goal of shareholder value maximisation and the discounted cash flow model; from business strategy, it has made use of the idea that value creation stems from exploring opportunities based on the firm’s comparative advantage; from accounting, it has taken the structure of financial statements with some modifications; from organsational behaviour, it has borrowed the notion that ‘you get what you measure and reward.’

Several value based management approaches have been developed by leading consulting organizations. Several methods have been used in value based management. The three principal methods are: The free cash flow method proposed by McKinsey and LEK/Alcar group. The economic value added/market value added (EVA/MVA) pioneered by Stern Stewart & Company. The cash flow return on investment/cash value added method developed by BCG and Holt Value Associates.

Though these methods look externally dissimilar, the basic premises underlying them are the same. They are as follows:

The value of any company or its individual strategies and investments is equal to the present value of the future cash flows the company is expected to produce.