Keeping EVA and MVA in the equation when measuring investment performance

by Dr Anbalagan Krishnan

Economic profit measures are becoming increasingly important performance measures of many firms. Economic profit measures, which include the financial perspective of BSC approach, is in addition to other measures of accounting profit.

Economic profit is a more intuitively satisfying measure of performance than most of the traditional accounting measures (Baum.L, 2004). According to the author, the latter measure annual dollar income to the suppliers of common equity capital after charge for the cost of debt capital alone, while the former measures income after charging for the cost of common equity capital.

Many firms include Economic Value Added (EVA) and Market Value Added (MVA) as part of the financial perspective in a balanced scorecard approach.

The EVA measures the firm contribution to the shareholder. The concept of EVA is relatively new to the financial press and the term EVA was copyrighted by the consulting firm Stern Steward & Company (Steward & Bennet, 1991). EVA is a performance measure based on operating income after taxes, the investment in assets required to generate the income, and the cost of the investment in assets (or weighted average cost of capital). According to Steward, EVA is for a single period and is defined simply as operating profits less a capital charge (1991, p.137):

EVA = NOPAT – WACC х Capital,

NOPAT = Net Operating Profit after Tax
WACC = Weighted Average Cost of Capital, and
Capital= Total Debt + Equity

The EVA is dollar-based and therefore the maximisation of EVA correlates with wealth maximisation. According to Stewart (1992), positive EVA means the firm is providing a higher return than shareholders can earn elsewhere, and thus deserve to sell for a premium-to-book value. On the other hand, firms with zero EVA just meet investor expectations, and thus should sell for book value, while negative EVA firms should sell at a discount-to-book value (Griffith, 2006).

However, researchers have identified some limitations with EVA such as size difference, financial orientation, short-term orientation and results orientation.

When it comes to size limitation, EVA does not control size differences across plants or divisions, which means larger plants or divisions will tend to have higher EVA relative to their smaller counterparts (Hansen & Mowen, 1997; Horngren, Foster & Datar, 1997).

A second limitation would be the fact that EVA are computed numbers that rely on financial accounting methods of revenue realisation and expense recognition. According to Horngren et al., (1997) managers can manipulate these numbers by altering their decision making processes if motivated to do so.

A third limitation, in the short term orientation, would be the EVA approach’s over-emphasis on the need to generate immediate results. This creates a disincentive for managers to invest in innovative product or process technologies as any innovation in product does not give immediate returns and the result of the innovation is only realised in the long term. This means the costs or expenses incurred for the innovation are recognised immediately but the benefits or revenues associated with it are not recognised until a few years down the road.

The recording of cost in the current period has an impact on EVA. EVA is form of managerial remote control that forces managers to put undue emphasis on the short-term bottom line (Brewer, Chandra & Hock, 1999).

As for result orientation, EVA is classified as results-oriented financial numbers that are accumulated at the end of an accounting period, which does not provide much help to identify the root causes of operational inefficiencies.  Therefore, these measures offer limited useful information to people charged with the responsibility of managing business processes.

Despite all these limitations, EVA is still considered a valuable tool for measuring wealth creation and is used to help align managerial decision with firm preferences (Brewer, Chandra & Hock, 1999). The adoption of this value-based measure coincides with increasing pressure from capital markets and corporate control markets for managers to focus their strategies on value creation, that is, economic performance (Haspeslagh, Noda & Boulos, 2001; Hawawini, Subramanian & Verdin, 2003).

According to Chen & Feng (2006) that value creation occurs only when firms earn returns greater than the cost of capital, which implies that value creation is a reasonable proxy for economic performance.

Other value creation measures that complement the EVA metric performance is Market Value Added (MVA). A companion metric, MVA purports to compare the firm current market value to the value of capital provided over time by its investors (Baum, Sarver & Strickland, 2004).

Market Value Added = Market Value – Capital

According to Griffith, MVA is the difference between the market value of a company (both equity and debt) and the capital that lenders and shareholders have entrusted to it over the years in the form of loans, retained earnings, and paid in capital (2006).

He further noted that MVA is a measure of the difference between ‘cash in’, that is, what investors have contributed, and ‘cash out’, that is, what they could get by selling at today’s prices.

If MVA is positive, it means that the company has increased the value of the capital entrusted to it, and thus created shareholder wealth. If the MVA is negative, however, the company has destroyed wealth (Griffith, 2006).

Hawawini defined the difference between EVA and MVA, stating that the former indicates economic profit, and reflects operating performance in a given year, while the latter indicates market-to-book value, reflecting the market’s expectations of the firm’s future operating performance (2003).

As Brewer (1999) noted, the EVA and MVA are both economic profit measures but constitute only one component of the performance measurement and control system. They must be use together with other balanced sets of measures that assess the organisation in various aspects.

The EVA and MVA measures incorporated with other financial perspective measures, and together with other non-financial leading and lagging indicators, are necessary to measure the performance of the organisation.

Many research conducted have recommended the BSC integrated performance control system incorporate both financial and non-financial accounting measures and economic measures. Thus, the BSC approach is a complete strategic performance control tool that looks into economic growth, financial growth, customer satisfaction, business process and employee learning and growth, which well fit into the dynamic, competitive and unpredictable business environment of today.

In summary, the BSC approach is a critical strategic performance control system that provides a well-rounded performance measurement tool for the implementation of an organisation’s strategies, as well as for its long term business growth.

Dr Anbalagan Krishnan is the Head of the Accounting Department and Senior Lecturer at Curtin Sarawak’s School of Business. He has had many years of professional experience prior to becoming a lecturer. His teaching experience includes teaching accounting and managerial accounting units for university degree programmes, as well as conducting industrial training programmes on accounting and non-accounting subjects. His research interests are in managerial accounting and control, performance measurement and management systems, integrated performance measurement systems, ethical issues related to non-accounting and accounting issues, accounting information systems, leadership, corporate governance, and accounting education. Anbalagan can be contacted by e-mail to