Volume 13, Number 3 Article by Joel Stern September 2001
What is EVA? :
The idea that the primary responsibility of corporate management is to increase shareholder value has gained widespread acceptance in the US in the last two decades and with globalisation, intensification of competition, and massive privatisation initiatives, shareholder value is gaining the attention of executives all over the world, including India. To help firms create value for shareholders, value based management (VBM) systems have been developed. VBM represents a synthesis of various disciplines like finance, strategy, accounting, and organisational behaviour and though a recent innovation in financial practice, many regard it as one of the most important developments in corporate management. Prasanna Chandra briefly discusses the methods and premises of VBM and evaluates its prospects in India.
The key difference between the VBM methods is their metrics and Joel Stern elaborates on one of them, Economic Value Added or EVA, which he and his partner Bennett Stewart III developed and refined, and which Fortune described in 1993 as ‘today’s hottest financial idea’. An alumnus of the University of Chicago Graduate School of Business, Stern says that it was Merton Miller’s classes which led him to question the usefulness of orthodox accounting information in making important business decisions. Turning his back upon earnings per share as a tool of investment analysis, Stern developed the concept of free cash flow which later led to EVA. He admits that there is nothing new about EVA and put most simply, it is trading profit after the capital charge for tying up capital in the business has been subtracted. Stern Stewart claim that EVA helps managers incorporate two basic principles of finance into their decision making. One, that the primary financial objective of any company should be to maximise the wealth of their shareholders and two, that the value of the company depends on the extent to which investors expect future profits to exceed or fall short of the cost of capital. The capital charge forces managers to use assets more diligently and eliminates accounting distortions that lead managers astray. Further advantages claimed for EVA are that it is conceptually simple and easy to explain to non-financial managers and that it ends the confusion of different measures used to express financial goals and objectives by using a single financial measure that links all decision making. Ultimately the objective of EVA is to optimise behaviour and it uses its no-caps bonus plan to turn employees into owners.
Joel Stern, Managing Partner of Stern Stewart, spoke on EVA at IIMB to an invited audience comprising academics and representatives from several leading companies. Further, while speaking to S Venkatesh, Associate Professor of Finance at IIMB, Stern, who has been a columnist with several newspapers and has authored books on financial economics, analytical methods and financial planning and measuring corporate performance, claims that EVA was emerging as a strong consulting practice in India, thanks to the sharpness of the quantitative side of the Indian brain and defends EVA against the points raised by Prof Zimmerman and C K Prahalad.
S Mahalingam of Tata Consultancy Services explains the part EVA plays in transforming TCS from an Indian enterprise with a global reach to a truly global organisation. Their first hand experience of the tool was a revelation of the fact that EVA results in an enlarged pie which benefits both the individual and the organisation. It is a barometer on how the organisation is run, focussing on strategies and the accountability of people. While Indian corporates have taken to EVA, they have customised it to suit their organisational needs. If quantifying the value-add to the customer has been the raison d’être for EVA in a services company like Infosys, Marico has converted it into SEVA or simplified EVA. For the Godrej Group, EVA has been a tool to measure, motivate, manage and finally, overhaul the mindsets of people. C K Vaidya, Executive Head, Corporate Personnel, Godrej Group; Milind Sarwate, CFO, Marico India, and S Gopalakrishnan, Co-founder and Member of the Board of Infosys, spoke to S Venkatesh about the interpretation and implementation of EVA in their respective organisations.
Reprint No 01306 a-e
