Economic value added (EVA) can serve as the cornerstone of a value-based management system.1
EVA is more than a performance metric. It also represents a mindset that focuses management attention on the value-creation imperative.
EVA is profit as economists think about profit. It differs from the conventional accounting-based approach in that it imposes charges for the use of all capital, including equity.
When managers are evaluated and paid on the basis of EVA, they have stronger incentives to improve operational and capital efficiency, dispose of unprofitable business, achieve more optimal capital structures, and invest in value-creating projects.
The value-based management movement is based on two assumptions. The first is that the main aim of any business in a market economy is to maximize shareholder value. The second is that markets are too competitive for companies to create such value by accident. They must plan for it. And that means having the right culture, systems, and processes in place so managers make decisions in ways that deliver better returns to shareholders.
At the very least, corporate functions must be informed by value-based thinking—planning, capital allocation, operating budgets, performance measurement, incentive compensation, and corporate communication. EVA is a tool for achieving this. EVA is a measure of performance, but its uses extend further. When implemented properly, and especially if tied to management compensation, it is a powerful way to promote shareholder value.
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