Economic Value Added in performance measurement: A simulation approach and empirical evidence

Abstract

AbstractWith increasing criticism on measuring executive performance based primarily on Total Shareholder Return (TSR), some academics and practitioners have revived discussions on using Economic Value Added (EVA) as an alternative. But if EVA failed to gain traction over the past two decades, is there any new evidence for it or different approaches to better implement it in corporate settings? In this study, we start by confirming EVA‐related metrics' significant positive relationships with long‐term TSR in the Australian market. Our empirical findings also address EVA's major drawback – too much complexity arising from accounting adjustments. Our results suggest that accounting adjustments are generally not necessary, and efforts should be re‐directed to designing direct and intuitive plan mechanisms. In addition, we develop a pseudo environment to illustrate EVA's managerial benefits and potential to cultivate sustainable growth. To study this influence, we leverage capital‐based simulation techniques and mimic executive decision making under different performance measurement conditions, which was typically only discussed in a qualitative or theoretical sense. We find that EVA‐related metrics naturally induce long‐term, strategic and sustainable decision making without limiting executives to overly focus on short‐term profitability. This simulation approach not only provides quantitative evidence, but also gives practitioners in different market environments an expandable and scalable pseudo framework to test the effect of different incentive plans and inform performance target setting, a useful but often overlooked feature in, for instance, the Australian market, where data is relatively scarce.