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The increasing frequency with which the business environment demands strategic change elevates the role played by performance measures in assessing alternative business strategies. Traditional accounting measures of performance have long been criticized for their inadequacy in guiding strategic decisions. Two alternative measures of business performance, EVA (economic value added) and MVA (market value added) have been attracting much attention of late. According to a recent article in Fortune, EVA is employed by a large number of firms, including Coca-Cola, AT&T, Quaker Oats, Eli Lilly, Georgia Pacific, and Tenneco.1 Unlike traditional accounting measures of performance, EVA attempts to measure the value that firms create or destroy by subtracting a capital charge from the returns they generate on invested capital. In addition to their use as performance measures, EVA and MVA are recommended by some as metrics for executive compensation plans and the development of corporate strategies.
Despite this wide interest in EVA and MVA, little is known empirically about the advantages of these measures over traditional accounting measures. Conceptually, EVA and MVA are superior to accounting profits as measures of value creation because they recognize the cost of capital and, hence, the riskiness of a firm's operations. However, conceptual superiority does not always translate into practical advantage.
To shed empirical light on the subject, we have investigated the effectiveness of EVA and MVA as measures of performance, as signals of strategic change, and as metrics relevant to strategic development. The study followed 241 firms over the period of 1987 to 1993. We analyzed the relation between various performance measures and stock returns, which generally are considered to be the best benchmark for a firm's performance; the turnover of chief executives, which is an indicator of strategic change; and the desirable extent of diversification to be pursued by firms, which has been the subject of considerable debate.
EVA and MVA Defined
EVA and related measures attempt to improve on traditional accounting measures of performance by measuring the economic profits of an enterprise-after-tax operating profits less the cost of the capital employed to produce those profits. Details on how to estimate the parameters necessary for the computation of economic profits are contained in the books of Stewart, Copeland et al., and Rappaport.2,3,4 Some of the ways in which...