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1. Introduction
The agency problem has long been recognised as one of the major issues in management and finance. A rational manager maximises his/her own utility and cares about the shareholders’ interest only as long as his/her interest and theirs coincide. Thus, aligning those potentially conflicting interests has been subject to considerable debate.
The expected role of the executive manager is to maximise the firm’s value (Wallace, 1997) and, hence, shareholder wealth. This maximisation is achieved through optimal management decisions; particularly investment, financing and operating decisions. Traditionally, shareholders try to achieve this through managerial ownership. However, theoretical and empirical arguments show that share ownership can have both an alignment and entrenchment effects (Khan and Mather, 2013). The quality and independence of remuneration committees have also been argued to help align executive compensation with firm financial performance (Cybinski and Windsor, 2013; Gray and Nowland, 2019).
One principle that has long been recognised is that, for a company to create value and to generate wealth, a firm must earn a rate greater than its cost of capital (Drucker, 1995). This is historically referred to as residual income (henceforth RI). One variant of RI is the economic value added (EVA) introduced by Stern Stewart and Co, US-based consulting firm, in 1991, as an alternative performance measurement to traditional earnings and cash flows-based metrics. EVA is similar to RI but includes additional adjustments to accounting values suggested by Stewart (1991) and Stern et al. (1995). However, EVA has been criticised as simply “re-labelling the resultant residual income concept” (O’Hanlon and Peasnell, 1998, p. 425). According to O’Hanlon and Peasnell (1998), the adjustments are based on consulting experiences that are not clearly underpinned by a theoretical framework. Although 120 aspects of conventional generally accepted accounting principles (GAAP) are identified to adjust the financial accounts for EVA, the basic adjustments include the capitalisation of all intangible investments, such as goodwill and research and development expenditure, and general provision for bad debts and inventory obsolescence (Stewart, 1991; O’Hanlon and Peasnell, 1998).
The EVA metric has received considerable attention in the literature as the best performance measure with the ability to align managers’ interests with those of the shareholders (Wallace, 1997; Balachandran, 2006).
In a seminal paper, Wallace (1997) investigated whether the use...