The EVA Paradox: Why So Many Firms Mess with Success
11 Pages Posted: 27 Jul 2015 Last revised: 17 Aug 2015
Date Written: February 25, 2015
Nearly three-fourths of firms that adopt EVA or similar value-based management programs end up dropping them within five years of adoption, even though those firms are seeing the shareholder value gains promised by these programs. The reward to shareholders for sticking it out is significant; companies on the programs for longer than five years outperform their sector peers by an average eight percentage points per year in total shareholder returns. Companies that dropped their plan within five years also outperformed their market peers by a lesser, but still significant amount.
So why would firms performing so well under a value-based management program discard it? A review of the literature and interviews revealed five main reasons for dropping their programs:
o The incentive plan didn’t pay out for one or more years o Managers or board members felt the measure was too complicated o The measure was repeatedly, significantly changed from year-to-year o The program champion left the firm o The program lost momentum after initial flurry of gains
The longest-term adopters consistently did three things well:
o Measurement: They developed a simple, but robust version of EVA (one that needed little modification over time) o Communications: They continually invested in financial literacy via steady training and reporting; managers and directors understood it o Incentives: They incorporated the value-based measure into a value-sharing incentive plan
Firms that successfully integrated all three elements into their management system found that each element reinforced the others, making it more likely that the program would survive a departure of its champion, or the higher expectations created by initial successes.
Keywords: measurement, executive compensation, incentives, corporate governance
JEL Classification: D24, G30, l20, M10, M52
Suggested Citation: Suggested Citation