Economic Value Added and Value-Based Management

Evidence of Jordan

Abstract

  EVA (Economic Valued Added) is a modern financial measurement tool that determines if a business is earning more than its true cost of capital. Including a cost for the use of equity capital sets EVA apart from more popular measures of bank performance, such as return on assets (ROA), return on equity (ROE), net banking income and the efficiency ratio, which do not consider the cost of equity capital employed. As a result, these measures may suggest a bank is performing well, when in fact it may be diminishing its value to its shareholders. EVA is a tool that focuses on maximizing shareholder wealth.

The aim of this paper is to extensively discuss the underlying concept of Economic Value Added, to present its strengthens and weaknesses, to discuss the revealed results from the empirical studies up to now concerning its usefulness as a financial performance measure, and finally, to show the results of the empirical study on the issue conducted in Jordanian  capital market. Despite all positive and encouraging comments about EVA, the empirical literature which came out provided mixed results for the usefulness of EVA in explaining stock returns. Studies focused on whether EVA is more highly associated with stock returns than other performance measures provided mixed and controversial results. This study employs pooled time-series, cross sectional data of 14 banks in the ASE over the period 2004-2009 to examine whether EVA or the traditional accounting-based measures are associated more strongly with stock returns. Relative information content tests reveal that stock returns are more closely associated with earnings per share than with EVA. However, incremental information content tests suggest that EVA adds considerable explanatory power to earnings per share in explaining stock returns.

JEL Classification: G21, G31, G32, M21, M41, O31