Investors are currently demanding Shareholder value more strongly than ever. In the1980s, shareholder activism reached unforeseen levels with the companies in the United States (Bacidore et al. 1997). Thereafter also investors in Europe have increased the pressure on companies to maximize shareholder value. Even in Finland the so-called Shareholder value -approach has gained grounds. This is due to e.g. abolishing the restrictions on foreign stock ownership. Foreign investors emphasize and demand focus on Shareholder value -issues. (Löyttyniemi 1996)
The financial theory has since long suggested that every company's ultimate aim is to maximize the wealth of its shareholders. That should be natural since shareholders own the company and as rational investors expect good long-term yield on their investment. In the past, this ultimate aim has however been often partly ignored or at least misunderstood. This can be seen e.g. from measurement systems. Metrics like Return on investment and Earnings per share are used as the most important performance measures and even as a bonus base in a large number of companies, although they do not theoretically correlate with the Shareholder value creation very well. Against this background it is no wonder that so-called Value based measures have received a lot of attention in the recent years. These new performance metrics seek to measure the periodic performance in terms of change in value. Maximizing value means the same as maximizing long-term yield on shareholders' investment.
Currently the most popular Value based measure is Economic Value Added1, EVA™. There has been a vivid debate for and against EVA in academic and management literature. Unfortunately most EVA advocates and adapters have not acknowledged or discussed the faults of EVA, while they have praised the concept as a management tool. On the other hand most criticism against EVA has kept to fairly insignificant topics from the viewpoint of corporate control. There are currently very few articles dealing objectively with EVA's strengths and weaknesses as a management tool.
1.1 The objective and motivation of the study
This study seeks to clarify the concept of EVA especially from the viewpoint of business unit controlling. The objective of the study is twofold. Firstly, the study describes the theory and characteristics of EVA. This gives the framework to discuss the main objective: How companies should use EVA considering both its favorable and unfavorable features? In this context, the study also offers some recommendations of how EVA should be used as a management tool. The study tries to bring together the relevant theoretical issues and controlling practice. The topics discussed are essential and current in the case-group as well as in many other companies implementing EVA-approach in their organizations.
1.2 The structure of the study
The study consists of three main chapters. The first discusses the general theory behind EVA. This chapter presents the background and basic theory of EVA as well as main findings about EVA in financial literature. The chapter explains also in general what EVA has to give to corporate world. The second chapter focuses on the use of EVA in group-level controlling. It discusses how EVA could be defined in controlling and reporting, how it can be used in bonus systems and what are the problems faced in implementing EVA. The third and final main chapter deals with EVA more practically inside the case SBU. The chapter presents with numerical example the calculation of EVA and the impacts of a few different calculation methods. Chapter also illustrates one possible way to allocate the capital costs in the case SBU.
Shareholder value = Shareholder value is being used as a overall term covering various aspects in thinking that promotes the interests of shareholders. Normally the term also means a company's value to its shareholders i.e. market capitalization.
Shareholder value approach = Shareholder value approach refers to the focus of organization and management on acting within the interests of shareholders. Hence it means focus on maximizing the wealth of shareholders (creating shareholder value).
Value based measures = Value based measures are new performance measures that originate from the shareholder value approach. They seek to measure the periodic performance in terms of shareholder value created (or destroyed).
1.4 Case-companies and applied conversions
The subject will be discussed from both the viewpoint of the case-group and the case-SBU (Strategic business unit). The case-SBU is a unit of the case-group. From the reader's point of view it is completely irrelevant which real companies this study deals with. Therefore the group and the parent company will be called Group A or (parent) Company A. The Group and the parent company have the same name also in reality. The SBU (daughter company) will be called Company B or SBU B. Company B has been a kind of EVA-pilot in the case-group, since it has used EVA in reporting and bonus systems from the beginning of this year (1997). This naturally influences the whole study. Some problems are discussed in the light of these early experiences.
All of the figures in this study have been conversed linearly, so that meaning of the figures and the respective relations between the figures are still unchanged even though they do not relate to any real numbers.