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Timo Salmi, Ilkka Virtanen: EVA

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Timo Salmi and Ilkka Virtanen - Economic Value Added

A simulation analysis of the trendy, owner-oriented management tool

Article Summary


The value-based management performance measure EVA® introduced by Stern Stewart & Co. is an incarnation of the underlying residual income (RI) concept. The concept is evaluated and compared with traditional profitability measures within a controlled simulation framework. It is observed that EVA is very sensitive to its cost of equity component, but it is unexpectedly insensitive to its cost of debt component under regular conditions. EVA and its variability are observed to be strongly affected by the firm's growth policies because of leverage effects. EVA is observed to be much more unstable than the traditional return on investment and directly related to the return on equity measure. Methodologically, the paper demonstrates the advantages of using a controlled simulation approach in financial research.


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