Excess Return
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Excess Return |
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Calculation of Excess Return. Abstract |
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Excess Return (ER) is the difference between actual wealth and expected wealth at the end of the measurement period. Good methodology to evaluate top management of listed companies.
Actual Wealth is the future value of all the cashflows received over the measurement period. Expected Wealth is the future value of the initial investment
(= II0(1+cost of equity)N,
where N is the number of periods over which the ER is calculated.
Financial Value
Market-based
Stock-based
Economic Profit
Actual Wealth (N)
- Expected Wealth (N)
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Excess Return (N)
Unlike MVA, ER charges a company for the capital it has used since the beginning of the measurement period, while crediting companies for the returns their shareholders should have earned from dividends and share buybacks, reinvested in the market. Also unlike MVA, ER does take into account intermediate cash returns to shareholders.
Therefore Maximizing ER should be the financial goal of any value-based corporation.
Excess Return can only be used at firm / corporate level and is not practical for performance evaluation over a specific period of time, since it is stock-based, i.e. it expresses value accumulated as of a certain date.
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