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In recent times, creating value for shareholders is a widely accepted corporate objective.
Corporate world has been looking for apposite strategies to maximize the shareholders’ worth.
Developing value-based financial performance measures can be viewed as the strategic move
of the corporate to meet this fundamental objective of its finance function. Economic Value
Added (EVA) has been introduced in the corporate world as the only integrated financial
management system that ‘drives stock prices’ (Stewart, 1991; 1999; and Stern et al., 1995).
A significant amount of research in the past estimated the relations between stock return
and company fundamentals. Most of these studies have used traditional financial measures
such as profits, cash from operations, PE ratios and PB ratios. Basu (1977), Chan et al. (1991),
Fama and French (1992), Campell (1998), Leledakis and Davidson (2001), Estrada (2005) and
Athanassakos (2009) are some of the significant studies of this kind. Similarly, academics have
shown interest in models of equity valuation that express value in terms of book value and the
expected stream of residual income or abnormal earnings (Ohlson, 1995; and Feltham and
Ohlson, 1995). Most of the traditional models use earning measures which often ignore the
impact of the cost of capital. Later, the equity research started to use value added measures
that consider the cost of capital along with earnings. EVA, which compares the firms’ operating
profit with their cost of capital employed, is proposed as a major improvement over the
traditional measures, and its proponents report high levels of its correlation with stock returns. It is a measure of total factor productivity (Drucker, 1995). EVA provides a single, unified, and
accurate measure of value as well as performance.
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