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Three Versions of EVA®: the Compability with the Final Aim of the Enterprise’s Actions and Control and Simplicity

By Andrzej Cwynar

Abstract

Periodic performance measure should be goal-congruent: it ought to motivate managers to achieve firm's goals, including its ultimate goal, i.e. NPV maximization (owners' wealth maximization). It should also be controllable and simple. There is a measure especially promising in the field of congruity—residual income and its most popular variant, economic value added (EVA). One can distinguish three versions of EVA using three different methods of depreciation: EVA based on book depreciation (EVABV), EVA based on annuity depreciation (EVAANN) and EVA based on economic (present value) depreciation (EVAPVD). First version—EVABV—offers so called weak goal-congruence, second one—semi-strong goal-congruence and finally there is strong goal-congruence in the case of EVAPVD (with IRR as discount rate). In practice the difference in the level of congruence between EVABV and EVAANN is relatively small. They are also equally controllable because they do not include expectations concerning future performance. EVAPVD is much less controllable because of its dependency on expectations via economic (market) values. From the point of view of simplicity, EVABV is the most preferable version. EVAANN and EVAPVD are much less practical. Ultimately, it seems that EVABV can offer the most beneficial proportions of congruity, controllability and simplicity, especially if one take into account the fact that stronger congruity can be achieved by imposing a special mechanism, e.g. bonus bank.

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