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Building EVA awareness Linking pay decisively to EVA Developing EVA-based action steps for line managers.
EVA is a registered trademark of Stern Stewart & Co. The directors of Finegan & Gressle are former partners and officers of Stern Stewart who contributed significantly to developing and popularizing EVA.
A large Market Rapid highstock stock and growing price price? market capitalization? appreciation? premium to book value? !
MVA Losers ($77.1) (52.4) (46.4) (36.7) (34.0) (19.5) (14.4) (7.0) (6.4) (6.0)
Coca-Cola $124.1 ITT Microsoft 83.3 General Motors The Point: Coke and GM have identical trading values, Intel 85.0 Loews but GM invested $200 billion more than Total Market Value $134.5 Merck American Express Coke to 72.5 get there. Total Market Value $135.5 Capital Invested 10.4 Phillip Morris 59.8 Ford Motor Company During the last187.9 5 years alone, Coke Capital Invested MVA $124.1 Proctor & Gamble generated 54.5 Travelers Group $73 billion more in value than MVA ($52.4) Exxon 51.5 RJR Nabisco could have been expected from the market 5-Year XVA $73.1 By contrast, GM destroyed $83 Johnson & Johnson in general. 48.8 PG&E 5-Year XVA ($83.2) Chase Manhattan billion. 43.7 Phillips Electronics Pfizer 40.8 Digital Equipment
Source: Finegan & Gressle survey of the 1,700 largest companies traded on a U.S. exchange based on year-end 1996 data ($ Billions). A complete listing is available at www.shareholdervalue.com.
MVA comes from operations, not finance. MVA depends on the future, not the past.
MVA comes from operations, not finance. MVA depends on the future, not the past.
Reconcile the discrete and often conflicting value drivers of a business. Differentiate substantive economic performance from bookkeeping entries. Capture the real time cost of money.
Corporate Office
Investor Relations
EPS
Asset Turns
No common denominator of value. Heavily dependent on corporate synthesis and reconciliation of departmental figures. Information transfers slow and inefficient.
Investor Relations
Treasury Management
Cost Accounting
No common denominator of value. Heavily dependent on corporate synthesis and reconciliation of departmental figures. Information transfers slow and inefficient.
Common language for allocating resources, conducting valuations, measuring performance, and communicating with investors. Minimal corporate synthesis and reconciliation. Information transfers real-time and meaningful.
Investor Relations
Treasury Management
Cost Accounting
No common denominator of value. Heavily dependent on corporate synthesis and reconciliation of departmental figures. Information transfers slow and inefficient.
Common language for allocating resources, conducting valuations, measuring performance, and communicating with investors. Minimal corporate synthesis and reconciliation. Information transfers real-time and meaningful.
Cost of Borrowing?
Dividend Yield? The return (or expectation) foregone by not investing in a comparably risky portfolio of projectsthe weighted cost of debt and equity capital. Opp. Cost = Cost of Capital x Beg. Capital
Beg. Capital
Improve efficiency, and thus returns. Grow, but only if new investments can earn the cost of capital. Redeploy capital from underperforming operations. Manage risk, and therefore the cost of capital.
PV NOPAT C
MVA
PV EVA2 PV EVA1
PV EVA3
Capital
The discounted present value of a companys expected EVA is its market value premium or discount to book value (MVA). A companys discounted EVA plus its level of capital employed will always equal the discounted present value of expected Free Cash Flow. EVA is the only integrated measure of growth and profitability which relates directly to stock value.
Measurement Challenges:
Acquisition accounting Write-offs and restructuring charges Off balance-sheet financing Expensing of long-term investments
Executive Talent
Tremendous opportunities Fewer competitive barriers Accelerating change Rapid competitive response Investor pressure
Strategy: Use performance-based pay to attract top talent and and encourage value creation
The Reality:
Most incentive plans arent designed to drive value creation
Stock and Options
Cash Incentives
Linked to stock price Competitive Line of sight often poor No focus on goals
Mainly annual EPS, ROE goals, capped Weak link to value Battles over fairness
Value-based plans, in contrast, clearly link decisions, results and shareholder value.
Target
Key Features:
Greater leverage
portion of award
EVA Performance Target
Key Features:
Greater leverage
Self-adjusting targets EVA
Performance Target
$80
PV EVA PV EVA
MVA
EVA C
Current EVA Capitalized
$ 30
$100
Capital
$ 50
Management recognition that current financial measures distort capital allocation or weaken incentives to create shareholder value. Understanding and appreciation by Operations, Human Resources and Finance of EVAs role in effecting change. Sufficient investment of time and resources to help managers understand what EVA is and how it should be used in managing their business.
Rollout
Evaluate Results
Product Margin
Total Costs
Volume
Weighted Margin
Variable Costs
Period Costs
Retained Accounts
New Accounts
Grade Ratio
Grade Margin
Premium
Mid-Grade
Regular
Product Margin
Total Costs
Volume
Weighted Margin
Variable Costs
Period Costs
Retained Accounts
New Accounts
Grade Ratio
Grade Margin
Premium
Mid-Grade
Regular
Premium
Mid-Grade
Regular
EVA
Cost of Capital
Cost of Debt Cost of Equity Capital Charge Fixed Capital Capital Employed Property Inventory Working Capital Receivables Payables Other Good Will Intangibles Plant & Equipment
Legend:
Common Concerns:
We have too many initiatives already underway; this will just confuse everyone. Its too complicated; nobody will understand it. Were already very successful, so why do we need this? Im investing for the future, but youre measuring todays returns.
You cant compare my SBU to SBU X, were different. We should formulate our strategy first and decide where were trying to go before we start measuring performance. We just convinced everyone that Return on Capital is the most important measure to evaluate performance.
EVA Implementation
If I had to do it over
Keep it simple! Devote greater resources to improving financial literacy. Establish clear line-of-sight between a managers actions and EVA, and EVA and shareholder value. Integrate the EVA initiative with other efforts such as cycle time, customer satisfaction, and balanced scorecard. Develop EVA Coaches to provide continuing support. Gain early buy-in from operations.