Economic Value Added (EVA).

Is it really the best performance

measure? A Review of the Theoretical and Empirical Literature. The case
of Athens Stock Exchange (ASE)
Dimitrios I. Maditinos, PhD
Lecturer in Informatics and Finance
European Affairs Responsible for the Business School
Technological Educational Institute of Kavala Business School
Agios Loukas, 654 04, Kavala, Greece
Tel. ++30-2510-462219
Fax. ++30-2510-462219
E-mail: [email protected]
eljko evi, SJD, PhD
University Professor of Accounting, Finance and Public Policy
Director of Research, Outreach and European Affairs
The University of Greenwich Business School
Old Royal Naval College
30 Park Row, Greenwich
London SE10 9LS
England, UK
Tel. +44-20-8331-8205
Fax. +44-20-8331-9924
E-mail: [email protected]
Nikolaos G. Theriou, PhD
Professor in Strategic Management
Head of the Business Administration Department
Technological Educational Institute of Kavala Business School
Agios Loukas, 654 04, Kavala, Greece
Tel. ++30-2510-462156
Fax. ++30-2510-462156
E-mail: [email protected]

Dimitrios I Maditinos is the responsible author.

Economic Value Added (EVA). Is it really the best performance

measure? A Review of the Theoretical and Empirical Literature. The case
of Athens Stock Exchange (ASE)
Dimitrios I. Maditinos*1, eljko evi **, and Nikolaos G. Theriou*
*TEI of Kavala, Greece, Department of Business Administration
**University of Greenwich, the Business School
Abstract
The aim of this paper is to extensively discuss the underlying concept of Economic
Value Added, henceforth EVA, to present its strengthens and weaknesses, to discuss
the revealed results from the empirical studies up to now concerning its usefulness as
a financial performance measure, and finally, to show the results of the first empirical
study on the issue conducted in the Greek capital market. Despite all positive and
encouraging comments about EVA, emphasised by Stewart (1991; 1994; 1999),
Sheehan (1994), Walbert (1994), Stern, Stewart and Chew (1995) and other EVA
proponents such as Tully (1993), OByrne (1996), Ehrbar (1998), Stern (1974; 2001)
and Grant (2003) among others, the empirical literature which came out provided
mixed results for the usefulness of EVA in explaining stock returns. Studies focused
on whether EVA is more highly associated with stock returns than other
performance measures provided mixed and controversial results. This study employs
pooled time-series, cross sectional data of 163 listed companies in the ASE over the
period 1992 2001 to examine whether EVA or the traditional accounting-based
measures are associated more strongly with stock returns. Relative information
content tests reveal that stock returns are more closely associated with earnings per
share than with EVA. However, incremental information content tests suggest that
EVA adds considerable explanatory power to earnings per share in explaining stock
returns.
Key words: Traditional and value-based performance measures, EVA
Jel Classification:
1

L25

Responsible author: Phone and fax: 0030-2510-462219, e-mail: [email protected]

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1. Introduction
Modern value-based performance measures, such as Shareholder Value Added
(SVA), Economic Value Added (EVA), Market Value Added (MVA), Economic
Profit (EP), Cash Flow Return on Investment (CFROI) and Cash Value Added
(CVA), have attempted to divert management focus away from earnings and towards
cash flows. These measures recognise that capital invested in a corporation is not free,
and make a charge for the use of the capital employed by the corporation in its
operations (OHanlon and Peasnell, 1998).
According to Rappaport (1986) within a business, there are seven drivers (e.g.
sales growth rate, operating profit margin, income tax rate, working capital
investment, fixed capital investment, cost of capital, and forecast duration) that can be
managed to create value. The theory suggests that improvement in these value drivers
leads to an increase in shareholder value. A common theme of the value-based
performance measures is that they take these drivers and summarise them into a single
measure, be it SVA, EVA, or any of the other value-based measures that have been
developed. Ehrbar (1998, p. 134) for instance states that the mandate under an EVA
management system is to increase EVA as much as possible in order to maximise
shareholder wealth.
Modern value-based performance measures gained their popularity since the
late 1980s (Rappaport, 1986; Stewart, 1991; Stern, Stewart and Chew, 1995;
Copeland, Koller and Murrin, 1996; Black, Wright and Bachman, 1998; Madden,
1999), and thereby, the Value Based Management (VBM) approach became
increasingly popular both as a decision making tool and as an incentive compensation
system (Knight, 1998).
Many studies have been conducted in the last two decades, first in the US and
later in the rest of the international market community to answer questions such as
whether it is really better to use modern value-based measures than traditional
performance measures to measure the corporate financial performance, or which
performance measure best explains corporations change in market value. Reported
results are quite mixed and controversial. This study is inspired by the controversial
results of the previous studies and aims to investigate whether traditional and/or
modern value-based performance measures are value relevant in the context of ASE.
Since there are many financial performance measures (traditional and modern valuebased), which appear in different variations, this study is focused on the most popular
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of them, those that have been extensively mentioned in the literature. From the
traditional accounting performance measures we selected the EPS, ROI and ROE,
while from the modern value-based performance measures we focused on EVA.
2. Literature review
2.1. Introduction
The choice of performance measures is one of the most critical challenges facing
organisations (Knight, 1998). Poorly chosen performance measures routinely create
the wrong signals for managers, leading to poor decisions and undesirable results.
There are enormous hidden costs in misused performance measures. Shareholders pay
the bill each day in the form of overinvestment and acquisitions that do not pay off
etc. It is not that management is poor. Simply, it is the wrongly chosen performance
measures, which in turn push management to take improper decisions (Ferguson and
Leistikow, 1998; Knight, 1998).
Over the last few years an increasing number of consultants, corporate
executives, institutional investors and scholars have taken part in the debate on the
most appropriate way to measure performance (Rappaport, 1998). Consultants are
willing to demonstrate the mastery of their recommended performance models.
Corporate executives show clearly that the performance models adopted by their
corporations are the most appropriate and successful. Institutional investors debate the
advantages of alternative performance models for screening underperforming
companies in their portfolios. Finally, scholars develop performance measurement
models and test the extent to which existing performance evaluation and incentive
compensation systems inspire management decisions and performance itself
(Rappaport, 1998).
Traditional performance measurement systems were developed at a time when
decision-making was focused at the center of the organisation and responsibilities for
decision-making were very clearly defined. According to Knight (1998, p. 173) these
performance measurement systems were designed to measure accountability to
confirm that people met their budget and followed orders. However, during the last
two decades it was widely argued (Rappaport, 1986; 1998; Stewart, 1991; 1999) that
most of the performance measurement systems failed to capture and encourage a
corporations strategy, producing mostly poor information leading to wrong decisions.
Knight (1998), in an attempt to explain why traditional performance measures were so
misused, asserted that part of the answer lies in three myths surrounding performance
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measurement, which are: growing quarterly EPS is all that matters, accounting
measures tell the whole story, and that you can manage anything only with financial
reporting methods. These myths are all based on the common belief that accounting is
the only means of measuring performance. He then discussed the shortcomings of
these three myths and suggested that value-based performance measures such as
EVA and SVA, among others, could be considered as alternative options to measure
a corporations financial performance.
Value-based management approach, based mainly on NPV techniques, FCF,
and cost of capital, has as its main objective the maximisation of shareholder value. In
recent years, SHV approach and VBM became particularly popular both as a decision
making tool and as an incentive compensation system as well. Thus, value-based
performance measures, such as EVA, MVA, SVA, CFROI2, EP3, CVA, and
Economic Value Management (EVM)4 have spread all over Europe gaining
acceptance by many companies.
Moreover, many shareholder value proponents such as Rappaport (1986;
1998), Stewart (1991; 1999), Stern, Stewart and Chew (1995), Ehrbar (1998), Knight
(1998), and Stern (1974; 2001) have strongly criticised earnings since they fail to
measure changes in the economic value of a company. Their critique was mainly
based on three reasons: alternative accounting methods may be employed to calculate
earnings, investment requirements are excluded from earnings calculation, and the
time value for money is ignored in earnings calculation.
2.2. The EVA Financial Management System
EVA is considered as the centerpiece of a completely integrated financial framework
for financial management and incentive compensation (Stewart, 1994; Stern, Stewart
and Chew, 1995). It is a technique for value creation measurement and has been
developed and trademarked by the New York consultant group Stern Stewart & Co.
(Stern, 1985; Stewart 1991). Stern Stewart & Co. (established by Joel Stern and
Bennett Stewart), promoted the EVA technique not only as a simple performance
measure but as an integrated Financial Management System as well, which associates

CFROI and CVA has been developed by Boston Consulting Group (BCG) / HOLT Planning
Associates
3
EP has been introduced by Marakon Associates
4
EVM has been developed by KPMG Peat Marwick

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the value creation with incentive compensations (Stewart 1991; 1994; 1999; Stern,
Stewart and Chew, 1995; Ehrbar 1998).
EVA is calculated as the product of the economic book value of the capital
committed to the business multiplied by the spread between the rate of return on
capital, defined as r, and the cost of capital, defined as c* (Stewart, 1991). Therefore,
the formula for EVA calculation becomes as follows:
EVA = (r - c*) X capital

(2-1)

EVA = (rate of return cost of capital) X capital

(2-2)

or
where r is the rate of return, and c* is the cost of capital, or more correctly stated, the
WACC.
The rate of return, r, is computed by dividing a companys NOPAT by the total
capital employed in operations:
r=

NOPAT
Capital

(2-3)

According to Stewart (1991; 1999) the rate of return measures the productivity of
capital employed without taking into consideration the method of financing, and it is
free from accounting distortions that arise from accrual bookkeeping entries, from the
conservative bias in accounting statements, and from the tendency to understate
capital by writing off unsuccessful efforts. It may be compared directly to the
companys overall cost of capital employed and therefore it is able to indicate whether
value has been created or destroyed. Stern Stewart & Co. has proposed up to 164
adjustments in order to eliminate financing distortions in a companys NOPAT and
Capital (Stewart, 1991; 1994; 1999).
Rearranging equation (2-1), EVA becomes:

EVA =(r X capital)-(c* X

capital) and rearranging equation (2-3), NOPAT becomes: NOPAT = r X capital

Thus, replacing the (r X capital) in equation (2-1) with NOPAT, EVA becomes:
EVA = NOPAT (c* X capital)

(2-4)

where NOPAT is operating profits and (c* X capital) is the capital charge. Therefore,
we can define EVA as operating profits less a capital charge.
EVA is based on accounting items such as net income, interest bearing debt
and capital. Compared to the other traditional accounting measures, EVA differs to
the degree that it includes the cost of capital in its calculation. Additionally, Stewart
(1991, p. 3) argued that algebraically EVA produces the same results in valuation as
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DCF or NPV, valuation methods that are widely accepted as the theoretically best
valuation mechanisms from the shareholders point of view (Miller and Modigliani,
1961; Stern, 1974; Gordon, 1962). DCF and NPV take into account the time value for
money, use the opportunity cost of equity capital and moreover, they do not suffer
from any sort of distortions caused from accounting. However, since they are alone in
being based on forecasted cash flows, they do not match in performance evaluation,
while EVA seems to fit quite satisfactorily in measuring the performance (Stewart,
1999).
2.3. The Introduction of EVA in Corporate World

In 1991, Stern Stewart & Co. revised the computation of Residual Income (RI)
through a series of accounting adjustments and the result was the trademarked variant
of RI, the EVA. They recommended EVA as a measure that could be used instead
of earnings or cash from operations in order to capture both internal and external
performance. Stewart (1991, p. 66) as a principal advocate of EVA argued:
Earnings, earnings per share and earnings growth are misleading measures of
corporate performance. Earnings are diminished by bookkeeping entries that have
nothing to do with recurring cash flow, and are charged with such value-building
capital outlay as R&D, all in an attempt to placate lenders desires to assess
liquidation value. EPS at best measures only the quantity of earnings, but the quality
of earnings reflected in the P/E matters too.
Many other important studies contributed to the increasing interest in EVA.
For example, Peterson and Peterson (1996) and Copeland, Koller and Murrin (1996)
provided details for EVA calculation (or variations of EVA, since Copeland refers
to economic profit). OHanlon and Peasnell (1998) and Young (1997; 1999) discussed
and explained the applicable use and cost of the potential accounting adjustments for
EVAcalculation. McConville (1994), Jackson, Mauboussin and Wolf (1996), Dierks
and Patel (1997), Stewart (1998), Prober (2000), Ray (2001), and Grant (2003)
promoted the usefulness of EVA as a financial reporting tool and described it as a
vital measure of total factor productivity, one that reflects all the dimensions by which
management can increase value. Managers of leading companies such as Coca Cola,
Sprint Corporation, and Quaker Oats have also presented their encouraging aspects
for the effectiveness of the EVA financial management system. Besides, there has
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been a widespread adoption of EVA by security analysts such as Credit Suisse, First
Bostons and Goldman Sachs. They prefer this model instead of the dividend
discount approach (Abate, Grant and Stewart, 2004).
What makes EVA challenging and interesting to study, is its adoption as a
performance measure and/or incentive compensation system of hundreds of
companies in the US. Moreover, in recent years the EVA concept/system crossed
oceans and made sense in many other countries. EVA figures have been largely
promoted in countries such as the UK, Australia, Canada, Brazil, Germany, Mexico
and France among others (Gnther, Landrock and T. Muche, 2000; Worthington and
West, 2001). Ehrbar (1998) refers to the adoption of EVA by New Zealand state
owned companies in order to be invigorated, while Worthington and West (2001)
discuss the adoption of the EVA financial management system by companies in
Australia.
Despite all positive and encouraging comments about EVA emphasised by its
proponents, the empirical literature which came out provided mixed results for the
usefulness of EVA in explaining stock returns. Studies focused on whether EVA is
more highly associated with stock returns than other performance measures provided
mixed and controversial results. For example, OByrne (1996), Uyemura, Kantor and
Petit (1996), Milunovich and Tsuei (1996), Lehn and Makhija (1997), Herzberg
(1998) and Forker and Powell (2004) provided positive results for the value relevance
of EVA. Their findings supported the Stewarts (1991; 1999) claim for the
superiority of EVA as a financial performance measure.
On the other hand, studies carried out by Peterson and Peterson (1996),
Biddle, Bowen and Wallace (1997), Chen and Dodd (1997; 2001) and Turvey et al.
(2000) did not provide encouraging results for the superiority of EVA compared to
traditional accounting performance measures such as EPS, ROI and ROE. Many other
studies have been conducted examining other parameters of EVA. Bacidore et al.
(1997) examined an alternative option of invested capital (they used market values
instead of book values to estimate the capital invested) and proposed the Refined
EVA (REVA) as the proper representative of economic value added. Although their
findings proved that REVA is preferable than EVA, a study carried out by Ferguson
and Leistikow (1998) proved that it does not hold. Finally, Wallace (1997) and Lovata

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and Costigan (2002) examined the consequences of the adoption of the EVA
financial management system.
2.4. Adjustments in EVA Calculation

According to Young (1997) EVA is not bound by accounting conventions. If

National accounting principles distort the measurement of operating income or
capital, adjustments are made as necessary. Most of the adjustments are in the form of
what Stern Stewart & Co. call equity equivalents. The reasoning behind these
adjustments is that when companies apply generally accepted accounting principles or
National accounting principles, certain items are charged to operating income, such as
R&D, goodwill, provisions, and deferred taxes, that misleadingly reduce stated
capital. Unless these charges are restored to equity, capital charges will be
understated. Additionally, operating income will also be mis-stated.
To define and refine its EVA measure, Stern Stewart & Co. has identified a
total of 164 performance measurement issues, including methods of addressing
shortcomings in conventional accounting such as: inventory costing and valuation,
seasonality, depreciation, revenue recognition, the write off of bad debts, the
capitalisation and amortisation of R&D, intangibles, mandated investments in safety
and environmental compliance, valuation of contingent liabilities and hedges, special
issues for taxation, inflation, currency translation, etc. (Stewart, 1994). However, the
number of accounting shortcomings or adjustments needed appears differently in the
literature. For example Stern, Stewart and Chew (1995, p. 41) stated: Stern Stewart
has identified over 120 shortcomings in conventional GAAP accounting. Ehrbar
(1998, p. 164) quoted Stern Stewart has identified more than 160 potential
adjustments to GAAP and to internal accounting treatments, all of which can improve
the measure of operating profits and capital, while other scholars (for instance,
Young, 1999; Worthington and West, 2001) are referring to 120-150 possible
adjustments5.

Nevertheless, because of the great number of possible adjustments, no

company is intended to apply all of them (Stewart, 1994; Stern, Stewart and Chew,
1995; Ehrbar 1998). In general, they found it necessary to address only 20 to 25 key

5
Most common adjustments are referred on: Recognising non-recurring gains and losses, R&D,
deferred taxes, intangibles (goodwill), depreciation, provisions, restructuring changes and other
macroeconomic conditions.

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measurement issues in detail and as few as 5 to 10 key adjustments to be actually

made in practice. Young (1999)6 also observed that a figure of no more than fifteen
adjustments to published accounts has progressively decreased in recent years.
Despite the large amount of possible EVA adjustments Young (1997; 1999)
suggested that companies adopting this method should limit the number of
implemented adjustments to fewer than ten. Otherwise, they face the risk of making
the system very complicated and costly as well. Young (1999) argued that many of
the adjustments are of little importance to the company level, and some may be
difficult, if not impossible, to replicate at the security level. Finally, Young (1997, p.
338) summarising the critique on the adjustment processing suggested as a rule that
adjustments should be made only if the amounts are significant, the required
information is readily available, and no finance professionals can understand them.
The last point is very important, since it is the basis for truthful communication
between managers and the companys finance persons.
Although EVA proponents are considering the adjustments as a crucial
process to produce the equity equivalence and consequently the correct EVA, a
number of scholars discussed in detail their usefulness. Anderson, Bey and Waver
(2004) asserted that there is no theoretical or empirical evidence that the EVA
adjustments convert wrong accounting numbers into correct estimates of value, and
moreover, there is no economic theory to guide the selection of the most relevant
accounting variables that will be adjusted. They also found that the impact of the
primary adjustments is inconsistent from year to year and, in general, insignificant.
This led them to believe that the use of EVA as a basis for compensation or a
measure of corporate wealth creation is limited. According to Chen and Dodd (1997,
p. 331) this result can be supported since they argued that a company could
implement performance measures, based on the computationally simpler RI, which
will likely provide them with most of the practical benefits promised by the EVA
system.
The EVA calculation as proposed by Stern Stewart & Co. is not an easy
process at all. However, there are only a few studies that discuss the particular
difficulties in EVA calculation. Keys, Azamhuzjaev and Mackey (2001) presented a
6
In our days special software packages have been developed, e.g. FINANSIER from Stern Stewart and
Company, that can very easily apply all proposed adjustments for the exact measurement or the refined
EVA.

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critical analysis for the calculation of EVA. They examined step-by-step EVA
calculations, and concluded that EVA has several weaknesses, especially in
calculation of NOPAT and Capital, EVA has eight general limitations and EVA is
identical to RI, an older financial measure largely abandoned by US companies years
ago.
Concerning the weaknesses in calculation of NOPAT and capital, they were
mainly focused on the proposed accounting adjustments by EVA proponents, which
they have criticised in detail. As for the general limitations they summarised them as
follows: managers will have fewer choices in financing operations, risky projects will
be accepted and moderate ones will be rejected, EVA is too complex, EVA is easy
to manipulate, EVA is a short term measure, EVA is a single performance measure
that includes no measures for quality or time, EVA terminology is misleading, and
EVA should not be used for capital budgeting (Keys, Azamhuzjaev and Mackey,
2001).
2.5. Empirical Evidence on Value-Based Performance Measures

Stewart (1991) first provided evidence of the correlation between EVA and MVA.
Using a sample of 613 US companies over the period 1987-1988 and examining both
levels and changes in EVA and MVA, he found that there is a striking relationship
between both levels of EVA and MVA, and even more pronounced, between
changes in these levels. Since the correlation between changes in EVA and MVA
was high, he suggested that adopting the goal of maximising EVA and EVA
growth would in fact build a premium into the market value of the company.
Lehn and Makhija (1996) examined EVA and MVA as measures of
performance and as signals for strategic change. Their sample consisted of 241 US
companies over the years 1987, 1988, 1992, and 1993. Firstly, they found that both
EVA and MVA correlated positively with stock returns and that this correlation was
slightly better than with traditional performance measures such as ROA, ROE and
ROS. Secondly, they suggested that both EVA and MVA were effective
performance measures containing information about the quality of strategic decisions
and that they can serve as signals for strategic changes.
Milunovich and Tseui (1996) examined the computer service industry for the
period 1990-1995. They found that MVA is more highly correlated with EVA than
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with EPS, EPS growth, ROE, FCF or FCF growth. OByrne (1996) challenged the
suggestion of other scholars (e.g. Easton, Harris and Ohlson, 1992) that earnings,
without regard to the amount of capital employed to generate those earnings are
sufficient to explain differences in stock returns. He examined the association
between market value and two performance measures: EVA and NOPAT. He found
that both measures had similar explanatory power when no control variables were
included in the regression models, but that a modified EVA model had greater
explanatory power when indicator variables for 57 industries and the logarithm of
capital for each firm were included as additional explanatory variables.
Uyemura, Kantor and Petit (1996) using ten years data (1986-1995) studied
the relationship between EVA and MVA. They also studied the relationship between
MVA and four traditional performance measures: EPS, NI, ROE and ROA. They
provided evidence suggesting that the correlation between MVA and those measures
are: EVA 40 per cent, ROA 13 per cent, ROE 10 per cent, NI 8 per cent and EPS 6
per cent. Lehn and Makhija (1997) also found that stock returns over a ten-year period
were more highly correlated with average EVA over the period than with the
average of ROA, ROS or ROE. Moreover, Worthington and West (2001) clearly
suggested the superiority of EVA compared to earnings and other accounting
performance measures in explaining stock returns.
Other scholars found that EVA is predictive of stock returns, but it is not the
only performance measure that ties directly to a stocks intrinsic value, which is one
of the primary assertions of EVA proponents (Stewart, 1991; 1999). Among others,
they suggested that EVA is not a superior measure of companys performance. Dodd
and Chen (1996) and Chen and Dodd (1997) based on a ten years (1983-1992) sample
of 566 US companies obtained from the 1992 Stern Stewart Performance7 1,000 and
the Compustat database, provided important evidence concerning the implementation
of EVA.
Dodd and Chen (1996) found that stock returns and EVA per share are
correlated as advocated by EVA adopters. However, the correlation was far from
perfect. On the other hand they found that ROA explained stock returns slightly better
than EVA. Their findings also suggested that if a company wants to adopt the

Stern Stewart Performance7 1,000 is a database containing EVA figures produced by Stern Stewart
& Company.

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philosophy of EVA as a corporate performance measure, it might want to consider

using RI instead. Finally, since nearly 80 per cent of their samples stock returns
could not be explained by EVA, they concluded that EVA is neither the only
performance measure to tie with stock returns nor a very complete one. This is
consistent with other stock market research suggesting that to explain more
completely the variability in stock returns, multiple determinants are required.
Chen and Dodd (1997) extended the previous research and examined the
explanatory power of EPS, ROA, ROE, RI, and four EVA related measures. Firstly,
they found that improving EVA performance is associated with higher returns.
However this association is not as strong as suggested by EVA proponents. No
single EVA measure was able to account for more than 26 per cent of the variation
in stock returns. Secondly, the EVA measures provided relatively more information
than the traditional accounting measures in terms of the strength of their association to
the stock returns. Moreover, the findings of this study suggested that the accounting
earnings provided significant incremental explanatory power above EVA. Thus,
Chen and Dodd (1997) concluded that companies should not follow the suggestions of
EVA advocates where traditional accounting measures should be completely
replaced with EVA and suggested that along with EVA, companies should continue
monitoring the traditional measures of accounting profits such as EPS, ROA and
ROE. Finally, consistent with their previous results, they found that RI provided
almost identical results to EVA, without the need of accounting adjustments
advocated by Stern Stewart & Co.
Bacidore et al. (1997) suggested a refinement of EVA, the REVA. REVA
assesses a capital charge for a period equal to WACC times the market (rather than
book) value of the company at the beginning of the period. Their sample was based
on 600 companies randomly selected from the Stern Stewart Performance 1,000
database, and on accounting and financial data selected from Standard and Poors
Compustat and University of Chicago CRSP database respectively. They compared
EVA to REVA and found that although both measures were statistically related to
abnormal stock returns, REVA outperformed EVA.
Biddle, Bowen and Wallace (1997) provided the most comprehensive study of
EVAs value relevance to date. They used a sample of 773 US companies from Stern
Stewart & Co. database, resulting in a 6,174 year-observations over the period 1984- 12 -

1993. Using relative and incremental information content tests and constructing
models based on Easton and Harris (1991) methodology found that traditional
accounting measures, generally, outperformed EVA in explaining stock returns.
Some scholars applied Biddle, Bowen and Wallace (1997) methodology into
their own countries (e.g. Worthington and West, 2001) and found similar results.
Worthington and West (2001), using pooled time-series, cross-sectional data on 110
Australian companies over the period 1992-1998, proved that relative information
content tests reveal earnings to be more closely associated with returns than Net Cash
flows (NCF), RI and EVA. However, consistent with the construction of EVA-type
measures, incremental information content tests suggested that EVA adds more
explanatory power to earnings than either NCF or RI. The pair wise combination of
EVA and earnings indicated that the explanatory power has increased by 10.26
percent, higher than any other pair wise combination.
However, other scholars (e.g. Forker and Powell, 2004; Worthington and
West, 2004) using different methodologies provided totally different results than those
reported by Biddle, Bowen and Wallace (1997). Worthington and West (2004) using
the same sample but changing the methodology found that EVA is more associated
with stock returns than earnings. Forker and Powell (2004) also revisited Biddle,
Bowen and Wallace (1997) study and provided reverse results. They showed that
investors factor of cost of capital into equity pricing and residual-based metrics, such
as EVA, are superior to traditional accounting metrics in providing a basis for
investors to confirm or revise their expectations in the valuation process.
Turvey et al. (2000) studied the relationship between EVA and stock market
returns for a sample of 17 publicly traded food companies in Canada. The key finding
was that no relationship could be found between the two. Keef and Rush (2003)
examined both theoretically and empirically the link between EVA and stock price
reaction. They found the results of Turvey et al. (2000) as expected, but moreover,
they considered the EVA concept as an enigma. In light of the findings and the
arguments of Turvey et al. (2000) and Keef and Rush (2003), Sparling and Turvey
(2003) examined the relationship of EVA and shareholder returns and found an
extremely weak correlation.
Chen and Dodd (2001) based on the valuation models used in previous studies
from Easton and Harris (1991) and Chen and Dodd (1997) examined the value
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relevance of three profitability measures: OI, RI and EVA. For a ten year period they
used only those companies from 1992 Stern Stewart 1,000 database that were also
available in Standard and Poors Compustat PC Plus database with relevant data for
the operating income and residual income variables. The final combined data set
consisted of 6,683 observations. Relative and incremental information content tests
were then conducted according to previous studies Relative information content test
revealed that Operating Income (OI) outperformed RI and EVA. This result
suggested that the new information provided by EVA is less value relevant, at least
from stock returns perspective, a finding consistent with Biddle, Bowen and Wallace
(1997). The incremental information content tests revealed that RI measures contain
significant information that is not available in OI.
Many other studies reported the weak correlation of RI metrics with stock
returns. Peterson and Peterson (1996) provided evidence that EVA type measures do
not provide much more information than stock prices. Stark and Thomas (1998)
examined the UK market and concluded that the relationship between RI and market
value is by no means perfect. Gnther, Landrock and Muche (2000) in examining the
Germany stock market, could not prove that value-based measures (EVA, CVA,
DCF and Tobins Q) outperform traditional accounting-based measures (ROS, ROI,
and ROE). Goetzmann and Garstka (1999) found that long-term survival of
companies may be related to accounting earnings, and more, simple EPS does as well
or better than EVA at explaining differences across companies and at predicting
future performance. Finally, Kramer and Peters (2001) also reported the weak
correlation between EVA and MVA.
As for the Greek capital market, there is almost no evidence concerning the
relevance of value-based measures on performance measurement. Only Kousenidis,
Negakis and Floropoulos (1998) studied the analysis of divisional profitability using
the RI profile. They reported results indicating that in addition to the question of
whether RI and ROI were useful in divisional performance evaluation, both measures
had an important role to play as a means of approximating actual cash flow.
3. Methodology of the study
3.1. Sample and the data collection

Our sample period spans 10 years, from 1992 to 2001. There are 163 companies in the
sample with different number of participating years for each of them. These
- 14 -

companies gave a total of 984 year-observations. After excluding the extreme

observations (3 standard deviations), the final sample was reduced to that of 977 yearobservations.
The research started the sample selection using daily closing prices of the
common stocks, which were trading in the ASE during the period from January 1990
to April 2002, even though the investigation period spans from 1992 to 2001. They
are raw prices in the sense that they do not include dividends but they are adjusted for
capital splits and stock dividends. It starts from January 1990 since it needs at least
two years prior trading period for each stock to incorporate it in the sample. The main
reason for this was the need of 36 monthly returns for each stock in order to calculate
its risk (beta) for each year. Thus, the stocks which consist the sample of 1992 have a
trading presence in the ASE at least from the first month of 1990.
It also included the closing prices three months after the fiscal year end 2001
since the return period for each year spans nine months prior to three months after the
fiscal year end (Easton and Harris, 1991; Biddle, Bowen and Wallace, 1997; Chen
and Dodd, 2001). Except from the daily closing prices for each stock, it was also
collected the daily General Index of the ASE and the three-month Government
Treasury Bill rate, which is considered to be the short-term interest rate (risk free
interest rate). All data was acquired directly from the ASE data bank.
From the daily closing prices of the common stocks the daily returns for each stock
was calculated using the logarithmic approximation:

P
Ri ,t = log i ,t

P
i ,t 1

(3-1)

where Ri ,t is the return of stock i at time t, while Pi ,t and Pi ,t 1 are the prices of stock i
at time t and t-1 respectively.
Daily returns were aggregated to compose the monthly returns, which are the primary
inputs for our investigation. Using the same procedure, the monthly returns for the
General Index (GI) were also calculated. Employing the first selection criterion, all
financial companies and the Banks were excluded from the sample, while employing
the second selection criterion the companies with penalties or with long periods
without transactions (more than two months) or with missing values were also
excluded. Using the monthly returns of each stock and the monthly returns of GI, the
annual betas for each stock were estimated. Finally, annually returns were calculated
as the aggregation of the monthly returns, extending nine months prior to three
- 15 -

months after each fiscal year end. The estimation of the adopted accounting and
value-based performance measures was based on the annual balance sheet and income
statement of each listed company included in the sample. This information was taken
from the ASE data-base.
3.2. The Model

This research is based on Easton and Harris (1991) formal valuation model, which has
been used by the majority of researchers who contacted similar studies (Biddle,
Bowen and Wallace, 1997; Chen and Dodd, 1997 and 2001; and Worthington and
West, 2001) and which is actually the only model supported theoretically by their
proponents and, up to now, according to our knowledge, remains without any sound
criticism by academia. The model links stock returns to earnings levels and earnings
changes as below:
Rjt = t0 + t1 A jt / Pjt-1 + t2 A jt /Pjt-1 + 3jt

(3-2)

Where Rjt is the return on a share of firm j over the 12 months, extending from 9
months prior to fiscal year-end to 3 months after the fiscal year-end, Ajt is the
accounting earnings per share of firm j for period t, Ajt is the earnings change, and
Pjt-1 is the price per share of firm j at time t-1.

Both relative and incremental information content approaches were employed to

answer the two research questions under examination. The relative information
content approach is used to explore the first research question, while the incremental
information content approach is employed to answer the second one.
To explore the first research question four equations (variations) were
developed based on Easton and Harris (1991) adopted model. Analytically, the
earnings and earnings change variables were replaced with each of the performance
measures under examination. Thus, the following equations were finally developed:
Equation (1): Returns = a0 + a1 EPS/Pt-1 + a2 EPS/Pt-1 + u1
Equation (2): Returns = b0 + b1 ROI + b2 ROI + u2
Equation (3): Returns = c0 + c1 ROE + c2 ROE+ u3
Equation (4): Returns = d0 + d1EVA/Pt-1 + d2 EVA/Pt-1 + u4

Where, for all equations:

Returns are the annual compounded returns extending nine months prior to current

fiscal year end to three months after the current fiscal year end

- 16 -

EPS is the earnings per share of firm at time t, EPS is the change in earnings per
share over period t-1 to t, Pt-1 is the market value per share at the first trading day of
the ninth month prior to fiscal year end, ROI is the return on investment of firm at
time t, ROI is the change in ROI over period t-1 to t, ROE is the return on equity of
firm at time t, ROE is the change in ROE over period t-1 to t, EVA is the economic
value added of firm at time t, EVA is the change in EVA over period t-1 to t and
Through this approach (the relative information content approach), the study
will investigate which one of the performance measures under examination is superior
in terms of association with stock returns in the Greek capital market. The equations
will be estimated cross-sectionally by years as well as using pooled cross-sectional
and intertemporal data (Easton and Harris, 1991; Chen and Dodd, 2001; Worthington
and West, 2001). This design facilitates the use of testing procedures that are common
in the information content literature and, therefore, will ease the comparison of the
present study with those in the literature. In order to reveal the explanatory power of
the variables under examination, the coefficients significance, F-statistics, and R2s
will be examined.
To explore the second research question the incremental information content
tests will be employed (Chen and Dodd, 2001; Worthington and West, 2001). The
purpose of these tests is to examine whether one measure adds information to that
provided by another measure. The coefficient of determination, R2p/q, denotes the
increase in R2 due to variable p, conditional on variable q, and R2p.q denotes the R2 due
to both variables p and q (Cheng, Cheung and Gopalakrishnan, 1993). Pooled timeseries cross sectional data (all years) will be employed to reveal the information
usefulness of each regression model. For this purpose the Easton and Harris (1991)
model was extended incorporating the combination of one traditional and one valuebased performance measure. The new equations (variations) that have been developed
to explore the incremental information content of the pairwise combination of these
measures are three (equations 5-7):
Equation (5) : Returnst = l0 + a1 EPS/Pt-1 + a2 EPS/Pt-1 + d1 EVA/Pt-1 + d2 EVA/Pt-1+ u5t
Equation (6) : Returnst = n0 + b1 ROI + b2 ROI + d1 EVA/Pt-1 + d2 EVA/Pt-1 + u6t
Equation (7) : Returnst = p0 + c1 ROE + c2 ROE + d1 EVA/Pt-1 + d2 EVA/Pt-1+ u7t

4. Results

4.1. Relative information content approach

- 17 -

Relative information content is assessed by comparing R2s from four separate

regressions (1 to 4), one for each performance measure, EPS, ROI, ROE and EVA.
R2s from these regressions are provided in Table 1. The higher R2 is shown on the left
and the lowest is shown on the right.
Following the Easton and Harris (1991) and Chen and Dodd (2001)
methodology, the model was estimated using both the pooled cross-sectional and
intertemporal (all years) sample and the individual year cross-sectional sample.
Table 1: Summary (all years) results from the five (1-4) regressions
Regression Regression Regression Regression
(3)
(2)
(4)
(1)
ROE
ROI
EVA
EPS
All Years
R2
0.019
0.009
0.004
0.000
(9.577)*** (4.546)*** (2.781)*
(0.005)
F
Significance 0.000
0.01
0.062
0.995
* significance at 10% level, ** significance at 5% level, *** significance at 1% level

Firstly, there is a significant difference between the four regressions in the relative
information content tests. Regressions (1) and (4) are significant at 0.01 level,
regression (2) is significant at 0.1 level, while regression (3) is not statistically
significant. Secondly, comparing the reported R2s of the four pooled regressions, it is
noticed that all are largely consistent to those of Biddle, Bowen and Wallace (1997),
Worthington and West (2001), and Chen and Dodd (2001).
The results of the present study show that EPS (R2 = 1.9 per cent) provide
more information in explaining stock returns than EVA (R2 = 0.9 per cent). Biddle,
Bowen and Wallace (1997) found that Earnings Before Extraordinary Items-EBEI
with an R2 = 9.0 per cent provides more information than Residual Income-RI (R2 =
6.2 per cent), and EVA (R2 = 5.0 per cent). Worthington and West (2001) also found
similar results: EBEI (R2 = 23.6 per cent), RI (R2 = 19.2 per cent) and EVA (R2 =
14.3 per cent), while Chen and Dodd (2001) reported that Operating Income-OI with
an R2 = 6.2 per cent explains the stock returns better than RI (R2 = 5.0 per cent) and
EVA (R2 = 2.3 per cent). The results of this research suggest that for the Greek
capital market, the new information provided by the EVAmeasure is less value
relevant than EPS, at least from a stock return perspective. Examining separately each
of the four regressions (1 to 4) and using the individual year cross-sectional sample,
- 18 -

results are largely consistent with those reported for the pooled cross-sectional and
intertemporal (all years) sample.
4.2. Incremental information content approach

To test the incremental information power, each traditional performance measure

(EPS, ROI and ROE) is combined pairwise with EVA forming three different
equations (5 to 7). An assumption of a linear relationship between these variables was
made. All regression models were tested for multicollinearity using the variance
inflation factor (VIF). According to Neter, Wasserman and Kunter (1985) a VIF in
excess of 10 is often taken as an indicator of severe multicollinearity, while mild
multicollinearity exists when the VIF is between 5 and 10. A VIF lower than 5
indicates that multicollinearity does not exist. The reported VIF from our regressions
are mostly less than 5. Examination of residual plot and normality plot reveal no
serious violations of the regressions assumptions. There was an attempt to correct
these minor violations, but the outcome was either produced regressions with
insignificant coefficients or regressions with similar explanatory power to the initial
ones.
Table 2 shows the detailed results from the pairwise combinations of one
traditional performance measure and the EVA. It is noticed that regressions (5), (6)
and (7) are significant at 0.05 level or better. The highest R2 (7.2 per cent) is reported
in regression (5), which combines EPS, EPS and EVA, EVA. The contribution of
the EPS in the explanatory power of this regression is higher than that of EVA, since
the R2 of EPS alone is 1.9 per cent (regression 1, table 1) while that of EVA alone is
0.9 per cent (regression 4, table 1).
This suggests that the combination of EPS and EVA represents the most
satisfactory explanation for stock returns in the Greek stock market. Chen and Dodd
(1997; 2001) and Worthington and West (2001) revealed almost similar results for the
US and Australian capital markets respectively. They found that EVA is a useful
measure for measuring the financial corporate performance, especially when it is
combined with EPS. All other examined models have reported low R2s (lower than
2.1 per cent). SVA has been also examined providing relatively weak results in
explaining stock returns.

- 19 -

Table 2: Incremental information content approach Pairwise combinations

Incremental / One Traditional Measure + One Value-Based Measure (EVA)

No of

ALL
Regression YEARS
5

CONST

EPS

ROI

ROE

ROE

EVA

EVA

-0.0249

0.2580

0.0056

-0.1570

0.0001

(-1.073) (7.772)***

(2.464)**

(-7.355)***

(0.405)

0.000

0.014

0.000

0.686

1.834

1.004

1.824

1.006

0.283

VIF

coef.

0.0281

0.0630

0.0032

-0.0680

0.0003

(1.243)

(2.195)**

(2.173)**

(-3.730)***

(1.000)

0.214

0.028

0.030

0.000

0.317

1.293

1.025

1.267

1.000

sign
VIF

ROI

coef.

sign

EPS

coef.
t
sign

0.0420

0.0001

0.0009

-0.0528

0.0003

(1.869)*

(0.027)

(1.027) (-3.072)***

(0.977)

0.062

0.979

0.305

0.002

0.319

1.002

1.113

1.115

1.001

VIF

Significance at 10% level, ** significance at 5% level, *** significance at 1% level.

- 20 -

R2

Obs
976

0.072
(18.761)***
0.000

976

0.021
(5.141)***
0.000

976

0.011
(2.599)**
0.035

5. Summary / Conclusions

Relative information content approach revealed that in the Greek stock market
earnings levels and earnings changes are associated with stock returns and outperform
all other performance measures under examination (ROI, ROE and EVA) in
explaining stock returns. These results are consistent to those reported for various
international markets. Easton and Harris (1991), for example, found that earnings
levels and earnings changes are associated with stock returns for the US market. Also,
Biddle, Bowen and Wallace (1997) and Chen and Dodd (2001) found that earnings
outperform EVA and residual income in the US stock market. Gnther, Landrock
and Muche (2000) and Worthington and West (2001) revealed similar results for the
Germany and Australian stock markets respectively. On the other hand, the results of
the present study do not support the claims of Stewart (1991) and the advocates of
EVA financial system that EVA alone is the best performance measure.
On the other hand, incremental information content approach provided further
interesting results. When EVA is incorporated in an EPS model its explanatory
power increases from 1.9 to 7.2 per cent. This suggests that the new information
provided by the EVA is of some value relevance in explaining stock returns. The
relative low explanatory power of performance measures under examination is, in
large, consistent with the reported results of several relevant studies conducted for the
US market. Chen and Dodd (1997) found that EVA variables and accounting profit
variables could not explain more than 47 per cent of the variation of stock returns.
Moreover, a recent study of Chen and Dodd (2001) provided evidences that EPS and
EVA could not explain more than 23.49 per cent of stock returns. These results
support the claims of many scholars that more determinants should be employed to
assess the value of the firm. This evidence suggests that the participants in the Greek
Stock market should pay additional attention to that relatively new value-based
performance measure.
This study can be further extended in examining the incremental information
content not only of the pairwise combinations but also from combinations
incorporating more than one traditional or value-based performance measure. The
examination of EVA adopters should also provide interesting results. Another
important suggestion for further research is to explore the value relevance of other
factors beyond the above examined performance measures in explaining stock returns.

Behavioural finance provides a good ground for this. Moreover, comparative studies
within stock markets with similar market characteristics as these of Greece should add
value to this kind of research.
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