EVA AND TOTAL QUALITY MANAGEMENT

Abstract

Both TQM and EVA can be viewed as organizational innovations designed to reduce “agency costs”—that is, reductions in firm value that stem from conflicts of interest between various corporate constituencies. This article views TQM programs as corporate investments designed to increase value by reducing potential conflicts among non‐investor stakeholders such as managers, employees, customers, and suppliers. EVA, by contrast, focuses on reducing conflicts between managers and shareholders by aligning the incentives of the two groups. Besides encouraging managers to make the most efficient possible use of investor capital, EVA reinforces the goal of shareholder value maximization in two other ways: (1) by eliminating the incentive for corporate overinvestment provided by more conventional accounting measures such as EPS and earnings growth; and (2) by reducing the incentive for corporate underinvestment provided by ROE and other rate‐of‐return measures.At a superficial level, EVA and TQM seem to be in direct conflict with each other. Because of its focus on multiple, non‐investor stakeholders, TQM does not address the issue of how to make value‐maximizing trade‐offs among different stakeholder groups. It fails to provide answers to questions such as: What is the value to shareholders of the increase in employees' human capital created by corporate investments in quality‐training programs? And, given that a higherquality product generally costs more to produce, what is the value‐maximizing quality‐cost combination for the company? The failure of TQM to address such questions may be one of the main reasons why the adoption of TQM does not necessarily lead to improvements in EVA.Because a financial management tool like EVA has the ability to guide managers in making trade‐offs among different corporate stakeholders, it can be used to complement and reinforce a TQM program. By subjecting TQM to the discipline of EVA, management is in a better position to ensure that its investment in TQM is translating into increased shareholder value. At the same time, a TQM program tempered by EVA can help managers ensure that they are not under investing in their non‐shareholder stakeholders.