Future Growth Value Research Articles

Does EVA valuation model outperform earnings valuation model in explaining market value of equity?

AbstractMost of the previous studies examine the efficiency of EVA versus accounting measures as a periodic performance measure. There is hardly any study conducted on examining and comparing the efficiency of EVA based valuation model with the earnings valuation model. However, this study examines and compares the efficiency EVA valuation with earnings valuation by conducting relative information content analysis across the years and on a year‐wise basis. It is observed that future growth value is the only difference between the two valuation models. This study further examines whether future growth value plays a significant role in increasing/decreasing the explanatory ability of EVA based valuation model compared to the earnings valuation model by conducting incremental information content analysis. It conducts both the analyses by using the sample data of 69 large‐cap, 88 mid‐cap and 79 small‐cap companies over the period 2002–17. The relative information content analysis conducted across the years reveals that large and small‐cap companies respond better to the earnings valuation model, whereas mid‐cap companies respond better to EVA based valuation model. The incremental analysis reveals that future growth value plays a significant role in increasing the decreasing explanatory ability of the EVA valuation model. The analysis conducted year‐wise manner also supported the fact.

Using EVA to Measure Management's Contribution to Value - A Missed Opportunity at ISS

EVA (Economic Value Added or economic profit) has a long history of intermittent use in corporate performance measurement. It was widely used as a funding formula for corporate incentive plans in the first half of the 20th century, it enjoyed considerable popularity in the 1990s under the leadership of the consulting firm Stern Stewart & Co and it has recently been embraced by the proxy advisor ISS. In all of these periods of popularity, the focus has been on current EVA (or ∆EVA) as a comprehensive measure of performance, ignoring the critical insight of the EVA math that investors’ dollar excess return has two components in addition to the capitalized future value of ∆EVA: the capitalized future value of expected ∆EVA and, most importantly, the unexpected change in future growth value (FGV). FGV is the capitalized present value of expected future ∆EVA. In a simple world with constant ROIC and capital growth rates, current ∆EVA is a perfect proxy for ∆FGV because both are determined by the current EVA spread and dollar capital growth. In the real world, where ROIC and capital growth rates are volatile and capital has delayed productivity, current ∆EVA is a very poor proxy for ∆FGV. In and out of turnaround situations, ∆EVA and ∆FGV move in opposite directions. For growing companies, better estimates of ∆FGV come from using expected, not actual, capital growth and measures of profitability, such as [EBITDA + R&D] ROIC, that are calculated before delayed productivity expenses such as capital charge, depreciation and R&D. In this paper, I show that operating performance measurement can be greatly improved by using regression models to estimate the ∆FGV associated with changes in expected profit from capital growth as well as the FGV fade associated with ∆EVA- and ∆EVA+. I show that operating excess return, using a model of ∆FGV, explains 65% of the variance in market excess returns for the median industry vs. only 38% for ∆EVA. The critical take-away for performance measurement is that we can’t accurately assess current EVA performance without estimating the change in future growth value.

Why EVA Bonus Plans Failed—and How to Revive Them

Most companies rely heavily on earnings to measure their financial performance, but earnings growth has at least two important weaknesses as a proxy for investor wealth. Current earnings growth may come at the expense of future earnings through, say, shortsighted cutbacks in corporate investment, including R&D or advertising. But growth in earnings per share can also be achieved by “overinvesting”—that is, committing ever more capital to projects with expected rates of return that, although well below the cost of capital, exceed the after‐tax cost of debt. Stock compensation has been the conventional solution to the first problem because it's a discounted cash flow value that is assumed to discourage actions that sacrifice future earnings. Economic profit—in its most popular manifestation, EVA—has been the conventional solution to the second problem because it includes a capital charge that penalizes low‐return investment.But neither of these conventional solutions appears to work very well in practice. Stock compensation isn't tied to business unit performance, and often fails to motivate corporate managers who believe that meeting consensus earnings is more important than investing to maintain future earnings. EVA often doesn't work well because increases in current EVA often come with reduced expectations of future EVA improvement—and reductions in current EVA are often accompanied by increases in future growth values. Since EVA bonus plans reward current EVA increases without taking account of changes in expected future growth values, they have the potential to encourage margin improvement that comes at the expense of business growth and discourage positive‐NPV investments that, because of longer‐run payoffs, reduce current EVA.In this article, the author demonstrates the possibility of overcoming such short‐termism by developing an operating model of changes in future growth value that can be used to calibrate “dynamic” EVA improvement targets that more closely align EVA bonus plan payouts with investors’ excess returns. With the use of “dynamic” targets, margin improvements that come at the expense of business growth can be discouraged by raising EVA performance targets, while growth investments can be encouraged by the use of lower EVA targets.

Do Corporate Governance impact Firm Value? An Indian Perspective

This paper discusses the possibility of a financial value chain with CG as the trigger that generates and transmits value till it reaches market. The study explores the nature and function of CG in value creation. The main goal is to expose the role of CG in the financial value chain that culminates in market value addition. Main attention was paid to identifying financial leading indicators for Current Operations Value, Future Growth Value, Tobin’s q and Shareholder Value Added that remains as anchors for complete value materialization process .This topic was chosen because when corporate failures happen, the blame is on the CG, hence all actions aiming at strengthening of CG practices are deemed as assurance on firm performance and firm value. The major findings of the paper is the identification of a value chain that originates at CGPI. CGPI activates COV and FGV which in turn leads to EV, which in turn produces SVA. SVA in turn amplifies q. The q generates MVA and WAI. The above findings suggest that CG instigates value creation.

Valuation of Corporate Innovation and the Pricing of Risk in the Biopharmaceutical Industry: The Case of Gilead

Much of a firm's market value derives from expected future growth value rather than from the value of current operations or assets in place. Pharmaceutical companies are good examples of firms where much market value comes from expectations about drugs still in the development “pipeline.”Using a new osteoporosis drug being developed by Gilead Sciences, Inc., the author combines discounted cash flow methods values and real option models to value it. Alone, discounted cash flow (DCF) calculations are vulnerable to the assumptions of growth, cost of capital, and cash flows. But by integrating the real options approach with the DCF technique, one can value a new product in the highly regulated, risky and research‐intensive Biopharmaceutical industry.This article shows how to value a Biopharmaceutical product, tracked from discovery to market launch in a step‐by‐step manner. Improving over early real option models, this framework explicitly captures competition, speed of innovation, risk, financing need, the size of the market potential in valuing corporate innovation using a firm‐specific measure of risk and the industry‐wide value of growth operating cash flows.This framework shows how the risk of corporate innovation, which is not fully captured by the standard valuation models, is priced into the value of a firm's growth opportunity. The DCF approach permits top‐down estimation of the size of the industry‐wide growth opportunity that competing firms must race to capture, while the contingency‐claims technique allows bottom‐up incorporation of the firm's successful R&D investment and the timing of introduction of the new product to market. It also specifically prices the risk of innovation by modeling its two components: the consumer validation of technology and the expert validation of technology. Overall, it estimates the value contribution per share of a new product for the firm.

Stock Options and Compensation

This note is a brief introduction to the logic and practice of using stock options to compensate executives. The Black-Scholes option-pricing model is used to estimate the value of option grants for a company. The note affords the opportunity to apply options valuation in the context of executive compensation, and serves as a companion to introductions to options that expose the reader to the Black-Scholes option-pricing model. A spreadsheet is available for student preparation of the case. Excerpt UVA-F-1521 Rev. Aug. 5, 2015 Stock Options and Compensation One of the major forms of executive compensation has been stock options. Use of stock options has been promoted as a way to help align incentives for shareholders and managers. That alignment is accomplished by linking executive compensation to performance for shareholders, which, in this instance, is reflected in the value of the company's stock. An alternative way to help align incentives is to give managers shares of company stock. Some firms do this, giving managers shares of stock with restrictions on managers' ability to sell the shares. A criticism of this approach is that it is not sufficiently forward-looking. Because the share price reflects the value of assets in place plus the value of future growth, when the manager gets shares, he or she receives the value of past decisions, and future price changes have only a marginal impact on the value of the shares. Moreover, with an option that gives the manager the right in the future to purchase stock at today's price, the manager gains only if the stock price increases over the current price. Generally, stock-option plans take three forms. A fixed-value plan gives a manager some fixed proportion of salary in the form of options. An example would be an executive whose salary is $ 500,000 and who is given a grant of options equal in value to half of the salary each year. A fixed number plan gives a manager a fixed number of options each year. For example, the plan might award the manager 5,000 at-the-money call options each year. Finally, there is the megagrant. Here, the executive receives a large grant of options this year and then none in the future. In all these forms, the intent is to align management incentives with those of shareholders. . . .

A Better Way to Measure Operating Performance (or Why the EVA Math Really Matters)

Most companies rely heavily on earnings to measure operating performance, but earnings growth has at least two important weaknesses as a proxy for investor wealth. Current earnings can come at the expense of future earnings through, for example, short‐sighted cutbacks in investment, including spending on R&D. But growth in EPS can also be achieved by investing more capital with projected rates of return that, although well below the cost of capital, are higher than the after‐tax cost of debt. Stock compensation has been the conventional solution to the first problem because it's a discounted cash flow value that is assumed to discourage actions that sacrifice future earnings. Economic profit—in its most popular manifestation, EVA—has been the conventional solution to the second problem with earnings because it includes a capital charge that penalizes low‐return investment.But neither of these conventional solutions appears to work very well in practice. Stock compensation isn't tied to business unit performance—and often fails to provide the intended incentives for the (many) corporate managers who believe that meeting current consensus earnings is more important than investing to maintain future earnings. EVA doesn't work well when new investments take time to become profitable because the higher capital charge comes before the related income.In this article, the author presents two new operating performance measures that are likely to work better than either earnings or EVA because they reflect the value that can be lost either through corporate underinvestment or overinvestment designed to increase current earnings. Both of these new measures are based on the math that ties EVA to discounted cash flow value, particularly its division of current corporate market values into two components: “current operations value” and “future growth value.” The key to the effectiveness of the new measures in explaining changes in company stock prices and market values is a statistical model of changes in future growth value that captures the expected effects of significant increases in current investment in R&D and advertising on future profits and value.

An Empirical Analysis of Linkage Between Economic Value Added (EVA) and Market Value Added (MVA)

Maximizing shareholder value has become the new corporate paradigm. Corporations in world wide have started disclosing EVA information from the beginning of 90s as a measure of corporate performance. It is believed that market value of a firm (i.e., the shareholders’ wealth) would increase with the increase in EVA. Many studies conducted in US and India also confirmed this belief. EVA is a residual income that subtracts the cost of capital from the operating profits generated by a business. The present study makes an attempt to find the relevance of Stewart's claim that market value of the firm is largely driven by its EVA generating capacity in the Indian context. Based on the data from the annual reports of Dr Reddy’s laboratories Ltd, over a period of five years, the study shows that market value of a firm can be well predicted by estimated future EVA streams. The study has also found that market value of the firm is explained more by current operational value than future growth value of the company.

O Marketing Relacional no Mercado Massivo: Teoria ou Prática Real?

O paradigma do marketing relacional, assim como seus precedentes, foi rapidamente incorporado no lxico e caixa de ferramentas da gerncia de marketing. Junto com o conceito, os tericos tambm elaboraram tcnicas que so essenciais para tornar operativo o emprego do mesmo, sendo a mais importante, o desenvolvimento de um processo de gesto do cliente, e dentro deste o uso e a aplicao da pedra angular do enfoque relacional, o conceito do Valor do Ciclo de Vida do Cliente (Customer Lifetime Vale - CLV), e da ferramenta do valor presente dos fluxos futuros gerados (VAN) por um cliente durante o perodo em que este conserve tal condio, que resulta essencial para tomar decises sobre a estratgia de trabalho com os clientes que permite empresa alcanar e/ou manter vantagem competitiva. A evidncia encontrada leva a sugerir que, no obstante as empresas do setor so proclives a adotar o paradigma do marketing relacional, ainda coexistem com enfoques de conceitos de marketing transacional, isto pela incipiente aplicao do conceito e a tcnica do Valor do Ciclo de Vida do Cliente (CLV) em pases da Amrica Latina como parte do processo de gesto de clientes. A falta de aplicao do mesmo em setores dinmicos como o consumo massivo constitui, em consequncia, um tpico de interesse para a cincia administrativa e particularmente, para a disciplina do marketing; da a inteno do artculo de chamar a ateno sobre este fato. DOI: 10.5585/remark.v11i1.2255

Incentives and Investor Expectations

This article argues that the Expectations‐Based Management (EBM) measure proposed by Copeland and Dolgoff (in the previous article) is essentially the same measure that EVA companies have used for years as the basis for performance evaluation and incentive compensation. After pointing out that the analyst‐based measures cited by Copeland and Dolgoff do not provide a basis for a workable compensation plan, the authors present the outline of a widely used expectations‐based EVA bonus plan. In so doing, they demonstrate the two key steps in designing such a plan: (1) using a company's “Future Growth Value”—the part of its current market value that cannot be accounted for by its current earnings— to calibrate the series of annual EVA “improvements” expected by the market; and (2) determining the executive's share of those improvements and thus of the company's expected “excess” return.One of the major objections to the use of EVA, or any single‐period measure, as the basis for a performance evaluation and incentive comp plan is its inability to reflect the longer‐run consequences of current investment and operating decisions. The authors close by presenting a solution to this “delayed productivity of capital” problem in the form of an internal accounting approach for dealing with acquisitions and other large strategic investments.

FUTURE VALUE: THE $7 TRILLION CHALLENGE

As of May 2003, $7.6 trillion (or 58%) of the aggregate value of the U.S. stock market represented “future value”–that portion of value that does not depend on current operating performance but rather on anticipated growth. This concept of future growth value is especially important in newer industry sectors and among companies whose value is based heavily on intangible assets, such as brand and proprietary knowledge. But traditional accounting remains focused on tangible assets. And because most executives rely on accounting‐ based financial data to run their businesses, they end up focusing on current operating results when they should be investing in strategies that optimize future growth. In short, many of the assets that are most responsible for creating value in today's economy are not managed as well as they could be.As part of its high‐performance business initiative, Accenture has developed a comprehensive research database and a set of tools for examining the components and drivers of future value, along with a methodology for applying this research on a companyspecific basis. Accenture's futurevalue analytics can determine the portion of a company's market value that is attributable to future growth, and can help identify the drivers of that future growth value. The development of a viable operational framework will enable executives to translate corporate intangibles into manageable market value.

GOODWILL ACCOUNTING: EVERYTHING HAS CHANGED AND NOTHING HAS CHANGED

In issuing Statements No. 141 and No. 142, the FASB has attempted to make accounting statements better reflect the economics of the exchange of value that takes place in business combinations. At the very least, requiring a single method of accounting reduces the costs of accounting, puts all acquirers on an equal accounting footing, and removes the incentive to incur significant costs to be able to report on a pooling‐of‐interests basis.But if the FASB rules have changed significantly, investors' expectations for acquiring companies have not. Therefore, accounting rules should have no impact on acquisition pricing or structuring unless they affect cash flows. Recorded goodwill and return on capital are the artificial result of accounting rules, and largely without economic content. However, understanding the growth value implicit in the price paid is key to helping ensure that acquisitions create value. Boards of directors and executives must understand the minimum annual performance targets they have set for themselves by paying a premium to acquire a company.The ideal measure of goodwill, which has not been contemplated by the FASB, would capture the premium of the current acquisition price over the value of the target firm's current operating value—that is, the discounted NPV of its current operating cash flows. Using such an economist's definition of goodwill, financial analysts could then come up with the variable that is of greatest interest to investors‐namely, the expected improvements in operating performance that are necessary to justify the acquirer's investment in the target company. The economic framework and future growth value analysis based on EVA can be used to answer this question, regardless of the accounting rules du jour.

Linkage between Economic Value Added and Market Value: An Analysis

Maximizing shareholder value has become the new corporate paradigm. Corporations in the US have started disclosing EVA information from the beginning of 90s as a measure of corporate performance. It is believed that market value of a firm (hence shareholder wealth) would increase with the increase in EVA. Various studies done in the US also confirm this belief. EVA (a term coined and registered by Stern Stewart & Co. New York) is a residual income that subtracts the cost of capital from the operating profits generated by a business. The present study makes an at tempt to find the relevance of Stewart's claim that market value of the firm is largely driven by its EVA generating capacity in the Indian context. Based on a sample of 200 firms over a period of five years, the study shows that market value of a firm can be well predicted by estimated future EVA streams. The study has also found that market value of most of the firms in the sample is explained more by current operational value than future growth value of firms.

The stock market and competitive analysis

AbstractA method is presented for analysing the stock market's implicit assessment of relative strategic position in an industry. The market's overall perception of strategic position is obtained by comparing the value of future growth potential to that of the existing earnings stream for each company. More detail is extracted by using the quality and quantity of future growth, implicit in the relative value of future growth, as a measure of competitive position and product market outlook respectively. The method is applied to a sample of firms from the computer and data processing industry.