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EVA AND DIVISIONAL PERFORMANCE MEASUREMENT: CAPTURING SYNERGIES AND OTHER ISSUES
Author(s) -
Zimmerman Jerold L.
Publication year - 1997
Publication title -
journal of applied corporate finance
Language(s) - English
Resource type - Journals
eISSN - 1745-6622
pISSN - 1078-1196
DOI - 10.1111/j.1745-6622.1997.tb00140.x
Subject(s) - incentive , measure (data warehouse) , performance measurement , business , stock options , stock (firearms) , contradiction , economics , actuarial science , accounting , operations management , microeconomics , marketing , finance , computer science , engineering , mechanical engineering , philosophy , epistemology , database
This article makes three basic points about divisional performance measurement that managers should keep in mind when attempting to choose between EVA and more conventional, accounting‐based measures. First, no divisional performance measure, whether it be EVA, divisional net income, or ROA, is capable of capturing synergies among divisions—those shared benefits or costs that make the sum of the parts worth more than the whole. And EVA is neither more nor less effective than more conventional financial measures in deterring divisional managers from taking actions that increase divisional profits at the expense of corporate value. Thus, there is a fundamental contradiction in the very attempt to evaluate the divisions of a multi—divisional firm as if they were independent companies. If there are synergies, divisional performance measures—even those employing transfer prices—are likely to prove inadequate in some respects (and this article recommends some methods for encouraging synergies that might be used to supplement if not replace divisional measures). But if there are no synergies, then top managers should re‐examine their business strategy and consider selling or spinning off divisions. Second, a given performance measure's degree of correlation with stock returns should not be management's sole, or even its most important, criterion in choosing to adopt a given performance measure. A better method for evaluating performance measures is to weigh the behavioral or incentive benefits of a given measure against all direct and indirect costs associated with its implementation. In making such a costbenefit analysis, the incentive benefits from the tighter linkage of rewards to share prices provided by more market‐based measures should be traded off against the greater market risk and exposure to other uncontrollables imposed by such measures as well as the costs involved in changing the firm's internal accounting and reporting systems. Third, the EVA practice of “decoupling” performance measures from GAAP accounting, while having have potentially significant incentive benefits, also has potential costs in the form of increased auditing requirements and the possibility of litigation.