Economic Value Added (EVA), Agency Costs and Firm Performance: Theoretical Insights through the Value Based Management (VBM) Framework

Abstract

The current paper, a review of literature, examines the association between the Economic Value Added (EVA) and the firm decision making and performance, and the interplay between the EVA and various dynamics of agency costs. The choice of both objectives is motivated by the inability of traditional accounting performance measures to reflect true financial health of firms and mitigate agency costs inflicted upon firms. The current paper is a critique of the traditional firm performance measures for their over-dependence on historic accounting data, which is subject to manipulation and has questionable conceptual credentials. The paper highlights that the EVA, one amongst various ‘Value Based Management’ (VBM) measures, enables managers, investors, and analysts to adopt futuristic approach, make comprehensive assessment of their firms, and take objective decisions. The essence of the EVA is that true profit does not arise merely by paying debt cost to firms’ debtholders but only when shareholders are also rewarded with a fair return on their investment. The EVA raises the bar of corporate performance, which adds value to the firm, and determines performance based executive pay; consequently, mitigating agency costs. Nonetheless, several institutional factors restrict applicability of the EVA.