Article Summary
The value-based
management performance measure EVA® introduced by Stern Stewart & Co. is an
incarnation of the underlying residual income (RI) concept. The concept is
evaluated and compared with traditional profitability measures within a
controlled simulation framework. It is observed that EVA is very sensitive
to its cost of equity component, but it is unexpectedly insensitive to its
cost of debt component under regular conditions. EVA and its variability are
observed to be strongly affected by the firm's growth policies because of
leverage effects. EVA is observed to be much more unstable than the
traditional return on investment and directly related to the return on
equity measure. Methodologically, the paper demonstrates the advantages of
using a controlled simulation approach in financial research.
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