BRIAN KANTOR: A tool well suited to holding managers accountable
The leading adviser on corporate governance in the US now agrees that economic value added helps prevent CEOs from gaming the system
The best managers can do for their shareholders is realise returns that exceed the opportunity cost of the capital entrusted to them. That is to generate returns that exceed the returns their shareholders could realistically expect from alternative, equivalently risky investments. This difference between the returns a firm is able to earn on its projects and the charge it needs to make for that capital is widely known as economic value added (EVA). This economic profit margin is sometimes described as a moat that protects a truly profitable firm from its competitors. But more than intellectual property or valuable brands that keep out competition and preserve pricing power, a truly valuable firm will have a long runway of opportunities to invest more in investments that beat the cost of capital. It is the margin between the internal rate of return of the company and the required risk-adjusted return, multiplied by the volume of investment undertaken, that makes for EVA and potentia...
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