Firms compete with each other for getting the scarce capital from the shareholders. To be able to get the capital, firm must perform better than those of the competitor. It must earn more than that earned by similar risk seekers. If it can achieve this objective it has created value for the shareholders and its stock price will command a higher premium in the market. In using the eva system employees on how the capital is being used on the cash flows generated to it. EVA makes managers care about managing assets as well as income, and helps them properly assess the trade off between the two. EVA forces managers to focus on value creating activities rather than wasting time and energy on playing with the accounting principles. EVA based bonus system is based on performance of employees and managers and they rewarded for increasing EVA relative to target and they are penalized for falling short. There is no upper limit of bonus. Incentive of employees and managers increase as they keep on increasing EVA relative to target. The EVA is target to set for every year on the basis of a standard acceptable formula. At the beginning of each year, the list of participating employees for the EVA bonus plan is disclosed along with the formula for calculating bonus on the basis of EVA. The formula is so transparent that each eligible employee can calculate his or her bonus without waiting for the authority to announce. The success of EVA lies only when it is linked with compensation plan. EVA would be effective only when the corporate decision makers and even rank and file officers get bonus linked to improvement in EVA.
EVA as a performance measure in corporate world:-
EVA might in some occasions give somewhat misleading signals of the true value added to shareholders. In spite of this fact EVA has become a very popular performance measure, perhaps because applying it has some powerful impacts on organizational behavior.
Unlike conventional profitability measures EVA helps the management and also other employees to understand the cost of equity capital. At least in big public companies, which do not have a strong owner, shareholders have often been conceived as a free source of funds. Similarly, business unit managers often seem to think that they have the right to invest all the retained earnings that their business unit has accumulated although the group would have better investment opportunities elsewhere. EVA might change the attitude in the sense because it emphasize on the requirement to earn sufficient return on all capital employed.
At best EVA can approach to view business, Perhaps the biggest benefit of this approach is to get the employees and managers to think and act like shareholders. It emphasize that that in order to justify investments in the long run they have to produce at least a return that covers the cost of capital. In other case the shareholders would be better off investing elsewhere. This approach includes that the organization tries to operate without lazy or excess capital and it is understood that the ultimate aim of the firm is to create shareholders value by enlarging the product of positive spread (between return and cost of capital) multiplied with the capital employed.
Than it would have been without the bonus system. With well designed bonus plan, the higher the bonus that are paid and better it is for the shareholders. EVA bonus paid is far from a cost to shareholders because it is often a share in the discretionary value created.
EVA as a performance measure in corporate world:-
EVA might in some occasions give somewhat misleading signals of the true value added to shareholders. In spite of this fact EVA has become a very popular performance measure, perhaps because applying it has some powerful impacts on organizational behavior.
Unlike conventional profitability measures EVA helps the management and also other employees to understand the cost of equity capital. At least in big public companies, which do not have a strong owner, shareholders have often been conceived as a free source of funds. Similarly, business unit managers often seem to think that they have the right to invest all the retained earnings that their business unit has accumulated although the group would have better investment opportunities elsewhere. EVA might change the attitude in the sense because it emphasize on the requirement to earn sufficient return on all capital employed.
At best EVA can approach to view business, Perhaps the biggest benefit of this approach is to get the employees and managers to think and act like shareholders. It emphasize that that in order to justify investments in the long run they have to produce at least a return that covers the cost of capital. In other case the shareholders would be better off investing elsewhere. This approach includes that the organization tries to operate without lazy or excess capital and it is understood that the ultimate aim of the firm is to create shareholders value by enlarging the product of positive spread (between return and cost of capital) multiplied with the capital employed.
Than it would have been without the bonus system. With well designed bonus plan, the higher the bonus that are paid and better it is for the shareholders. EVA bonus paid is far from a cost to shareholders because it is often a share in the discretionary value created.
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