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The link between residual income and value created for levered firms: A note
Abstract
In addition to other contributions to the literature, this note shows how value created can be measured if firms are financed not only by equity, but also by debt. We deal with this capital structure using the weighted average cost of capital (WACC) approach. We show that measuring value creation with residual incomes requires the use of a modified WACC for levered firms. Thus, we caution against applying the standard definition of WACC carelessly. This insight is important for all applications in which information about the performance of past periods is needed as for post-acquisition audits, capital budgeting or bonus banks.
... И уже это предположение сужает область применимости базовой версии EVC. Если же взять типичную для практики ситуацию, когда финансирование является смешанным и структура капитала может меняться в результате взаимного наложения инвестиционных, операционных и финансовых решений, то при расчете ставки средневзвешенной стоимости капитала WACC в прогнозной части EVC, модифицированной для компаний с левериджем [44], возникает проблема циклических зависимостей [46,44], требующая итерационных вычислений для нахождения удельных весов WACC для каждого периода и на всем горизонте прогноза. По совокупности факторов корректный расчет показателя EVC действительно становится излишне громоздким. ...
... И уже это предположение сужает область применимости базовой версии EVC. Если же взять типичную для практики ситуацию, когда финансирование является смешанным и структура капитала может меняться в результате взаимного наложения инвестиционных, операционных и финансовых решений, то при расчете ставки средневзвешенной стоимости капитала WACC в прогнозной части EVC, модифицированной для компаний с левериджем [44], возникает проблема циклических зависимостей [46,44], требующая итерационных вычислений для нахождения удельных весов WACC для каждого периода и на всем горизонте прогноза. По совокупности факторов корректный расчет показателя EVC действительно становится излишне громоздким. ...
... Авторы осознанно исключают из анализа эффекты левериджа [38, p. 230], что делает их построения изящными, формулы вычислительно простыми, но в то же время сильно ограничивает область их практического применения. В последующей публикации A. Schueler и S. Krotter [44] анализируют, как показатель EVC и его компоненты должны определяться для компании в целом при финансировании не только за счет собственного капитала, но и за счет заемных средств, и переопределяют EVC через EVA. Сценарий смешанного финансирования в реальности встречается гораздо чаще, однако исходные допущения относительно структуры капитала, стоимости капитала и риска операционной деятельности в построениях A. Schueler и S. Krotter остаются довольно жесткими. ...
The paper explores the excess value created (EVC) metric, which is an aggregated measure of the financial performance of a company over a multi-period measurement interval. The relevance of the study is due to the demand for practical solutions in the field of financial performance monitoring and incentive compensation, which makes it possible to achieve congruence between the interests of shareholders and the decisions of managers. The aim of the study is to build and justify a periodic financial measure that takes into account not only the current result but also the long-term consequences of management decisions. The scientific novelty of the study lies in the determination of the EVC metric via the TEVA indicator and providing the rationale for the new design of the performance measure. The result of the study is the derivation of formulas for calculating the EVC measure on multi-period and one-period intervals, which are free from restrictions on changes in the capital structure and the cost of capital, allow for a time-varying systematic risk of operating activities and possess the advantage of computational simplicity important for practical applications. The study concludes that the measurement of value created using the EVC indicator determined via TEVA makes it possible to achieve close conformity of the metric constructed to the real-world conditions with the unification of calculations in its retrospective and forecast components based on data available from historical and Pro Forma financial statements and information from the capital market.
... [3] Schueler and Krotter (2009) (2002) by explicitly including debt financing in the analysis. ...
... [4] The reason for this is that the link between value creation and residual income exists even by explicitly considering debt financing (Schueler and Krotter, 2009). Thus, simple adjustments to our derivation would lead to comparable results. ...
Purpose
The purpose of this paper is to outline the link between value creation, performance measurement and goodwill accounting according to the International Financial Reporting Standards (IFRS) and United States Generally Accepted Accounting Principles (US‐GAAP). Since economic goodwill is identical to the present value of future residual income, the paper examines how accounting information gathered for impairment testing of goodwill according to International Accounting Standard (IAS) 36 and Financial Accounting Standard (FAS) 142 can be used for internal control purposes.
Design/methodology/approach
The paper adopts common assumptions in the literature of residual income‐based valuation and analytically derives a periodic performance measure of both value creation and its realization based on information available from impairment testing.
Findings
This paper demonstrates that information required by IFRS and US‐GAAP to evaluate a firm's goodwill can be used to design a performance measurement system which provides information about both value creation and realization of value.
Practical implications
From a practical perspective, the paper shows that appropriate adjustments of data used in impairment testing result in information which ideally fits the requirements of an optimal performance measurement system.
Originality/value
The paper presents a performance measure which provides information about the actual creation of value as well as its realization in a period and is superior to traditional residual income‐based performance measures.
... Techniques and methods for assessing this type of capital are based on the methods used for the assessment and analysis of intangible assets and goodwill [27], [30], [32], but are integrated with financial and production and technical indicators. ...
The article reveals the features of the economic analysis of legal service enterprises. The key assets of enterprises of this type are formed by intangible assets — the competence of specialists in the field of law, their experience and reputation. For the accounting and analysis of these values, the concept of reputation-competence capital is formulated, which is considered as a set of assets of an enterprise that provides legal services, ensuring the quality of services and their competitiveness. The complexity of assessing such characteristics of service as reputation and competence leads to use of relative indicators formed by an expert and expressed in points. The analytical potential of these assessments is limited, but their formation is extremely important for management of enterprises that provide legal services, since it allows to select the optimal options for development of legal services considering the increase in intangible assets related to reputation and competence capital.
... The EVA is a specific formulation of the Residual Income model (Schueler, Krotter, 2008) -Stewart proposes an adjustment to the accounting measures in respect to the originally identified variable -the history of this performance measure is much longer than EVA. For this reason, it was object to a long debate in the Management-Accounting literature during the period 60-70's (O'Hanlon, Peasnell, 2002). ...
... In general, RI can be understood as an extension of the CF approach that improves the measurement and management of shareholder value creation. Consequently, RI is a useful concept for value-based management, as it serves as a tool for periodic performance controlling (Schueler & Krotter, 2008). The main disadvantage of the existing RI methods is that they provide no information regarding the portion of the value added attributed to operations and financing decisions separately. ...
This paper introduces a new approach for measuring shareholder value creation (called adjusted economic profit (EP)) which combines the advantages of both EP and APV (adjusted present value) methods. In particular, the shareholder value creation over a period is derived as the sum of two components: the EP relating purely to the operations of the company and the EP generated each period due to the tax benefit that arises from debt financing. We consider our results to be important for analysts and decision makers involved in appraising business performance or making investment decisions and HR professionals as well.
... Investment in integrating financial, ecological, and social issues simultaneously to realize a business case may enable a company to reap intangible benefits by establishing superior management standards such as positive reputation effects, investor trust, and the creation of more competent human capital (Dowell et al., 2000; Hart & Dowell, 2011). Thus, corporate sustainable capabilities can give a company a market value-added advantage, compared to other, less responsible, firms (Kramer & Peters, 2001; Schueler & Krotter, 2008). In this study, we attempt to offer an alternative empirical pathway in relation to corporate sustainable performance–corporate financial performance by simultaneously investigating the proper combination of the environmental, social, and financial aspects of a company's policies. ...
This study examines the effect of integrating sustainability into corporate strategy on various
aspects of shareholder value creation and financial performance in the British capital market. The
employed method is based on the content analysis of corporate disclosures and a new technique
for assessing the adoption of the corporate sustainability concept (embracing the environmental,
social, and financial aspects of a company’s policies at the same time). Using extensive data of
FTSE 350 firms covering the years 2006–2012, 65 companies were selected as meeting corporate
sustainability criteria. For the above period, we find that these firms were characterized by higher
financial risk exposure, lower asset growth rates, lower BV/MV ratios, lower EVA ratios, and
higher MVA ratios. Such relations were generally present among different size and industry groupings.
The results support the thesis that firms that incorporate sustainability issues into their
business operations are better able to leverage their resources toward stronger financial performance
and shareholder value creation than other companies. The paper contributes to the literature
by offering a more holistic approach to corporate sustainable performance measurement and
shedding additional light on its relation to financial performance in the context of the recent global
financial crisis and its direct aftermath.
... We concur with Krotter/Schueler that neither the utilized Net Value Created (NVC) measure nor its adaptation to the FTE is new, however we never claimed it to be. We adopted the NVC to a non-life insurance company and indicated the contribution of the work of Schueler and Krotter through the reference Schueler and Krotter (2008) and the phrase "a term coined by Schueler and Krotter" when introducing the NPVtime effect. Our final result, a particular decomposition of the NVC based on a "cost of capital"-deviation, has not been disclosed and discussed by Schueler or Krotter. ...
... Performance measurement and evaluation encompasses benchmarking (Deville, 2009), consequences for organisational behaviour and performance (Chung et al, 2009; Church et al., 2008; Demski et al., 2008; Dossi and Patelli, 2008; Hall, 2008; Hansen, 2010; Hartmann and Slapničar, 2009; Mensah et al., 2009; Román, 2009; and Schueler and Krotter, 2008), incentive systems (Budde, 2009; Dikolli et al., 2009; Homburg and Stebel, 2009; Pfeiffer and Velthuis, 2009; Upton, 2009; Zamora, 2008), and performance measurement systems (Abernethy et al., 2010; Broadbent and Laughlin, 2009; Burney et al., 2009; Cardinaels and van Veen-Dirks, 2010; Davila et al., 2009; Demski et al., 2009; Ferreira and Otley, 2009; Kennedy and Widener, 2008; Lillis and van Veen-Dirks, 2008; Malmi and Brown, 2008; Mundy, 2010; Sandelin, 2008; van Veen-Dirks, 2010; Wiersma, 2008; Wiersma, 2009; and Wouters and Wilderom, 2008). ...
... A line of research in accounting finance and corporate finance is devoted to exploiting this property for valuation purposes; it investigates the relations existing between residual income and firm valuation and studies the opportunity of replacing cash flows with residual incomes in the computation of the market value of a firm (e.g. Peasnell, 1981Peasnell, , 1982Ohlson, 1989Ohlson, , 1995Penman, 1992;Brief, 2007;Schüler and Krotter, 2008). Residual income is periodic in nature and this makes it a good candidate for performance measurement. ...
This paper presents a theoretical framework for valuation, investment decisions, and performance measurement based on a nonstandard theory of residual income. It is derived from the notion of "unrecovered" capital, which is here named "lost" capital because it represents the capital foregone by the investors. Its theoretical strength and meaningfulness is shown by deriving it from four main perspectives: financial, microeconomic, axiomatic, accounting. Implications for asset valuation, capital budgeting and performance measurement are investigated. In particular: an aggregation property is shown, which makes the simple average residual income play a major role in valuation; a dual relation between the standard theory and the lost-capital theory is proved, clarifying the way periodic performance is computed in the two paradigms and the rationale for measuring performance with either paradigm; the average accounting rate of return is shown to be more reliable than the internal rate of return as a capital budgeting criterion, and maximization of the average residual income is shown to be equivalent to maximization of Net Present Value (NPV). Two metrics are also presented: one enjoys the nice property of robust goal congruence irrespective of the sign of the cash flows; the other one enjoys periodic consistency in the sense of Egginton (1995). The results obtained suggest that this theory might prove useful for real-life applications in firm valuation, capital budgeting decision-making, ex ante and ex post performance measurement, incentive compensation. A numerical example illustrates the implementation of the paradigm to the EVA model and the Edwards-Bell-Ohlson model.
... Following the above sense of analysis, easily we have the same components (operations value and future growth) for any other VBM measure like RI, FCF, and CVA. O'Hanlon J. and Peasnell K. (2002), Schueler A. and Krotter S. (2008) examined the link between RI with Excess Value Created (ECV). Their studies provide the link between ECV and RI by differentiating between two components: the terminal value of previously realized RI, including the RI of current period, and the present value of future RI. ...
This article investigates the relationship between a firm's performance and Residual Value Models (RVM) which serve as decision making tools in corporate management. The main measures are the Economic Value Added (EVA® 2) and Cash Value Added (CVA® 3), with key components the Residual Income (RI), Free Cash Flow (FCF) and Weighted Average Cost of Capital (WACC). These measures have attracted considerable interest among scientists, practitioners and organizations in recent years. This work focuses on the relations, among Net Income (NI), Residual Income, Cash Flows from Operations activities (CFO), cost of equity capital and debt capital, we also discuss the usage of accounting data from accrual or cash flow basis, the economic adjustments on them, and the compatibility with IFRS 4 rules or other countries' GAAPs 5. Generally, the decision making based on Value Based Management (VBM) key metrics shows inconsistencies and limitations in definitions and applications, but at the same time, it is a way for management to have influence on the company's performance and total market value (TMV) which are strongly related to current and future VBM key metrics' amounts. The contribution of this paper is that it surveys from a critical perspective, literature about Residual Value Models (RVM) and VBM metrics and proposes a new framework for managing the firm's value and monitoring performance.
8., vollständig überarbeitete und erweiterte Auflage 2021 Dieses Buch ist eine grundlegende und zugleich vertiefende Einführung in den Bereich der Unternehmensbewertung. Es ist konzipiert für Studierende der Betriebs- und Volkswirtschaftslehre und des Rechts, für Wirtschaftsprüfer, Unternehmensberater, Investmentbanker, Steuerberater und alle mit dem Erwerb, Verkauf bzw. der Restrukturierung von Unternehmen befassten Praktiker. Der gesamte Text der Vorauflage wurde überarbeitet, z. T. gestrafft und in einigen Teilen deutlich erweitert. Nach den einleitenden Kapiteln 1 bis 3, die Grundlagen der Bewer- Bewertung bei Unsicherheit unter Beachtung von Steuern präsentieren, startet die Behandlung tung des Kerns des Buches in Kapitel 4, das die Konzeptionen der DCF-Bewertung vorstellt. Kapitel 5, überschrieben mit „Bewertungsrelevante Überschüsse“, diskutiert neben deren Definition auch deren Planung einschließlich verschiedener Ausprägungen der Gestaltung der Lebensphasen eines Unternehmens und damit des Wachstums. Die Kapitel 6, 7 und 8 behandeln die Bewertungsansätze, die in Literatur und Praxis als herrschend anzusehen sind: APV-Ansatz, WACC-Ansatz und Flow-to-Equity-Ansatz bzw. Ertragswertmethode. Wir bemühen uns, die relativen Vor- bzw. Nachteile der Methoden detailliert und anschaulich zu erläutern. Anzufügen ist, dass diese relativen Vorteile oder Nachteile in späteren Kapiteln des Buches ebenfalls deutlich zutage treten werden. Dies gilt z. B.– aber nicht nur– für das Kapitel10, das über Rückstellungen und Unternehmenswert referiert. Kapitel 9 behandelt den Diskontierungssatz, dessen Bestandteile und die Möglichkeiten der Messung. Erweiterungen des Problemgefüges finden sich in den folgenden Kapiteln. Kapitel10 greift das in der Literatur nur stiefmütterlich behandelte Problem des Zusammenhangs zwischen Rückstellungen und Unternehmenswert auf. Kapitel 11 untersucht den Kontext zwischen Finanzierungsleasing und Unternehmensbewertung. Dabei bilden wir auch die Auswirkungen des IFRS 16 auf die Unternehmensbewertung ab. Kapitel 12 und 13 bringen die ökonomische Schieflage von Unternehmen und damit die Bewertung von Eigentümer- und Gläubigerpositionen bei Ertrags- und Liquiditätsdefiziten ins Spiel. Kapitel 12 erläutert zunächst, welche Kriterien in Form sog. „Eröffnungsgründe“ die deutsche Insolvenzordnung kennt, um eine ökonomische Situation, die Gläubigerpositionen mit Ausfallrisiko belastet, zu markieren und welche Schwachstellen diese Kriterien aufweisen. Dies hat Konsequenzen für die anstehenden Restrukturierungsentscheidungen, die innerhalb oder außerhalb eines Insolvenzverfahrens zu treffen sind. Bei Restrukturierungen im Schatten einer ökonomischer Schieflage kommt der Bewertung der Position der Alteigentümer eine besondere Bedeutung zu. Wir erläutern den ökonomischen Kontext des Problems, der sich auftut zwischen dem Anreiz zu einer zeitigen Eigentümer-gesteuerten Initiierung eines Restrukturierungsprozesses und dem hinter der Prioritätenrangfolge der Ansprüche stehenden Sanktionscharakter der Insolvenzordnung. Wir zeigen auch, wie brauchbar sich der APV-Ansatz erweist, wenn es um eine transparente Aufbereitung der ökonomischen Folgen einer Sanierungsstrategie, z. B. in Form eines Debt-Equity-Swaps, geht. Kapitel 13 analysiert die Kalküle derjenigen, die bei temporären Ertrags- und Liquiditätsdefiziten, in der Vorinsolvenzphase oder im Rahmen eines Insolvenzverfahrens über Kreditverlängerung, Besicherung, Liquidation oder Fortführung mit oder ohne Insolvenzplan und die Neuzuordnung der Anteilsrechte entscheiden. Es stellt einen allgemein einsetzbaren Formelapparat bereit, der relevant wird, sobald Gläubiger Ausfallrisiko übernehmen. Wir haben das Kapitel um eine Würdigung des IDW Praxishinweises 2/2018 „Zur Berücksichtigung der Verschuldungsgrads bei der Bewertung von Unternehmen“ erweitert. Kapitel 14 behandelt Fragen und Ansätze der periodischen Performancemessung, die präzise Methoden der Bewertung voraussetzen, wenn man mindestens Barwertkompatibilität oder – anspruchsvoller – Barwertidentität verlangen will. Dabei stellen wir auch die aus Literatur und Praxis bekannten Konzepte wie EVA™ oder CVA vor und ordnen sie konzeptionell ein. Kapitel 15 wirft einen Blick auf die Bewertung von Unternehmen mittels Multiplika- Multiplikatoren, wobei auch den Querverbindungen unter den verschiedenen, in der Praxis zum Einsatz kommenden Multiplikatoren Aufmerksamkeit gewidmet wird. Nicht verändert hat sich unsere kritische Einstellung gegenüber diesem Bewertungsansatz. Kapitel 16 haben wir überschrieben mit „Gutachtenpraxis und Rechtsprechung“. Wir haben es erweitert um eine kritische Auswertung von fast 300 Bewertungsgutachten und einigen Dutzend Gerichtsentscheidungen, die sich mit einer Reihe dieser Gutachten auseinandersetzen. So können wir nach einer zusammenfassenden Darstellung der Rechtsprechung weiter untersuchen, wie diese Gutachten von den Gerichten gewürdigt werden und welche Änderungen vorgenommen werden. Zudem berechnen wir auch die Werteffekte, die durch die richterliche Korrektur der gutachterlichen Bewertung ausgelöst werden. Kapitel 17 ist neu. Es ist der Bewertung von Überschüssen in Fremdwährung gewidmet. Wir zeigen mögliche Bewertungsansätze auf, würdigen die Relevanz von Terminwechselkursen und weisen auf Besonderheiten bei der Abbildung von Fremdfinanzierungen in fremder Währung und Steuereffekten hin. Kapitel 18 bietet zahlreiche Übungsaufgaben an. Kurze Lösungshinweise sind beigefügt. Zudem haben wir die Übungsaufgaben durch Excel-Tabellen so aufbereitet, dass die eigene Entwicklung von Finanzplänen, Zufallsbäumen etc. nicht mehr erforderlich ist. Die Nutzung der Übungsaufgaben, die wir empfehlen, ist somit erheblich erleichtert. Wer an anspruchsvolleren und realitätsnahen „Aufgaben“ zur Bewertung von Unternehmen interessiert ist, sei auf unser Buch „Akquisitionen, Börsengänge und Restrukturierungen: Fallstudien zur Unternehmensbewertung“ verwiesen, das im gleichen Verlag erschienen ist. Zu den lebensnahen Fällen, die von der Bewertung mittelständischer GmbHs bis zu Großunternehmen (Fraport, Philipp Holzmann) bzw. Großprojekten (Airbus A380, Eurotunnel) reichen, bietet das Buch neben Sachverhaltsbeschreibungen und Daten auch ausführliche Lösungsvorschläge. Alle Berechnungen einschließlich der Lösungen der Übungsaufgaben stehen auf der Website zu diesem Buch unter http://www.vahlen.de/31026831 zum Download bereit. Wir haben in die einzelnen Kapitel eine Reihe von Wissensbausteinen eingearbeitet. Diese fassen die Kernbotschaften eines Abschnitts zusammen und repräsentieren aneinandergereiht die Essenz unseres Buches.
One of the most recent innovations in the field of internal and external performance measurement is a trade-marked variant of residual income known as economic value-added (EVA). The aim of this paper is to present a narrative literature review of 210 papers published on the EVA and its variants from 1992 to 2013. It provides a classification scheme, identifies the gaps in existing literature and suggests the path for future research. Studies are classified and offered on the basis of the time period, issues covered, distribution of literature in various sources, methodology used, country-wise publications and contributions made by the researchers on the concept. The concept of EVA has gained significant attention in the advanced economies, but implementation issues and its validity is under doubt all over the world. The paper presents a wide-ranging literature review and a critical analysis to move in the direction of the advances in EVA. It may be a very useful source of information to the researchers and managers who wish to realize and implement EVA and carry out further research on the miscellaneous issues of this interesting and value adding performance metric.
The article describes the relationship between value creation, performance measurement and accounting for goodwill in accordance with the IFRS and US-GAAP. It shows how to use accounting information collected to verify goodwill for impairment in accordance with IAS36 (“Impairment of Assets”), and FAS142 (“Goodwill and Other Intangible Assets”) to improve internal control. The authors prove that the information for estimating goodwill of a company can make the foundation for the development of a system of performance measurement, which in turn provides the data about value creation and its future use. The paper provides practical evidence that adjustments of the information used for impairment testing generate the data which meet the requirements of optimal system of performance management. The paper contributes to the theory of accounting by developing an innovative indicator to measure the performance of the actual value created.
With growing pressure on firms to deliver shareholder value, there has been a changed prominence on devising means of corporate financial performance and incentive compensation plans that encourage managers to enhance shareholder wealth. One professedly newest innovation in the field of internal and external performance measurement is a trade-marked variant of residual income known as Economic Value Added (EVA). The aim of this paper is to present a logically arranged literature review of 212 papers published on EVA and its variants from 1992 to 2014. Paper reflects a classification scheme, identifies the gaps in existing literature and suggests the lane for future research. Studies are classified and offered on the basis of the time period, issues covered, distribution of literature in various sources, methodology used, country-wise publications and contributions made by the researchers on the concept. It may be a very useful source of information to the managers and researchers who want to apply this modern value added concept for financial performance measurement or carry out further research on the miscellaneous issues of this interesting and value added performance metric.
Keywords: EVA, MVA, NOPAT, Traditional financial performance measures, Value added financial performance measures and ROE.
Three comments on Schmautz/Lampenius, Net value created: measuring a non-life insurer's performance, ZVersWiss (2013), 237-255 Simon Krotter/Andreas Schueler The paper of Schmautz/Lampenius consists of two parts. First, the authors describe the performance measure Net Value Created (NVC). The concept is then applied to an insurance company. We have two comments on the first part and one on the second part. Comment 1: NVC is not new and the formulae used by Schmautz/Lampenius, also the adaptation to FTE, are not new If a scientific paper is written for instance about the application of a concept like a performance measure, the authors are required to clarify the origin of that concept and the underlying framework. There are two possibilities: the authors have developed that measure or the measure has been developed before. The second explanation holds true here. Based upon contributions of others we: coined the term Net Value Created (NVC) and developed the concept behind that performance measure, formulated NVC both with cash flows and residual incomes for all DCF approaches (APV, WACC, TCF and FTE), showed the interactions between the DCF approaches in the NVC concept, uncovered related pitfalls and provided respective solutions, and developed the formulae and the approach in terms of interpreting and splitting it into different components, i.e. the realized deviation from expectations and the revision of expectations. In all the articles and working papers on the subject we listed all the previous articles important for that field of research, i. e. O'Hanlon/Peasnell (2002) and many others. In literature it is widely accepted that some terms like CAPM and DCF are common knowledge which might not make it necessary to quote the original sources each and every time. However, after working years on the subject we are well aware that our concept of NVC has not become common knowledge (yet). Table 1 lists the formulae used in Schmautz/Lampenius (2013) and their origin in our research without claiming to cover all possible sources. Again, references to related work by others are listed in our papers.
Two of the most important issues related to value-based management are a company’s value and the contribution made to it in a certain period. Variations in residual income have been discussed and used for such kinds of valuation purposes and performance measurement for many years to link the value of a company to traditional accounting data. Considering certain financing policies with changing levels of debt, the technical problem of circularity has to be solved concerning the readjustment of the cost of capital. As a practical way to handle that issue, a matrix-based approach is presented in this article. The result of this technique is a vector of the current and future expected amounts of a firm’s goodwill. This vector provides a useful base simultaneously for valuation purposes and for measuring the contribution made to the corporate value in a particular period. Thus, the method presented tackles these two main issues of value-based management at once solely by focusing on traditional accounting data.
Textbook on valuation (capital budgeting, risk, DCF, APV, WACC, FTE, multiples, financial distress, valuation & jurisdiction, value based management), 7th edition, 2016
PurposeThe purpose of this study is to review the capital budgeting literature over the past decade.
Design/methodologySpecifically, over the years 2004–2013, we review works appearing in the major academic journals in accounting, finance, and management. Further, we review the specialized academic journals in management accounting. We examine the frequency of articles by journal and year published, the type of research method applied, and the topic area studied. We then review the research findings by topic area.
FindingsWe find 110 articles appearing in the selected journals. While the articles increase in frequency, the research methods applied are predominantly analytical and archival in nature with relatively few experiments, case studies, or surveys. Some progress is observed for capital budgeting techniques and new methods for structuring uncertainty. The studies find that the size of capital budgets is about right for companies with high financial reporting quality, for liquid companies, during periods of normal cash flow, when the budget is financed by equity, for companies when they first go public or first go private. Tax rates and financial reporting methods for depreciation and tax expenses distort capital budgets. Organization structure and performance measurement can distort capital budgeting. Individual differences, especially optimism and honesty, can influence capital budgeting decisions.
Limitations and ImplicationsThis review is limited to the major journals in accounting, finance, and management; and the specialized journals in management accounting. There is much research to be done on capital budgeting, especially case studies of actual practice and experiments related to individual and group decision processes.
No author likes his contributions to be used without proper citation, neither do we. This comment clarifies that Schmautz/Lampenius use a concept without providing a sufficient list of references.
This paper compares different performance metrics used for value-based management in life and non-life insurance business. The goal is to find a consistent basis for performance measurement at the insurance group level. This is important since management techniques used in non-life insurance, such as economic value added and risk-adjusted return on capital, are at first sight very different from those used in life insurance, that is, an analysis of market-consistent embedded value earnings, thus making management difficult at the group level. This paper aims to compare and contrast these concepts and to show that all approaches can be unified under a single consistent framework, and that all present residual cash flow concepts that can be linked under the residual income valuation theory.
The measure Net Value Created (NVC) captures periodic deviations of planned for and realized net present values at a specific reporting date. Therefore, NVC provides control-related signals about the company’s performance additional to economic value added/residual income measures. In this paper we adopt the NVC to the Flow to Equity approach, commonly used in non-life insurance company valuation. In a multi-period context the NVC allows for an update of information over time regarding planned for and realized values and, it further allows for a separation of value contributions of the main insurer’s business units and value contributions due to a change in cost of capital. Thus, NVC is useful for value-based performance measurement in the retrospect and for strategic (investment-) decision support in the prospect for non-life insurance companies.
In this paper we discuss peformance measurement and VBM for performance indicators based upon cash flows vs. residual income. For this purpose, we also discuss different DCF approaches (APV, WACC, FTE).
Zur wertorientierten Unternehmenssteuerung werden Performance-Kennzahlen für Entscheidungsfindung und Incentivierung benötigt, die den Grad der Zielerreichung, d. h. die Veränderung des Unternehmenswerts, messen. Dabei bestehen konzeptionelle Alternativen, da Performance-Maße aus unterschiedlicher zeitlicher Perspektive formuliert werden können, auf Cashflows oder Residualgewinnen aufsetzen können und auf Basis verschiedener DCF-Methoden konzipiert werden können. Wir disuktieren diese Alternativen und vervollständigen ausgehend von bereits vorliegenden Literaturbeiträgen das konzeptionelle Gerüst barwertkompatibler Performance-Messung insbesondere vor dem Hintergrund anteilig fremdfinanzierter Unternehmen. Dabei entwickeln wir zwei technische Verfeinerungen – die Definition eines modifizierten WACC und die konsequente Umsetzung auf Basis des APV-Ansatzes –, die für die konsistente Messung der Performance über die Gesamtlaufzeit unverzichtbar sind.
This paper deals with the notion of residual income, which may be defined as the surplus profit that residues after a capital charge (opportunity cost) has been covered. While the origins of the notion trace back to the 19th century, in-depth theoretical investigations and widespread real-life applications are relatively recent and concern an interdisciplinary field connecting management accounting, corporate finance and financial mathematics (Peasnell, 1981, 1982; Peccati, 1987, 1989, 1991; Stewart, 1991; Ohlson, 1995; Arnold and Davies, 2000; Young and O’Byrne, 2001; Martin, Petty and Rich, 2003). This paper presents both a historical outline of its birth and development and an overview of the main recent contributions regarding capital budgeting decisions, production and sales decisions, implementation of optimal portfolios, forecasts of asset prices and calculation of intrinsic values. A most recent theory, the systemic-value-added approach (also named lost-capital paradigm), provides a different definition of residual income, consistent with arbitrage theory. Enfolded in Keynes’s (1936) notion of user cost and forerun by Pressacco and Stucchi (1997), the theory has been formally introduced in Magni (2000a,b,c; 2001a,b; 2003), where its properties are thoroughly investigated as well as its relations with the standard theory; two different lost-capital metrics have been considered, for value-based management purposes, by Drukarczyk and Schueler (2000) and Young and O’Byrne (2001). This work illustrates the main properties of the two theories and their relations, and provides a minimal guide to construction of performance metrics in the two approaches.
This paper shows that periodic NPV including NPV for periods t > 0 can be defined by past, current and expected residual incomes. It uses figures more than formulae. A similar idea was developed more analytically and independently by O'Hanlon/Peasnell, RASt 2002, later. At least, this paper paved the way for Schueler/Krotter, MAR 2008.
Im Rahmen des Value Based Managements werden in vielen Unternehmen Residualgewinnkonzepte zur Performance-Messung eingesetzt. Ein Vorteil dieser regelmäßig auf Jahresabschlussdaten basierenden Konzepte ist, dass sie bei konsistenter Definition barwertkompatibel sind: Der Barwert künftiger Residualgewinne entspricht im Startzeitpunkt dem Nettokapitalwert. lm vorliegenden Beitrag wird der Erklärungsbeitrag von Jahresabschlussdaten und buchwertbasieter Residualgewinne zur Messung des Nettokapitalwerts im Zeitablauf und damit auch zur Messung der periodischen Nettokapitalwertveränderung untersucht. Dabei wird insbesondere die Eignung des Buchwertes als lndikator für das eingesetzte Kapital hinterfragt.
This paper provides an approach for developing risk-adjusted discount rates that follows naturally from the standard presentation of the weighted average cost of capital. In addition to examining the implied assumptions about the valuation of corporate debt, the paper shows the pedagogic advantages of the proposed approach.
This paper extends the residual income-based valuation framework to encompass an articulation between (i) value created for a firm's shareholders beyond the cost of their invested capital (excess value created) during a multi-period interval and (ii) a matching cumulation of the firm's residual incomes. We show that, absent an initial difference between economic value and book value of shareholders' funds, excess value created comprises (i) the end-of-interval terminal value of all residual incomes accruing during the interval plus (ii) the present value at the end of the interval of all residual incomes expected to accrue subsequently.
EVA is a variant of residual income marketed by Stern Stewart & Co., a New York consulting firm, with the purpose of promoting value-maximising behaviour in corporate managers. This paper reviews the EVA system in the light of this purpose. First, it outlines the rationale for the use of residual income in "value-based management", highlighting the potential shortcomings of residual income as a single-period performance indicator. Second, it considers the adjustments to GAAP-based accounting advocated by Stern Stewart in order to produce a more economically meaningful version of residual income (EVA) which might serve as an effective indicator of single-period performance. Third, it examines the Stern Stewart approach to the setting of EVA benchmarks. Finally, it reviews the logic behind the use of the "bonus bank" to separate the award of EVA-based bonuses from the payment of such bonuses.
The paper develops and analyzes a model of a firm's market value as it relates to contemporaneous and future earnings, book values, and dividends. Two owners' equity accounting constructs provide the underpinnings of the model: the clean surplus relation applies, and dividends reduce current book value but do not affect current earnings. The model satisfies many appealing properties, and it provides a useful benchmark when one conceptualizes how market value relates to accounting data and other information.
Résumé. L'auteur élabore et analyse un modèle dans lequel il conceptualise la relation entre la valeur marchande d'une entreprise et ses bénéfices, ses valeurs comptables et ses dividendes actuels et futurs. Deux postulats de la comptabilisation des capitaux propres servent de charpente au modèle: a) la relation du résultat global s'applique et b) les dividendes réduisent la valeur comptable actuelle sans influer, cependant, sur les bénéfices actuels. Le modèle présente de nombreuses propriétés intéressantes et il peut, fort utilement, servir de repère dans la conceptualisation de la relation entre la valeur marchande et les données comptables et autres renseignements.
This is the sequel to the authors' 1989 article discussing the two basic discounted cash flow approaches for valuing debt-financed transactions and corporations: weighted average cost of capital (WACC) and adjusted present value (APV). The WACC method discounts all after-tax (but pre-interest) cash flows at the company's weighted average cost of capital. The APV method treats the value of a levered firm as the value of the same firm if financed entirely with equity plus the discounted value of the interest tax shields from the debt its assets will support. The authors argue that the WACC approach is more practical if the firm intends to hold its (market) leverage ratio relatively constant over time, but that the APV technique is the preferred method if the firm plans to reduce its leverage ratio according to a pre-determined schedule (as tends to be the case in highly leveraged transactions). 1997 Morgan Stanley.
This article considers the strengths and weaknesses of value-based management approaches based upon the residual income (RI) concept as the basis for incentive-based reward systems. The objective of these systems is to encourage optimal corporate investment selection by divisional managers and to encourage them to act as if they were independent owners of their divisions sharing a proportion of all losses and all profits. Part 1 of the article considers these systems in the light of the earlier RI debate in the 1960s and 1970s which raised a number of problems applicable to today's value-based systems. It also considers recent attempts to solve, perhaps, the major problem generated in the earlier debate—how to ensure that a single period RI is congruent with project net present value. Part 2 of the article provides a brief survey of current research into incentive systems based on RI. It then presents a possible programme of further research emphasising relevant research in finance theory.
We survey 392 CFOs about the cost of capital, capital budgeting, and capital structure. Large firms rely heavily on present value techniques and the capital asset pricing model, while small firms are relatively likely to use the payback criterion. A surprising number of firms use firm risk rather than project risk in evaluating new investments. Firms are concerned about financial flexibility and credit ratings when issuing debt, and earnings per share dilution and recent stock price appreciation when issuing equity. We find some support for the pecking-order and trade-off capital structure hypotheses but little evidence that executives are concerned about asset substitution, asymmetric information, transactions costs, free cash flows, or personal taxes.
Anyone who learned valuation techniques more than a few years ago is probably due for a refresher course. For the past 25 years, managers have been taught that the best practice for valuing assets-that is, an existing business, factory, product line, or market position-is to use a discounted-cash-flow (DCF) methodology. That is still true. But the particular version of DCF that has been accepted as the standard-using the weighted-average cost of capital (WACC)-is now obsolete. Today's better alternative, adjusted present value (APV), is especially versatile and reliable. It will likely replace WACC as the DCF methodology of choice among generalists. Like WACC, APV is used to value operations, or assets-in-place-that is, any existing asset that will generate a stream of future cash flows. Timothy Luehrman explains APV and walks readers through a case example designed to teach them how to use it. He argues that APV always works when WACC does-and sometimes when WACC doesn't, because it requires fewer restrictive assumptions. And APV is less prone to yield serious errors than WACC is. But, most important, general managers will find that APV's power lies in the managerially relevant information it provides. APV can help managers analyze not only how much an asset is worth but also where the value comes from.
This paper presents the Capital Cash Flow (CCF) method for valuing risky cash flows. I show that the CCF method is equivalent to discounting Free Cash Flows (FCF) by the weighted average cost of capital. Because the interest tax shields are included in the cash flows, the CCF approach is easier to apply whenever debt is forecasted in levels instead of as a percent of total enterprise value. The CCF method retains its simplicity when the forecasted debt levels and the implicit debt-to-value ratios change throughout forecast period. The paper also compares the CCF method to the Adjusted Present Value (APV) method and provides consistent leverage adjustment formulas for both methods.
Business Analysis & Valuation Using Financial Statements
- K G Palepu
- P M Healy
- V L Bernard
Palepu, K.G., Healy, P.M., Bernard, V.L., 2004. Business Analysis & Valuation Using Financial Statements, third ed. South-Western College Publishing.
Accounting earnings, book values, and dividends: the theory of the clean surplus equation (Part I)
- Ohlson
Ohlson, J., 1989. Accounting earnings, book values, and dividends: the theory of the clean surplus equation (Part I). In: Brief, R., Peasnell, K. (Eds.), Clean Surplus: A Link Between Accounting and Finance, vol. 1996. Garland, pp. 167–227.