The impact of economic value added measure in assessing the business performance of UK construction companies

Traditional methods of assessing profitability are being questioned in relation to their relevance to creating wealth for shareholders. Notably, traditional accounting profit does not take into account opportunity cost and the risk to shareholders investments, hi order to overcome the limitations of generally accepted accounting principles (GAAP), Stem Stewart & Company developed the concept of Economic Value Added (EVA). EVA is net operating profit after tax (NOPAT) minus an appropriate charge for the opportunity cost of all the capital invested in a company. EVA more accurately reflects the economic reality as opposed to the accounting reality. This thesis presents an analysis of accounting and economic performance measures and examines the economic value model which identifies value creation for shareholders. The performance measures are specifically applied to 43 companies within the UK construction industry. Necessary adjustments to these financial statements have been made to prepare the data for the EVA calculations. These companies were examined to assess their business performance over a period of three years (2001 to 2003). This study also examines which measures EVA or the other traditional accounting measures have a greater association with the company's market value as measured by Market Value Added (MVA) and whether components unique to EVA (capital charge and accounting adjustments) provide additional information to that provided by the other traditional accounting measures. The financial analysis reveals that the size of the difference between a company's after-tax rate of return on economic capital employed (ROEC) and the weighted average cost of capital employed (WACC) has a significant impact on the company's fundamental ability to generate positive EVA for their shareholders. This is because their post-tax rate of return on invested capital was more than sufficient to cover the overall capital costs. Therefore, the excess of ROEC above WACC is theoretically one of the most important elements to consider when valuing a company. Under GAAP, the findings from the financial analysis shows that almost all companies investigated in this study appear to be profitable. However, when the EVA principles are applied to the data it reveals that a number of these companies (35%) have in fact been destroying shareholder wealth. The statistical analysis indicates that all six profitability measures provide relevant information that contributes towards identifying company market value. The four measures (EVA, ROCE, ROE and ROA) were shown to be statistically significant in explaining the company's market value. (ROS and EPS) were not. EVA was identified as the best of these measures for valuation purposes as it has the highest association with MVA measure. This research has provided the basis for further studies into how company financial information can be analysed in a way that will provide managers with the opportunity to improve their company's financial performance. The use of EVA has identified those companies within the sample that are creating or destroying value for their shareholders.