Shareholders can provide a closer link to long-term organisational

Shareholders are
the owners of the company; they invest money into the company hoping for an
increase in stock valuation which increase their wealth. That’s why the top
objective for most companies are maximising stock value. Shareholders concern
whether the company is making profit therefore the performance measures they
are interested will be profit related.

 

The most significant
advantage of EVA over non-financial KPIs is it meets the needs of shareholders
more directly. EVA is able to calculate economic profit by deducting its cost
of capital from its operating profit. So the EVA value is the actual wealth
created for the shareholders. On the other hand, Ittner and Larcker (2000) suggest non-financial KPIs
sometimes lack verifying links to accounting profits or stock prices and may have
weak statistical reliability that those factors don’t really influence the performance of the firm
at all. So
those figures are not really relevant to shareholders.

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EVA and KPIs are both good ways
to allow managers identify areas to improve. EVA includes total assets and
current liabilities in the calculation, so managers can identify how and where
wealth was created in the company. Managers can look at the balance sheet items
and focus on areas they can improve or look out for. EVA can also motivate
managers through compensation schemes because as share price increases,
managers’ bonus also increases. Similarly, non-financial KPIs can provide
quantitative information on company’s intangible
assets such as branding and loyalty. Therefore, managers can easily compare the
non-financial performance to the industry benchmark and develop strategies to
beat competitors.

 

The major problem of EVA is
short-term orientated. Because EVA is a financial measure, it overemphasises on
the short-term result (Brewer et al 1999). Therefore, it demotivates managers to invest in
innovative products and technologies. It is because all the investment costs
will be recognised in the current accounting period but the benefits or
revenues associated with the investments can only be recognised in the future.

This will cause the EVA of the current period low which the manager may be
questioned by the shareholders and lead to layoff. However, non-financial KPIs are long-term
orientated, Ittner and Larcker (2000) point out non-financial KPIs can provide
a closer link to long-term organisational strategies. Improving education
level, innovations and customer satisfactions can bring economic benefit in the
future. So they also prevent managers to focus on the short-term
financial measures that it provides a balanced view about the organisational
performance.

 

Although EVA takes into
account of the cost of equity which is neglected in normal accounting. Another
disadvantage of EVA is its complex calculations. Abdeem and Haight (2002)
suggest it is particularly difficult in the calculation of operating income
after tax as it require to convert the GAAP based income to economic income. It
is also difficult to find the correct cost of equity in WACC as there are many
assumptions were made in the capital asset pricing model and it might not be
suitable to all kinds of companies. There are also many adjustments to profit
and capital employed figures in order to rectify any possible accounting
distortions of income and investment (Abdeen and Haight 2002). Measuring
performance by KPIs is also difficult, Ittner and Larcker (2000) suggest they can be time consuming as it
takes considerable thought to develop an appropriate scorecard. Also
implementing the strategies might involve changing the structure or the culture
of the organisation which may be costly (CIMA 2008, p.8). They do not have a
common denominator and
entail different denominators such as time, percentage, quantities. Therefore,
it is difficult for managers to decide how much they need to change or how far
off they are to the target.