Residual Income

JUSTUS-LIEBIGUNIVERSITÄT
GIESSEN

Andreas Bausch / Barbara E. Weißenberger / Marcus Blome

Is market value-based residual income a superior performance measure compared to book value-based residual income?
Working Paper 1 / 2003

– Arbeitspapiere Industrielles Management und Controlling –
Herausgeber:

Professur für Betriebswirtschaftslehre mit dem Schwerpunkt Industrielles
Management und Controlling (Prof. Dr. Barbara E. Weißenberger)
Justus-Liebig-Universität, Gießen http://wiwi.uni-giessen.de/controlling/ JEL-Classification:

M40

Vortrag auf dem Kongress der European Accounting Association am 04.04.2003, in Sevilla, Spanien

-1-

Is market value-based residual income a superior performance measure compared to book value-based residual income?

Abstract
With the increasing use of residual income-based concepts of performance measurement, significantly different formulas are proposed for calculating both the firm’s operating profit as well as its cost of capital. On the one hand, there is the traditional book value-based approach (EVA), on the other hand there are market value-based approaches, in which either only the cost of capital (REVA) or both cost of capital and the firm’s operating profit before interest (residual economic income, REI) are determined by using market values.
In our paper, we compare the advantages and disadvantages of these different types of residual income measurement. Our results are the following. First, we show that REVA compared to EVA might lead to underinvestment in projects with a strictly positive net present value as well as to overinvestment in projects with a strictly negative net present value even if principal and agent discount a project’s income stream at the same rate. Second, we show that a proposition to base incentives on strictly positive EVA targets derived from an observed Market Value Added (MVA) equals the application of a REVA-type performance measure and, therefore,

Bibliography: Bacidore, Jeffrey M./Bequist, John A./Milbourn, Todd T./Thakor, Anjan V. (1997): The Search for the Best Financial Performance Measure Baldenius, Tim/Fuhrmann, Gregor/Reichelstein, Stefan (1999): Zurück zu EVA. In: Betriebswirtschaftliche Forschung und Praxis, Vol. 51, pp. 48-52. Bromwich, Michael/Walker, M. (1998): Residual income past and future. In: Management Accounting Research, Vol Fisher, Irving (1906): The Nature of Capital and Income, New York: Macmillan. Hax, Herbert (1989): Investitionsrechnung und Periodenerfolgsmessung. In: Delfmann, Werner et al. (Eds.): Der Integrationsgedanke in der Betriebswirtschaftslehre. Helmut Koch zum 70 Hicks, John R. (1946): Value and Capital: An Inquiry into some Fundamental Principles of Economic Theory, 2nd ed., Oxford: Clarendon Press. Laux, Helmut (1999): Unternehmensrechnung, Anreiz und Kontrolle: Die Messung, Zurechnung und Steuerung des Erfolges als Grundprobleme der Betriebswirtschaftslehre, 2nd ed., Berlin et al.: Springer. - 17 Lücke, Wolfgang (1955): Investitionsrechnung auf der Basis von Ausgaben oder Kosten?. In: Zeitschrift für handelswissenschaftliche Forschung - Neue Folge, Vol Neus, Werner (1998): Einführung in die Betriebswirtschaftslehre aus institutionenökonomischer Sicht, Tübingen: Mohr Siebeck. Preinreich, Gabriel (1937): Valuation and Amortization. In: The Accounting Review, Vol. 12, pp Reichelstein, Stefan (1997): Investment Decisions and Managerial Performance Evaluation. Reichelstein, Stefan (2000): Providing Managerial Incentives: Cash Flows versus Accrual Accounting. In: Journal of Accounting Research, Vol. 38, pp. 243-269. Richter, Frank/Honold, Dirk (2000): Das Schöne, das Unattraktive und das Hässliche an EVA & Co Stewart, G. Bennett (1991): Quest for Value: The EVATM Management Guide, New York: Harper Business. Stewart, G. Bennett (1994): EVATM: Fact and Fantasy. In: Journal of Applied Corporate Finance, Vol. 7(2), pp. 71-84. Stern, Joel M./Shiely, John S./Ross, Irwin (2001): The EVA Challenge, New York: Wiley.