Had he been a physicist, we would have been measuring the amount of value generated by a company in Sterns. Joel Stern, however, is an accountant. So, we still measure it in billions of dollars, or crores of rupees. As a prelude to an India trip in mid-January, 2000, the man, who-with Bennet Stewart-formulated the concept of Economic Value Added, exchanged e-mail with BT's Rajeev Dubey onEVA-based management. Then, during his visit, the two met again to thrash out more EVA-metrics.

Q. Welcome back to India, Mr Stern. It is now 18 years since the concept of EVA (Economic Value Added) was originated by Stern Stewart & Co. (SSC). Are you working on anyperformance- management metric that is fundamentally different from EVA? What can this metric do that EVA can't?

A. SSC has not, and does not plan to, develop a new tool. We believe that EVA is a comprehensive financial management system. But there are 2 things that we have worked on. One, we have improved EVA. And two, we have developed special applications for industries with unique characteristics, such as retailing, and exploration- and extraction-intensive industries-including oil and gas, public utilities, banks, and insurance companies. The new generation of EVA tools has been upgraded to include advanced capital budgeting ideas, including the most recent, Real Options, which is of critical importance in high-risk investment areas such as the Net and oil and gas exploration.

EVA is a technique that offers an alternative to the traditional accounting way in which corporate performance is measured. The Balanced Scorecard, developed by Harvard Professor Robert Kaplan and Renaissance Consultant David Norton, is another technique that does something similar. Does the Balanced Scorecard have a role to play in EVA-luating a company?

There is no reason why companies should not adopt the Balanced Scorecard and EVA at the same time. As Bob Kaplan has said, both EVA and the Balanced Scorecard are the result of shortcomings in the basic concepts of accounting. Accounting fails to include many different vital sources for decision-making that the Balanced Scorecard provides; EVA measures the true economic value of an enterprise that accounting omits.

For instance, accounting writes off all intangible assets-including R&D, advertising and promotion, training and development costs for people, and accounting goodwill-in the current year. In contrast, EVA capitalises the entire amount spent under these heads, and writes them off only over their expected economic useful life. The Balanced Scorecard and EVA are highly complementary, and are not in conflict.

Is there a geographical or cultural context to implementing EVA? Is it easy in some countries and cultures and difficult in others? How do you handle these cultural variations?

There is no question that implementing EVA is easiest in the Anglo-Saxon world, where issues related to motivation and rewards encourage a pay-for-performance attitude. However, in parts of the world where this type of culture is absent-France, Germany, and Japan come immediately to mind-implementing EVA can be difficult. However, over the last 5 years, the failure of the Japanese model has encouraged managers to look for a way out, and EVA has made breakthroughs in this cultural environment too. And the acceptance of EVA by companies in South Asia seems to suggest that a properly-designed EVA implementation programme works in Asian cultures.

What are the other variables that have an impact on EVA? For instance, what are the characteristics of a company where EVA can be implemented with the least trouble? And is there a particular stage in the organisational life-cycle when EVA works best? Or does it suit one industry-type more than the other?

The ideal company to implement EVA is one in which the board of directors and the senior management want to improve the efficiency of a firm, take advantage of opportunities quickly, and align the interests of the management and shareholders. However, there is no particular stage in a firm's life-cycle when EVA can be best applied. It works well in both the introductory and growth phases, where companies grow rapidly, as well as in the maturity and decline phases, where some companies seem to lose their way. As for the industry-type, the industry is far less important than the attitude of the management. The management must want the benefits of EVA. This is the key driver of its success.

EVA is, probably, best calculated at the level of a business unit. However, even in non-diversified businesses, decisions that have a bearing on the unit's profitability are rarely taken at that level. In a diversified business, of course, things are worse. To offer a simple example, how will EVA account for synergies between business units?

The goal, of course, is to maximise the EVA of the corporation as a whole, and not of any one business unit. The EVA of the total enterprise, naturally, captures the net impact of a decision on the EVAs of the various units. For this reason, incentives based on the EVA of the total enterprise are the most appropriate at the corporate level.

For individual business units, it is, often, best that a portion of all bonuses be based on aggregate EVA to discourage the individual units from pursuing courses that enhance their own EVAs, but detract from the EVA of the whole. SSC also has the expertise to craft proper transfer-pricing solutions that recognise the synergies between business units. The EVA framework we use results in the reduction of friction between units.

Is there a new stream of management-thinking emerging where metric-oriented tools, like EVA or ABC, aid a company's strategy process? Strategy, essentially, is a set of choices or decisions. If the impact of a particular decision on the EVA of a company were known, it would be possible to identify decisions that maximise EVA. Does EVA become part of the strategy process in such a case?

We like to say that EVA is an agnostic in the area of strategy. That is, it does not dictate one course of strategy or another. However, EVA does have an extremely important role in strategy formation: it is used to assess the likely impact of competing strategies on shareholder wealth, and can help the management select the one that will best serve shareholders. EVA can be particularly effective in this regard when it is augmented by new tools such as Real Options analysis.

How does EVA fit in with the concept of corporate governance? Both, after all, are focused on shareholder value...

All companies have some form of corporate governance. The important question is whether a company has an effective governance system, one that properly allocates decision rights and imbues managers and workers with a sense of ownership in the outcome of the decisions they take. EVA bonus systems do this by giving employees an ownership-stake in improvements in the EVA of their divisions or operations. This causes employees to behave like owners, and reduces or eliminates the need for outside interference in decision-making.

EVA and EVA-incentives provide this type of internal governance. EVA has the ability to punish a non-performing organisation by failing to reward it. EVA bonus plans are effective because they give managers and workers a stake in improving EVA. If the EVA of the division or operation they are in charge of fails to improve, they receive no reward. Equally important, a portion of exceptional rewards are held back for later payment, and are at risk if EVA fails subsequently. However, the key to wealth-creation is not punishing failure; it is to properly reward success.

The role of intangible assets is critical in today's context. Is the EVA way of dealing with assets like brands and goodwill superior to the accounting way?

EVA deals with goodwill by recognising that it is an investment on which managers must earn a minimum rate of return. Accordingly, we keep goodwill on the balance-sheet forever instead of gradually amortising it, as accountants do. In the case of other intangibles, such as R&D and brand-building activities, EVA recognises that these are investments, not expenses, and treats them as such. Outlays for these activities are capitalised and amortised over appropriate periods of time instead of immediately deducting them from profits. This encourages managers to spend the appropriate amount in these areas while still holding them accountable for the eventual results.

Indian CEOs are, normally, quick to adopt management tools. But only one Indian company has actually implemented EVA. Even globally, we learn that only 365 companies that have implemented EVA over 18 years. Why is this so?

Most companies have failed to adopt EVA, in India or elsewhere, because their managers are reluctant to adopt sweeping change. A handful do so because they recognise that it is the best course; and still others change because they are in trouble. Over time, however, the successes of those that have adopted EVA will convince others that they must do so to compete effectively tomorrow.

What happens when an EVA company acquires or merges with another company? What distortions are created by this M&A acti-vity, and how should they be handled?

The ideal approach is to start by accounting for the full cost of purchase, and whatever goodwill is acquired, in the books of the company. A company's acquisition doesn't have to generate positive EVA from Day 1. The company, thus, has some leeway in consolidating the acquisition. However, the EVA system has a memory of what is promised, and what is, eventually, delivered 2 to 3 years later. Thus, short-term gaming disappears.

Even with the best acquisitions, the fall in EVA is radical in the first 2-3 years. Since bonus-plans are based on EVA, it is in the management's interest to make the company EVA positive. However, in many instances, acquisitions change the company's future-outlook in terms of EVA, and require a recalibration of the incentive-system.

Since EVA is an annual measure, some people contend that it encourages the managers to focus only on the short term, and ignore the long-term repercussions of their decisions...

This is a popular charge by our competitors, and one that, unfortunately, seems plausible to those not fully educated in the EVA system. The EVA system puts brakes on growth only when it is non-profitable. And because bonuses are based on EVA, the only way managers can continually earn large bonuses is by finding ways to profitably grow the business. This is better for shareholders than rewarding managers for any growth, regardless of whether it provides returns that are less than, or greater than the cost of capital.

When can an EVA initiative fail in an organisation?

EVA will fail-that is, it will not change the behaviour of managers and workers-if it is not embraced enthusiastically by the CEO. It will fail if it is not used as the basis of incentive compensation; if you pay managers for something else, they will not strive to increase EVA. And, finally, it will fail when managers have a bureaucratic, rather than an entrepreneurial, outlook.

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