The second BT-Stern Stewart listing is probably the most accurate report card of India Inc's ability to create (or destroy) wealth. But there is more to the measures MVA and EVA than just math. The two could form the basis of an effective decision-making, corporate governance, and employee- motivation framework, argue  Tejpavan Gandhok and Sanjay Kulkarni.

They are the glimmer twins of the financial metric firmament. But although EVA (Economic Value Added), and MVA (Market Value Added) are fairly evolved financial measures, there is more to them than mere math. At one level, they are accurate measures of the wealth created by a company. At another, they are tools that can be used to enhance the quality of governance and management within an organisation.

Many private sector organisations around the world have found the implementation of the EVA framework a far more effective internally-driven initiative to improve governance as compared to transaction-driven alternatives such as Leveraged Buyouts or a change in corporate control. Indeed, even public sector organisations have benefited greatly from implementing EVA in support of their privatisation process.

To cut to the chase, Indian companies have a poor track record of creating shareholder wealth. The better performers are truly world class compared to other economies. Still, the ability of India Inc. as a whole to allocate and utilise capital is well below that of countries in other economies. Our analysis indicates that the average Indian company creates only 50 paise of MVA for every rupee of capital used. However, when we dug a little deeper we found the MVA performance of Indian companies highly stratified.

Those Indian companies that create wealth (have a positive MVA) generate more wealth per unit of capital used than their counterparts in other economies (See Wealth Creation: Us & Them). But such wealth creators utilise only 35 per cent of the total capital invested in Indian capital markets. In contrast, companies that destroy about 26 paise of wealth for every rupee invested, consume about 65 per cent of the total capital invested in the market. As a benchmark, the US economy invests 87 per cent of its capital in wealth creators, and these earn a handsome 1.65 times every unit of capital invested. In effect, the ills of the economy could well be attributed to improper allocation of capital.

This difference between wealth creating companies and wealth destroying ones isn't just a function of market sentiment. Companies with a positive MVA in our sample earned twice as much return on capital as those with a negative one.

Corporate governance can ensure optimal capital allocation, harvesting it out of wealth destroyers and deploying it in wealth creators. Ideally, this governance should stem within the company; it should adopt systems that encourage capital efficiency. We believe the EVA framework can achieve this, and more.

Most companies that destroy wealth do so simply because they chase the wrong metrics. A few companies assume maximising market value is the best thing they can do to their shareholders. It isn't. Market Value Added (MVA)-the difference between the Enterprise Value and the amount of invested capital-is what shareholders ultimately care about, because it answers the question of whether a business is worth more than the original investment or not.

A comparison of NIIT and Larsen & Toubro shows how misleading other numbers can be. Both companies have steadily grown over the past five years in terms of sales, and Market Value. But have they both done a good job of shareholder value creation? Far from it (See L&T and NIIT: Contrasting Indicators). While NIIT's MVA has steadily moved up, L&T's has declined because the incremental capital invested is earning a return below the cost of capital.

In both cases, the EVAs of the companies track the MVA trend closely. We find that (as is true in other markets around the world) EVA is a very good predictor of MVA in the Indian capital market across a broad range of sectors, new economy or old. Mathematically too, a correlation-exercise shows that the EVA-MVA correlation is higher than that of any other financial metric-Return on Total Assets, Earnings per Share, Return on Net Worth, or Profits After Tax-with MVA.

 Continues

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