THE RELATIONSHIP BETWEEN ECONOMIC VALUE ADDED AND STOCK PRICE RETURNS IN THAI ENERGY SECTOR

MISS PENG FANG- FANG

A Thesis Submitted in Partial Fulfillment of the Requirements For the Degree of Master of Business Administration

Department of International Business Graduate School

University of the Thai Chamber of Commerce 2008

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THE RELATIONSHIP BETWEEN ECONOMIC VALUE ADDED AND STOCK PRICE RETURNS IN THAI ENERGY SECTOR

PENG FANG- FANG

A Thesis Submitted in Partial Fulfillment of the Requirements

For the Degree of Master of Business Administration Department of International Business

Graduate School University of the Thai Chamber of Commerce

2008

copy Copyright by University of the Thai Chamber of Commerce

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THESIS APPROVAL GRADUATE SCHOOL

Master of Business Administration

Degree International Business

Major Field

THE RELATIONSHIP BETWEEN ECONOMIC VALUE ADDED AND STOCK PRICE RETURN IN THAI ENERGY SECTOR

Peng Fang-Fang 2008

Name Graduation Year

Accepted by the Graduate School University of the Thai Chamber of Commerce in Partial Fulfillment of the Requirements for the Masterrsquos Degree

Dean Graduate School (Dr Ekachai Apisakkul)

Thesis Committee

Chairperson

(Dr Phusit Wonglorsaichon)

Thesis Advisor (Dr Kittiphun Khongsawatkiat)

helliphellip Thesis Co-Advisor (Dr Thasana Boonkwan)

helliphellip Member

(Dr Pussadee Polsaram)

External Committee

(Assoc Prof Sriaroon Resanond)

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Thesis Title The Relationship between Economic Value Added and Stock Price Returns in Thai Energy Sector

Name Peng Fang-Fang Degree Master of Business Administration Major Field International Business Thesis Advisor Dr Kittiphun Khongsawatkiat Thesis Co-Advisor Dr Thasana Boonkwan Graduation Year 2008

ABSTRACT

In the eighties the rapid changes have led to a general dissatisfaction with traditional

performance measures One of the most popular mechanisms is Economic Value Added

(EVA) has been created by a US-based consulting firm called Stern Stewart amp Co The

company claimed that EVA can increase transparency for investors and managers

developed and trademarked Stern Stewart amp Co launched the concept of EVA and it

widespread as the financial management and incentive compensation system EVA has

been literally adopted by thousands of the leading firms all around the world EVA is not

constrained by the Generally Accepted Accounted Principle (or GAAP) so it also has its

critics Some experts suggested that EVA is not the best choice

An emerging literature of analyze whether EVA is highly associated with stock returns

than traditional performance measures has addressed the empirical issue Until now there

are only few EVA relevant studies in Thailand Thus this is an opportunity to

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start a research in this field The purpose of this study is to investigate if EVA can be

suitable for applying to the Thai energy sector which is were mostly affected the

performance of the Stock Exchange of Thailand (SET) and to investigate if EVA can

better affect the operational performance than the traditional performance index

(including EPS ROA and ROE) in explaining Market Value Added (MVA) thereby

stock returns

The evidence of this research shows that EVA may not be suitable for applying to

the Thai energy sector the correlation of MVA depends on all variables show EPS has

the most significant relevance and finally one is EVA EVA has relationship with MVA

but can not affect MVA by regression analysis Thus EVA is not a superior

performance measure in explaining market price returns compared with traditional

performance index of the Thai energy sector However the researcher suggests that

any managers shareholders and participants can use EVA as an assistant tool with

traditional performance measures instant of replacing anyone

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ACKNOWLEDGEMENTS I would like to express my gratitude to the people who have played especially

important role in the development of this research First of all let me pay my deepest

acknowledgement to my supervisors DrKittiphun Khongsawatkiat and Dr Thassna

Boonkwan for their valuable advice and recommendations The excellent research method

course taught by Dr Phusit Wonglorsaichon helps me out Next I need to single out my

key thinking partner MrWeera Weerakhajornsak for his professional directions and

generous contributions Also I acknowledge all committees Dr Phusit Wonglorsaichon Dr

Pussadee Polsaram and Assoc Prof Sriaroon Resanond to turn this research into its

final shape with their kindness critique

Perhaps the most important is the courage from my parents Mr Peng Han-Qing

and Mrs Nancy Pen whose comfort and support always keep me wrestling with all hard

times Of course my appreciation goes to all my friends whose sharing ideas and

comments are woven into the research I wish I could express my sincerely thanks for how

they have enriched my life

Peng Fang-Fang

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TABLE OF CONTENTS

Page ENGLISH ABSTRACT iv

THAI ABSTRACT vi

ACKNOWLEDGEMENTS viii

TABLE OF CONTENTShelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip xi

LIST OF ABBREVIATION helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip xii

LIST OF TABLES xiv

LIST OF FIGURES helliphelliphellip xv

Chapter 1 Introduction 1

State of the Problems 5 Objectives of the Study 6

Expected Benefits 7 Scope and limitations 7 Operation Definition 7 Organization of the Study 9

2 Literature Review 10 Traditional Performance Measures 11 Value-Based Management (VBM) 13 Market Value Added (MVA) 15

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TABLE OF CONTENTS (COUNTINUED)

Chapter Page From MVA to EVA 16 Economic Value Added (EVA)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 18 The Originsndash Residual Income (RI)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 17 The EVA Metric helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 19 The Elements of EVA helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 21 Accounting Adjustmentshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 24 Advantages and Disadvantageshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 26 Related Research helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 33 Research in support of EVA as the best driver of MVAhelliphelliphelliphelliphelliphellip 33 Criticisms of EVA and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 37

3 Research Methodology 42 Conceptual Frameworkhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 43 Research Designhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44 Population helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44 Data Collectionhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 45

Hypotheseshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 49 Data Analysishelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 50

4 Results of Analysis hellip 52 Analyze the innovation measure ndashEVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 56

Analyze the traditional measures (EPS ROA and ROE) helliphelliphellip 58 The results of all independent variableshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 59

5 Conclusion Discussion and Suggestion 62 Conclusion helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 62

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TABLE OF CONTENTS (COUNTINED)

Page

Discussion helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 65 Limitations of this study helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 68 Suggestions for further study helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 68 BIBLIOGRAPHY 71

APPENDICES 85

A Market Capital from 2003-2008 on SET 86 B Company Profile 87 C Statistics Analysis Resultshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 92

BIOGRAPHY 105

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xii

LIST OF ABBREVIATION

Capital asset pricing model CAPM

Cash flow return on investment CFROI

Discounted cash flow DCF

Dividends per share DPS

Earnings before interest and taxes EBIT

EBIT plus depreciation and amortization EBITDA

Earnings per share EPS

Economic Value Added EVA

Free cash flow FCF

Market Value Added MVA

Net income NI

Net operation profit after tax NOPAT

Profit after tax PAT

Residual income RI

Return on total assets ROA

Return on common equity ROE

Return on investment ROI

Return on invested capital ROIC

Return on net worth RONW

Return on sales ROS

Weighted average cost of capital WACC

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xiv

LIST OF TABLES Table Page 21 Accounting items under GAAP and adjustments in EVA method

Young and OrsquoByrne (2001)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 25

22 The relationship between EVA and other financial performance measures

Stern (1993)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 34

23 The relationship between EVA and other financial performance measures

Uyemura Kantor and Pettit (1996)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 35

32 A Regular Balance Sheet vs The EVA Balance Sheet helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 48

41 Descriptive statistics matrix of this study (2006Q4-2008Q3)helliphelliphelliphelliphelliphelliphelliphelliphelliphellip 53

42 Comparison of average MVA and EVA helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 54

43 Correlation statistics matrix of this study (2006Q4-2008Q3)helliphelliphelliphelliphelliphelliphelliphelliphellip 55

44 Summary of regression matrix between EVA and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 56

45 Selected coefficients for total sample EGCO RATCH and PTTEPhelliphelliphelliphelliphelliphellip 57

46 Summary of regression matrix between traditional accounting measures

and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 58

47 Summary of regression matrix MVA depends on all independent variableshelliphelliphelliphellip 59

48 Summary of regression matrix between all variables for each companyhelliphelliphelliphellip 60

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xv

LIST OF FIGURES Figure Page 11 Market Capitalization on SET (2003-2008) helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 6

21 A typical bonus plan helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 28

22 The EVA bonus plan helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 29

31 The conceptual frameworkhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44

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1

CHAPTER 1

INTRODUCTION

11 Introduction In the 1980rsquos while investors started to express interest in stock market the publicly

listed companies had to pursue the creation of value for their shareholders as the most

significant goal Many different interpretations of shareholder-value seem to wildly exist

throughout the public discussion and the press Although chairmen of big corporations have

taken up the talk of aiming at an increase of shareholder value they have not made exactly

clear how they will attempt to reach this goal or how success on this step shall be

measured (Young and OrsquoByrne 2001) Thus the rapid changes have led to a general

dissatisfaction with traditional performance measures (Needly et al 1999) new

mechanisms for measuring value have been created For example John Kay (1993)

developed the concept of Valued Added which measures the different between the

comprehensively accounted valued of the input and the output of a firm And one of the

most popular mechanisms is Economic Value Added (EVA) which increases transparency

for investors and managers developed and trademarked by a US-based consulting firm

called Stern Stewart amp Co

Stern Stewart amp Co launched the concept in order to motivate managers and other

employees in 1989 (Stern and Shiely 2001) Stewart revised through numbers of

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accounting adjustments and relabeled EVA in 2001 (Anderson et al 2005) But it

widespread as the financial management and incentive compensation system began with

Fortune Magazine proclaimed EVA asrdquo todayrsquos hottest financial idea and getting hotterrdquordquo

The real key to creating wealthrdquo (September 1993) ldquoA new Way to Find Bargainsrdquo

(December 1996) ldquoAmericarsquos greatest wealth creatorsrdquo(November1997) and even today ldquoA

new way to value the marketrdquo (February2008) the management guru Peter F Drucker

(1993) described it as ldquoa vital measure of total factor productivityrdquo in Harvard Business

Review

Originally in the United States EVA has been ldquoliterally adopted by hundreds of the

leading firms such as Coca-Cola Eli Lilly Quaker Oats AT amp T and the Postal Service in

the United Statesrdquo (Biddle et al 1998) and also by investment banks like Credit Suisse

First Boston or Goldman Sachs have supplements traditional valuation methods with EVA

The CEO of Coca-Cola Roberto Goizuera believed that adopted EVA in turning the firm

become the number one Market Value Added Company when itrsquos stock price increased

form $3 to over $60 in the early 1980s James Meenan the CFO of AT amp T long-term

business declared that EVA has an almost perfect correlation with stock price tracked back

the calculation to 1984 from 1994 and used it to be the lead indicator including ldquopeople and

customer value addedrdquo of their performance measurement

EVA has been world wildly promoted in UK Australia Canada Brazil Germany

Mexico Turkey and France that it has adopted by several international firms (Stern

Steward 1999) For example the ABSA Banking Group in South Africa

(Weldeghiorgis 2004) the ANZ Banking Group Fletcher Challenge Limited James Hardie

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Industries and the Wrighton Group in Australia have implemented EVA for many years

(Rennie1997) Furthermore the big European conglomerated such as Siemens has put

EVA to completely change the company since introduced there in 1998 and lately more

spreading to Latin American and Asia (Young and OrsquoByrne 2001)

In Asia the Japanrsquos financial magazine Toyokeizai mentioned that EVA is not only

a financial tool but also a mind-set creator for the managers and employees Many

international firms were actively to implement it such as Kao Corporation Asahi Kasei Kirin

BeerSonyhellipetc(Toyokeizai magazine 2000) In China state-owned assets supervision

and administration commission of Peoplersquos Government announced in the upcoming 2010

EVA will be one of the evaluation standards for senior managers (China Business News

2008)

The concept of EVA is definitely not new EVA is a modified computation of residual

income with a series of accounting adjustments to how one calculates income and capital

EVA is the net operation minus an appropriate charge for the ldquoopportunity costrdquo which

means the cost of capital by Stewart in an enterprise or projects (Maumlkelaumlinen and Roztocki

1998) In addition Stewart (1991) claimed that EVA is not only the financial measure

which comes closer than any other to capturing the true economic profit of an enterprise

but also the performance measure most directly linked to the creation of shareholder wealth

over time Stewart (1994) also stated that ldquoEVA stands well out from the crowed as the

single best measure of wealth creation on a contemporaneous basis and is almost 50

better than its closer accounting-based competitors in explaining changed in shareholders

wealthrdquo

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EVA basically stands for appeal to common sense although underlying application

can be complex But it is the way to show what ldquovaluerdquo was made from what capital was

used By using EVA is to help the firm to achieve more with as little capital as necessary

which points managers and firms toward efficiency It transforms employees into

entrepreneurs via incentive complementation and just simplest application needs commonly

financial statements

Managers can also used EVA as a diagnostic likely tool to show which one of the

departments needs more work to increase a firmrsquos value for the next period (Maumlkelaumlinen amp

Roztocki 1998) In short the EVA management system covers all managerial decisions

including strategic planning capital allocating setting day-to-day operating decisions

There is no absolute perfect measurement tool EVA also has its critics In fact EVA

is not constrained by the Generally Accepted Accounted Principle (or GAAP) Some experts

suggested that EVA is not the best choice for all companies which is not universal suitable

since it has no official standards about using the metric (Lars amp Clas 2001) OrsquoHanlon and

Peasnell (1966) stated that EVA provides a valuable transformation from wrong accounting

numbers into correct estimates of value But there is no theory to guide how to select

accounting adjustment of the most relevant items which depend on the financial structure

and industrial nature (Anderson et al 2005)

Brewer (1999) mentioned that ldquosize differencesrdquo across plants or division will effects

the EVA It is based on financial accounting method it is possible manipulated by

managers EVA provides immediate results which diminish innovation moreover it offers no

solutions in much the same way as historical financial statements do

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12 Statement of Problems Energy is one of the key factors to several economic movements Without it the

worldrsquos entire industrialized infrastructure would collapse (Liseadiratanakul and Uarkarn

2008) Moreover the opportunity that people would stop using oil natural gas or other

substitutions in next 10 years will not too much Therefore energy business would not be

disappeared (Vibul Perngprasert 2006)

As Asian economies bloomed their energy consumption grew by similar proportions

it will be the worldrsquos largest consumer of primary energy in the near year of 2010 (R

Manning 2000) In South Asia Thailand is considered to be the biggest consumer

Recently the total energy expenditure amounted closely to 17 of the GDP

In the past security in energy sector were mostly affected the performance of Thai

stock market Last year the resource sector including energy and mining industries had

also the highest capital which is 35 of all equity market The director of AWR Lloyd

(mining energy and metals advisory) Alexander Wood (2008) pointed out that by the year-

end of 2007 after generating total shareholder returns of around 70 the listed energy

sector had a total market capitalization around 25 trillion baht which is approximately 40

of the total equity capitalization of the entire Thai stock market Market capital data on SET

from 2003 to 2008 are compared shown as Figure 11 (Market capital data on SET from

2003 to 2008 is attached in Appendix A)

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6

000

50000000

100000000

150000000

200000000

250000000

Jan - Dec Jan - Dec Jan - Dec Jan - Dec Jan - Dec Jan - Dec

2008 2007 2006 2005 2004 2003

Period

Mill

ion

Baht

AgroConsumpFincialIndusPropconResourcServiceTech

Figure 11 Market Capitalizations on SET (2003-2008)

Source SET index

An emerging literature of analyze whether EVA is highly associated with stock

returns than traditional performance measures has addressed the empirical issue Tully

(1993) claimed that EVA has significant relationship with stock price returns and both are

remarkable tendency Some even claimed traditional accounting measures were inadequate

measures of a firmrsquos performance

So far there are few EVA relevant studies in Thailand covering the energy sector

Consequently this is an opportunity to begin a research in this area

13 Objectives of the Study The purpose of this study is to develop and test EVA as the performance measure in

the decision-making of investment by the management and in evaluation the future

performance of stock by the investor like Stern Stewart amp Co claimed The objectives of

this research are as follow

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1 To investigate if EVA can be suitable for applying to the Thai energy sector

2 Moreover to investigate if EVA can better affect the operational performance of

Thai energy sector than the traditional performance index (including EPS ROA and ROE)

in explaining Market Value Added( MVA) thereby stock returns

14 Expected Benefits 1 A better understanding of calculating EVA and MVA

2 International firms can take the finding of this study as a reference compared

between innovation measure - EVA and traditional performance measures

3 To make more investors sophisticate about the comprehension of EVA and MVA

as a practical tool of stock market investing

15 Scope and limitations

The sample firms are listed on the Stock Exchange of Thailand (SET) and are

gathered the quarterly financial reports in twenty quarters within the same organization and

cross the firms within the energy sector Assuming that the equity markets are efficient

eight companies of Thai energy sector is selected and completely qualified would be

employed in the empirical study

However due to the scope of the problem this research is obliged to make

limitations

16 Operation Definitions

Capital Asset Pricing Model (CAPM) - A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities

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Net Operating Profit After Tax (NOPAT) - The profit a company would generate if it had no debt and held only operating asset

Earnings before Interest and Taxes (EBIT) - When comparing companyrsquos operating performances it is essential to focus on their earnings before deducing taxes and interest payments And it is often referred to as operation income

Earning per share (EPS) - It is a bottom-line to denote that of all items on the income statement EPS shows that a companys profit allocated to each outstanding share of common stock EPS serves as an indicator of a companys profitability

Weighted Average Cost of Capital (WACC) ndash A weighted average of the component costs of debt preferred stock and common equity

Invested Capital - represents the total cash investment that shareholders and debt holders have made in a company

Economic Value Added (EVA) - The EVA is a registered trademark by its developer Stern Stewart amp Co that is an estimate of true economic profit after making corrective adjustments to GAAP accounting EVA can be measured as Net Operating Profit after Taxes (NOPAT) less the cost of capital

Market Value Added (MVA) ndash A measure to directly reflect the creation of shareholder value developed by Stern Stewart amp Co It shows the difference between the market value of a firmrsquos equity and the book value as shown on the balance sheet with market value found by multiplying the stock price by the number of shares outstanding Return on Total Assets (ROA) ndash The ratio of net income to total assets after interest and taxes Return in Common Equity (ROE) ndash The ratio of a fiscal years net income to common equity measures the rate of return on common stockholdersrsquo investment

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THE RELATIONSHIP BETWEEN ECONOMIC VALUE ADDED AND STOCK PRICE RETURNS IN THAI ENERGY SECTOR

PENG FANG- FANG

A Thesis Submitted in Partial Fulfillment of the Requirements

For the Degree of Master of Business Administration Department of International Business

Graduate School University of the Thai Chamber of Commerce

2008

copy Copyright by University of the Thai Chamber of Commerce

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THESIS APPROVAL GRADUATE SCHOOL

Master of Business Administration

Degree International Business

Major Field

THE RELATIONSHIP BETWEEN ECONOMIC VALUE ADDED AND STOCK PRICE RETURN IN THAI ENERGY SECTOR

Peng Fang-Fang 2008

Name Graduation Year

Accepted by the Graduate School University of the Thai Chamber of Commerce in Partial Fulfillment of the Requirements for the Masterrsquos Degree

Dean Graduate School (Dr Ekachai Apisakkul)

Thesis Committee

Chairperson

(Dr Phusit Wonglorsaichon)

Thesis Advisor (Dr Kittiphun Khongsawatkiat)

helliphellip Thesis Co-Advisor (Dr Thasana Boonkwan)

helliphellip Member

(Dr Pussadee Polsaram)

External Committee

(Assoc Prof Sriaroon Resanond)

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iv

Thesis Title The Relationship between Economic Value Added and Stock Price Returns in Thai Energy Sector

Name Peng Fang-Fang Degree Master of Business Administration Major Field International Business Thesis Advisor Dr Kittiphun Khongsawatkiat Thesis Co-Advisor Dr Thasana Boonkwan Graduation Year 2008

ABSTRACT

In the eighties the rapid changes have led to a general dissatisfaction with traditional

performance measures One of the most popular mechanisms is Economic Value Added

(EVA) has been created by a US-based consulting firm called Stern Stewart amp Co The

company claimed that EVA can increase transparency for investors and managers

developed and trademarked Stern Stewart amp Co launched the concept of EVA and it

widespread as the financial management and incentive compensation system EVA has

been literally adopted by thousands of the leading firms all around the world EVA is not

constrained by the Generally Accepted Accounted Principle (or GAAP) so it also has its

critics Some experts suggested that EVA is not the best choice

An emerging literature of analyze whether EVA is highly associated with stock returns

than traditional performance measures has addressed the empirical issue Until now there

are only few EVA relevant studies in Thailand Thus this is an opportunity to

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iv

start a research in this field The purpose of this study is to investigate if EVA can be

suitable for applying to the Thai energy sector which is were mostly affected the

performance of the Stock Exchange of Thailand (SET) and to investigate if EVA can

better affect the operational performance than the traditional performance index

(including EPS ROA and ROE) in explaining Market Value Added (MVA) thereby

stock returns

The evidence of this research shows that EVA may not be suitable for applying to

the Thai energy sector the correlation of MVA depends on all variables show EPS has

the most significant relevance and finally one is EVA EVA has relationship with MVA

but can not affect MVA by regression analysis Thus EVA is not a superior

performance measure in explaining market price returns compared with traditional

performance index of the Thai energy sector However the researcher suggests that

any managers shareholders and participants can use EVA as an assistant tool with

traditional performance measures instant of replacing anyone

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ACKNOWLEDGEMENTS I would like to express my gratitude to the people who have played especially

important role in the development of this research First of all let me pay my deepest

acknowledgement to my supervisors DrKittiphun Khongsawatkiat and Dr Thassna

Boonkwan for their valuable advice and recommendations The excellent research method

course taught by Dr Phusit Wonglorsaichon helps me out Next I need to single out my

key thinking partner MrWeera Weerakhajornsak for his professional directions and

generous contributions Also I acknowledge all committees Dr Phusit Wonglorsaichon Dr

Pussadee Polsaram and Assoc Prof Sriaroon Resanond to turn this research into its

final shape with their kindness critique

Perhaps the most important is the courage from my parents Mr Peng Han-Qing

and Mrs Nancy Pen whose comfort and support always keep me wrestling with all hard

times Of course my appreciation goes to all my friends whose sharing ideas and

comments are woven into the research I wish I could express my sincerely thanks for how

they have enriched my life

Peng Fang-Fang

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TABLE OF CONTENTS

Page ENGLISH ABSTRACT iv

THAI ABSTRACT vi

ACKNOWLEDGEMENTS viii

TABLE OF CONTENTShelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip xi

LIST OF ABBREVIATION helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip xii

LIST OF TABLES xiv

LIST OF FIGURES helliphelliphellip xv

Chapter 1 Introduction 1

State of the Problems 5 Objectives of the Study 6

Expected Benefits 7 Scope and limitations 7 Operation Definition 7 Organization of the Study 9

2 Literature Review 10 Traditional Performance Measures 11 Value-Based Management (VBM) 13 Market Value Added (MVA) 15

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TABLE OF CONTENTS (COUNTINUED)

Chapter Page From MVA to EVA 16 Economic Value Added (EVA)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 18 The Originsndash Residual Income (RI)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 17 The EVA Metric helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 19 The Elements of EVA helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 21 Accounting Adjustmentshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 24 Advantages and Disadvantageshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 26 Related Research helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 33 Research in support of EVA as the best driver of MVAhelliphelliphelliphelliphelliphellip 33 Criticisms of EVA and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 37

3 Research Methodology 42 Conceptual Frameworkhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 43 Research Designhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44 Population helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44 Data Collectionhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 45

Hypotheseshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 49 Data Analysishelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 50

4 Results of Analysis hellip 52 Analyze the innovation measure ndashEVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 56

Analyze the traditional measures (EPS ROA and ROE) helliphelliphellip 58 The results of all independent variableshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 59

5 Conclusion Discussion and Suggestion 62 Conclusion helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 62

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TABLE OF CONTENTS (COUNTINED)

Page

Discussion helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 65 Limitations of this study helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 68 Suggestions for further study helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 68 BIBLIOGRAPHY 71

APPENDICES 85

A Market Capital from 2003-2008 on SET 86 B Company Profile 87 C Statistics Analysis Resultshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 92

BIOGRAPHY 105

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LIST OF ABBREVIATION

Capital asset pricing model CAPM

Cash flow return on investment CFROI

Discounted cash flow DCF

Dividends per share DPS

Earnings before interest and taxes EBIT

EBIT plus depreciation and amortization EBITDA

Earnings per share EPS

Economic Value Added EVA

Free cash flow FCF

Market Value Added MVA

Net income NI

Net operation profit after tax NOPAT

Profit after tax PAT

Residual income RI

Return on total assets ROA

Return on common equity ROE

Return on investment ROI

Return on invested capital ROIC

Return on net worth RONW

Return on sales ROS

Weighted average cost of capital WACC

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xiv

LIST OF TABLES Table Page 21 Accounting items under GAAP and adjustments in EVA method

Young and OrsquoByrne (2001)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 25

22 The relationship between EVA and other financial performance measures

Stern (1993)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 34

23 The relationship between EVA and other financial performance measures

Uyemura Kantor and Pettit (1996)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 35

32 A Regular Balance Sheet vs The EVA Balance Sheet helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 48

41 Descriptive statistics matrix of this study (2006Q4-2008Q3)helliphelliphelliphelliphelliphelliphelliphelliphelliphellip 53

42 Comparison of average MVA and EVA helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 54

43 Correlation statistics matrix of this study (2006Q4-2008Q3)helliphelliphelliphelliphelliphelliphelliphelliphellip 55

44 Summary of regression matrix between EVA and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 56

45 Selected coefficients for total sample EGCO RATCH and PTTEPhelliphelliphelliphelliphelliphellip 57

46 Summary of regression matrix between traditional accounting measures

and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 58

47 Summary of regression matrix MVA depends on all independent variableshelliphelliphelliphellip 59

48 Summary of regression matrix between all variables for each companyhelliphelliphelliphellip 60

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LIST OF FIGURES Figure Page 11 Market Capitalization on SET (2003-2008) helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 6

21 A typical bonus plan helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 28

22 The EVA bonus plan helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 29

31 The conceptual frameworkhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44

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CHAPTER 1

INTRODUCTION

11 Introduction In the 1980rsquos while investors started to express interest in stock market the publicly

listed companies had to pursue the creation of value for their shareholders as the most

significant goal Many different interpretations of shareholder-value seem to wildly exist

throughout the public discussion and the press Although chairmen of big corporations have

taken up the talk of aiming at an increase of shareholder value they have not made exactly

clear how they will attempt to reach this goal or how success on this step shall be

measured (Young and OrsquoByrne 2001) Thus the rapid changes have led to a general

dissatisfaction with traditional performance measures (Needly et al 1999) new

mechanisms for measuring value have been created For example John Kay (1993)

developed the concept of Valued Added which measures the different between the

comprehensively accounted valued of the input and the output of a firm And one of the

most popular mechanisms is Economic Value Added (EVA) which increases transparency

for investors and managers developed and trademarked by a US-based consulting firm

called Stern Stewart amp Co

Stern Stewart amp Co launched the concept in order to motivate managers and other

employees in 1989 (Stern and Shiely 2001) Stewart revised through numbers of

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accounting adjustments and relabeled EVA in 2001 (Anderson et al 2005) But it

widespread as the financial management and incentive compensation system began with

Fortune Magazine proclaimed EVA asrdquo todayrsquos hottest financial idea and getting hotterrdquordquo

The real key to creating wealthrdquo (September 1993) ldquoA new Way to Find Bargainsrdquo

(December 1996) ldquoAmericarsquos greatest wealth creatorsrdquo(November1997) and even today ldquoA

new way to value the marketrdquo (February2008) the management guru Peter F Drucker

(1993) described it as ldquoa vital measure of total factor productivityrdquo in Harvard Business

Review

Originally in the United States EVA has been ldquoliterally adopted by hundreds of the

leading firms such as Coca-Cola Eli Lilly Quaker Oats AT amp T and the Postal Service in

the United Statesrdquo (Biddle et al 1998) and also by investment banks like Credit Suisse

First Boston or Goldman Sachs have supplements traditional valuation methods with EVA

The CEO of Coca-Cola Roberto Goizuera believed that adopted EVA in turning the firm

become the number one Market Value Added Company when itrsquos stock price increased

form $3 to over $60 in the early 1980s James Meenan the CFO of AT amp T long-term

business declared that EVA has an almost perfect correlation with stock price tracked back

the calculation to 1984 from 1994 and used it to be the lead indicator including ldquopeople and

customer value addedrdquo of their performance measurement

EVA has been world wildly promoted in UK Australia Canada Brazil Germany

Mexico Turkey and France that it has adopted by several international firms (Stern

Steward 1999) For example the ABSA Banking Group in South Africa

(Weldeghiorgis 2004) the ANZ Banking Group Fletcher Challenge Limited James Hardie

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Industries and the Wrighton Group in Australia have implemented EVA for many years

(Rennie1997) Furthermore the big European conglomerated such as Siemens has put

EVA to completely change the company since introduced there in 1998 and lately more

spreading to Latin American and Asia (Young and OrsquoByrne 2001)

In Asia the Japanrsquos financial magazine Toyokeizai mentioned that EVA is not only

a financial tool but also a mind-set creator for the managers and employees Many

international firms were actively to implement it such as Kao Corporation Asahi Kasei Kirin

BeerSonyhellipetc(Toyokeizai magazine 2000) In China state-owned assets supervision

and administration commission of Peoplersquos Government announced in the upcoming 2010

EVA will be one of the evaluation standards for senior managers (China Business News

2008)

The concept of EVA is definitely not new EVA is a modified computation of residual

income with a series of accounting adjustments to how one calculates income and capital

EVA is the net operation minus an appropriate charge for the ldquoopportunity costrdquo which

means the cost of capital by Stewart in an enterprise or projects (Maumlkelaumlinen and Roztocki

1998) In addition Stewart (1991) claimed that EVA is not only the financial measure

which comes closer than any other to capturing the true economic profit of an enterprise

but also the performance measure most directly linked to the creation of shareholder wealth

over time Stewart (1994) also stated that ldquoEVA stands well out from the crowed as the

single best measure of wealth creation on a contemporaneous basis and is almost 50

better than its closer accounting-based competitors in explaining changed in shareholders

wealthrdquo

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EVA basically stands for appeal to common sense although underlying application

can be complex But it is the way to show what ldquovaluerdquo was made from what capital was

used By using EVA is to help the firm to achieve more with as little capital as necessary

which points managers and firms toward efficiency It transforms employees into

entrepreneurs via incentive complementation and just simplest application needs commonly

financial statements

Managers can also used EVA as a diagnostic likely tool to show which one of the

departments needs more work to increase a firmrsquos value for the next period (Maumlkelaumlinen amp

Roztocki 1998) In short the EVA management system covers all managerial decisions

including strategic planning capital allocating setting day-to-day operating decisions

There is no absolute perfect measurement tool EVA also has its critics In fact EVA

is not constrained by the Generally Accepted Accounted Principle (or GAAP) Some experts

suggested that EVA is not the best choice for all companies which is not universal suitable

since it has no official standards about using the metric (Lars amp Clas 2001) OrsquoHanlon and

Peasnell (1966) stated that EVA provides a valuable transformation from wrong accounting

numbers into correct estimates of value But there is no theory to guide how to select

accounting adjustment of the most relevant items which depend on the financial structure

and industrial nature (Anderson et al 2005)

Brewer (1999) mentioned that ldquosize differencesrdquo across plants or division will effects

the EVA It is based on financial accounting method it is possible manipulated by

managers EVA provides immediate results which diminish innovation moreover it offers no

solutions in much the same way as historical financial statements do

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12 Statement of Problems Energy is one of the key factors to several economic movements Without it the

worldrsquos entire industrialized infrastructure would collapse (Liseadiratanakul and Uarkarn

2008) Moreover the opportunity that people would stop using oil natural gas or other

substitutions in next 10 years will not too much Therefore energy business would not be

disappeared (Vibul Perngprasert 2006)

As Asian economies bloomed their energy consumption grew by similar proportions

it will be the worldrsquos largest consumer of primary energy in the near year of 2010 (R

Manning 2000) In South Asia Thailand is considered to be the biggest consumer

Recently the total energy expenditure amounted closely to 17 of the GDP

In the past security in energy sector were mostly affected the performance of Thai

stock market Last year the resource sector including energy and mining industries had

also the highest capital which is 35 of all equity market The director of AWR Lloyd

(mining energy and metals advisory) Alexander Wood (2008) pointed out that by the year-

end of 2007 after generating total shareholder returns of around 70 the listed energy

sector had a total market capitalization around 25 trillion baht which is approximately 40

of the total equity capitalization of the entire Thai stock market Market capital data on SET

from 2003 to 2008 are compared shown as Figure 11 (Market capital data on SET from

2003 to 2008 is attached in Appendix A)

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6

000

50000000

100000000

150000000

200000000

250000000

Jan - Dec Jan - Dec Jan - Dec Jan - Dec Jan - Dec Jan - Dec

2008 2007 2006 2005 2004 2003

Period

Mill

ion

Baht

AgroConsumpFincialIndusPropconResourcServiceTech

Figure 11 Market Capitalizations on SET (2003-2008)

Source SET index

An emerging literature of analyze whether EVA is highly associated with stock

returns than traditional performance measures has addressed the empirical issue Tully

(1993) claimed that EVA has significant relationship with stock price returns and both are

remarkable tendency Some even claimed traditional accounting measures were inadequate

measures of a firmrsquos performance

So far there are few EVA relevant studies in Thailand covering the energy sector

Consequently this is an opportunity to begin a research in this area

13 Objectives of the Study The purpose of this study is to develop and test EVA as the performance measure in

the decision-making of investment by the management and in evaluation the future

performance of stock by the investor like Stern Stewart amp Co claimed The objectives of

this research are as follow

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1 To investigate if EVA can be suitable for applying to the Thai energy sector

2 Moreover to investigate if EVA can better affect the operational performance of

Thai energy sector than the traditional performance index (including EPS ROA and ROE)

in explaining Market Value Added( MVA) thereby stock returns

14 Expected Benefits 1 A better understanding of calculating EVA and MVA

2 International firms can take the finding of this study as a reference compared

between innovation measure - EVA and traditional performance measures

3 To make more investors sophisticate about the comprehension of EVA and MVA

as a practical tool of stock market investing

15 Scope and limitations

The sample firms are listed on the Stock Exchange of Thailand (SET) and are

gathered the quarterly financial reports in twenty quarters within the same organization and

cross the firms within the energy sector Assuming that the equity markets are efficient

eight companies of Thai energy sector is selected and completely qualified would be

employed in the empirical study

However due to the scope of the problem this research is obliged to make

limitations

16 Operation Definitions

Capital Asset Pricing Model (CAPM) - A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities

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Net Operating Profit After Tax (NOPAT) - The profit a company would generate if it had no debt and held only operating asset

Earnings before Interest and Taxes (EBIT) - When comparing companyrsquos operating performances it is essential to focus on their earnings before deducing taxes and interest payments And it is often referred to as operation income

Earning per share (EPS) - It is a bottom-line to denote that of all items on the income statement EPS shows that a companys profit allocated to each outstanding share of common stock EPS serves as an indicator of a companys profitability

Weighted Average Cost of Capital (WACC) ndash A weighted average of the component costs of debt preferred stock and common equity

Invested Capital - represents the total cash investment that shareholders and debt holders have made in a company

Economic Value Added (EVA) - The EVA is a registered trademark by its developer Stern Stewart amp Co that is an estimate of true economic profit after making corrective adjustments to GAAP accounting EVA can be measured as Net Operating Profit after Taxes (NOPAT) less the cost of capital

Market Value Added (MVA) ndash A measure to directly reflect the creation of shareholder value developed by Stern Stewart amp Co It shows the difference between the market value of a firmrsquos equity and the book value as shown on the balance sheet with market value found by multiplying the stock price by the number of shares outstanding Return on Total Assets (ROA) ndash The ratio of net income to total assets after interest and taxes Return in Common Equity (ROE) ndash The ratio of a fiscal years net income to common equity measures the rate of return on common stockholdersrsquo investment

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THESIS APPROVAL GRADUATE SCHOOL

Master of Business Administration

Degree International Business

Major Field

THE RELATIONSHIP BETWEEN ECONOMIC VALUE ADDED AND STOCK PRICE RETURN IN THAI ENERGY SECTOR

Peng Fang-Fang 2008

Name Graduation Year

Accepted by the Graduate School University of the Thai Chamber of Commerce in Partial Fulfillment of the Requirements for the Masterrsquos Degree

Dean Graduate School (Dr Ekachai Apisakkul)

Thesis Committee

Chairperson

(Dr Phusit Wonglorsaichon)

Thesis Advisor (Dr Kittiphun Khongsawatkiat)

helliphellip Thesis Co-Advisor (Dr Thasana Boonkwan)

helliphellip Member

(Dr Pussadee Polsaram)

External Committee

(Assoc Prof Sriaroon Resanond)

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Thesis Title The Relationship between Economic Value Added and Stock Price Returns in Thai Energy Sector

Name Peng Fang-Fang Degree Master of Business Administration Major Field International Business Thesis Advisor Dr Kittiphun Khongsawatkiat Thesis Co-Advisor Dr Thasana Boonkwan Graduation Year 2008

ABSTRACT

In the eighties the rapid changes have led to a general dissatisfaction with traditional

performance measures One of the most popular mechanisms is Economic Value Added

(EVA) has been created by a US-based consulting firm called Stern Stewart amp Co The

company claimed that EVA can increase transparency for investors and managers

developed and trademarked Stern Stewart amp Co launched the concept of EVA and it

widespread as the financial management and incentive compensation system EVA has

been literally adopted by thousands of the leading firms all around the world EVA is not

constrained by the Generally Accepted Accounted Principle (or GAAP) so it also has its

critics Some experts suggested that EVA is not the best choice

An emerging literature of analyze whether EVA is highly associated with stock returns

than traditional performance measures has addressed the empirical issue Until now there

are only few EVA relevant studies in Thailand Thus this is an opportunity to

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All rig

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serve

d

iv

start a research in this field The purpose of this study is to investigate if EVA can be

suitable for applying to the Thai energy sector which is were mostly affected the

performance of the Stock Exchange of Thailand (SET) and to investigate if EVA can

better affect the operational performance than the traditional performance index

(including EPS ROA and ROE) in explaining Market Value Added (MVA) thereby

stock returns

The evidence of this research shows that EVA may not be suitable for applying to

the Thai energy sector the correlation of MVA depends on all variables show EPS has

the most significant relevance and finally one is EVA EVA has relationship with MVA

but can not affect MVA by regression analysis Thus EVA is not a superior

performance measure in explaining market price returns compared with traditional

performance index of the Thai energy sector However the researcher suggests that

any managers shareholders and participants can use EVA as an assistant tool with

traditional performance measures instant of replacing anyone

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viii

ACKNOWLEDGEMENTS I would like to express my gratitude to the people who have played especially

important role in the development of this research First of all let me pay my deepest

acknowledgement to my supervisors DrKittiphun Khongsawatkiat and Dr Thassna

Boonkwan for their valuable advice and recommendations The excellent research method

course taught by Dr Phusit Wonglorsaichon helps me out Next I need to single out my

key thinking partner MrWeera Weerakhajornsak for his professional directions and

generous contributions Also I acknowledge all committees Dr Phusit Wonglorsaichon Dr

Pussadee Polsaram and Assoc Prof Sriaroon Resanond to turn this research into its

final shape with their kindness critique

Perhaps the most important is the courage from my parents Mr Peng Han-Qing

and Mrs Nancy Pen whose comfort and support always keep me wrestling with all hard

times Of course my appreciation goes to all my friends whose sharing ideas and

comments are woven into the research I wish I could express my sincerely thanks for how

they have enriched my life

Peng Fang-Fang

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TABLE OF CONTENTS

Page ENGLISH ABSTRACT iv

THAI ABSTRACT vi

ACKNOWLEDGEMENTS viii

TABLE OF CONTENTShelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip xi

LIST OF ABBREVIATION helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip xii

LIST OF TABLES xiv

LIST OF FIGURES helliphelliphellip xv

Chapter 1 Introduction 1

State of the Problems 5 Objectives of the Study 6

Expected Benefits 7 Scope and limitations 7 Operation Definition 7 Organization of the Study 9

2 Literature Review 10 Traditional Performance Measures 11 Value-Based Management (VBM) 13 Market Value Added (MVA) 15

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TABLE OF CONTENTS (COUNTINUED)

Chapter Page From MVA to EVA 16 Economic Value Added (EVA)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 18 The Originsndash Residual Income (RI)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 17 The EVA Metric helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 19 The Elements of EVA helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 21 Accounting Adjustmentshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 24 Advantages and Disadvantageshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 26 Related Research helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 33 Research in support of EVA as the best driver of MVAhelliphelliphelliphelliphelliphellip 33 Criticisms of EVA and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 37

3 Research Methodology 42 Conceptual Frameworkhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 43 Research Designhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44 Population helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44 Data Collectionhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 45

Hypotheseshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 49 Data Analysishelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 50

4 Results of Analysis hellip 52 Analyze the innovation measure ndashEVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 56

Analyze the traditional measures (EPS ROA and ROE) helliphelliphellip 58 The results of all independent variableshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 59

5 Conclusion Discussion and Suggestion 62 Conclusion helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 62

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TABLE OF CONTENTS (COUNTINED)

Page

Discussion helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 65 Limitations of this study helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 68 Suggestions for further study helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 68 BIBLIOGRAPHY 71

APPENDICES 85

A Market Capital from 2003-2008 on SET 86 B Company Profile 87 C Statistics Analysis Resultshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 92

BIOGRAPHY 105

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xii

LIST OF ABBREVIATION

Capital asset pricing model CAPM

Cash flow return on investment CFROI

Discounted cash flow DCF

Dividends per share DPS

Earnings before interest and taxes EBIT

EBIT plus depreciation and amortization EBITDA

Earnings per share EPS

Economic Value Added EVA

Free cash flow FCF

Market Value Added MVA

Net income NI

Net operation profit after tax NOPAT

Profit after tax PAT

Residual income RI

Return on total assets ROA

Return on common equity ROE

Return on investment ROI

Return on invested capital ROIC

Return on net worth RONW

Return on sales ROS

Weighted average cost of capital WACC

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xiv

LIST OF TABLES Table Page 21 Accounting items under GAAP and adjustments in EVA method

Young and OrsquoByrne (2001)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 25

22 The relationship between EVA and other financial performance measures

Stern (1993)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 34

23 The relationship between EVA and other financial performance measures

Uyemura Kantor and Pettit (1996)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 35

32 A Regular Balance Sheet vs The EVA Balance Sheet helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 48

41 Descriptive statistics matrix of this study (2006Q4-2008Q3)helliphelliphelliphelliphelliphelliphelliphelliphelliphellip 53

42 Comparison of average MVA and EVA helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 54

43 Correlation statistics matrix of this study (2006Q4-2008Q3)helliphelliphelliphelliphelliphelliphelliphelliphellip 55

44 Summary of regression matrix between EVA and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 56

45 Selected coefficients for total sample EGCO RATCH and PTTEPhelliphelliphelliphelliphelliphellip 57

46 Summary of regression matrix between traditional accounting measures

and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 58

47 Summary of regression matrix MVA depends on all independent variableshelliphelliphelliphellip 59

48 Summary of regression matrix between all variables for each companyhelliphelliphelliphellip 60

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LIST OF FIGURES Figure Page 11 Market Capitalization on SET (2003-2008) helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 6

21 A typical bonus plan helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 28

22 The EVA bonus plan helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 29

31 The conceptual frameworkhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44

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1

CHAPTER 1

INTRODUCTION

11 Introduction In the 1980rsquos while investors started to express interest in stock market the publicly

listed companies had to pursue the creation of value for their shareholders as the most

significant goal Many different interpretations of shareholder-value seem to wildly exist

throughout the public discussion and the press Although chairmen of big corporations have

taken up the talk of aiming at an increase of shareholder value they have not made exactly

clear how they will attempt to reach this goal or how success on this step shall be

measured (Young and OrsquoByrne 2001) Thus the rapid changes have led to a general

dissatisfaction with traditional performance measures (Needly et al 1999) new

mechanisms for measuring value have been created For example John Kay (1993)

developed the concept of Valued Added which measures the different between the

comprehensively accounted valued of the input and the output of a firm And one of the

most popular mechanisms is Economic Value Added (EVA) which increases transparency

for investors and managers developed and trademarked by a US-based consulting firm

called Stern Stewart amp Co

Stern Stewart amp Co launched the concept in order to motivate managers and other

employees in 1989 (Stern and Shiely 2001) Stewart revised through numbers of

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accounting adjustments and relabeled EVA in 2001 (Anderson et al 2005) But it

widespread as the financial management and incentive compensation system began with

Fortune Magazine proclaimed EVA asrdquo todayrsquos hottest financial idea and getting hotterrdquordquo

The real key to creating wealthrdquo (September 1993) ldquoA new Way to Find Bargainsrdquo

(December 1996) ldquoAmericarsquos greatest wealth creatorsrdquo(November1997) and even today ldquoA

new way to value the marketrdquo (February2008) the management guru Peter F Drucker

(1993) described it as ldquoa vital measure of total factor productivityrdquo in Harvard Business

Review

Originally in the United States EVA has been ldquoliterally adopted by hundreds of the

leading firms such as Coca-Cola Eli Lilly Quaker Oats AT amp T and the Postal Service in

the United Statesrdquo (Biddle et al 1998) and also by investment banks like Credit Suisse

First Boston or Goldman Sachs have supplements traditional valuation methods with EVA

The CEO of Coca-Cola Roberto Goizuera believed that adopted EVA in turning the firm

become the number one Market Value Added Company when itrsquos stock price increased

form $3 to over $60 in the early 1980s James Meenan the CFO of AT amp T long-term

business declared that EVA has an almost perfect correlation with stock price tracked back

the calculation to 1984 from 1994 and used it to be the lead indicator including ldquopeople and

customer value addedrdquo of their performance measurement

EVA has been world wildly promoted in UK Australia Canada Brazil Germany

Mexico Turkey and France that it has adopted by several international firms (Stern

Steward 1999) For example the ABSA Banking Group in South Africa

(Weldeghiorgis 2004) the ANZ Banking Group Fletcher Challenge Limited James Hardie

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Industries and the Wrighton Group in Australia have implemented EVA for many years

(Rennie1997) Furthermore the big European conglomerated such as Siemens has put

EVA to completely change the company since introduced there in 1998 and lately more

spreading to Latin American and Asia (Young and OrsquoByrne 2001)

In Asia the Japanrsquos financial magazine Toyokeizai mentioned that EVA is not only

a financial tool but also a mind-set creator for the managers and employees Many

international firms were actively to implement it such as Kao Corporation Asahi Kasei Kirin

BeerSonyhellipetc(Toyokeizai magazine 2000) In China state-owned assets supervision

and administration commission of Peoplersquos Government announced in the upcoming 2010

EVA will be one of the evaluation standards for senior managers (China Business News

2008)

The concept of EVA is definitely not new EVA is a modified computation of residual

income with a series of accounting adjustments to how one calculates income and capital

EVA is the net operation minus an appropriate charge for the ldquoopportunity costrdquo which

means the cost of capital by Stewart in an enterprise or projects (Maumlkelaumlinen and Roztocki

1998) In addition Stewart (1991) claimed that EVA is not only the financial measure

which comes closer than any other to capturing the true economic profit of an enterprise

but also the performance measure most directly linked to the creation of shareholder wealth

over time Stewart (1994) also stated that ldquoEVA stands well out from the crowed as the

single best measure of wealth creation on a contemporaneous basis and is almost 50

better than its closer accounting-based competitors in explaining changed in shareholders

wealthrdquo

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EVA basically stands for appeal to common sense although underlying application

can be complex But it is the way to show what ldquovaluerdquo was made from what capital was

used By using EVA is to help the firm to achieve more with as little capital as necessary

which points managers and firms toward efficiency It transforms employees into

entrepreneurs via incentive complementation and just simplest application needs commonly

financial statements

Managers can also used EVA as a diagnostic likely tool to show which one of the

departments needs more work to increase a firmrsquos value for the next period (Maumlkelaumlinen amp

Roztocki 1998) In short the EVA management system covers all managerial decisions

including strategic planning capital allocating setting day-to-day operating decisions

There is no absolute perfect measurement tool EVA also has its critics In fact EVA

is not constrained by the Generally Accepted Accounted Principle (or GAAP) Some experts

suggested that EVA is not the best choice for all companies which is not universal suitable

since it has no official standards about using the metric (Lars amp Clas 2001) OrsquoHanlon and

Peasnell (1966) stated that EVA provides a valuable transformation from wrong accounting

numbers into correct estimates of value But there is no theory to guide how to select

accounting adjustment of the most relevant items which depend on the financial structure

and industrial nature (Anderson et al 2005)

Brewer (1999) mentioned that ldquosize differencesrdquo across plants or division will effects

the EVA It is based on financial accounting method it is possible manipulated by

managers EVA provides immediate results which diminish innovation moreover it offers no

solutions in much the same way as historical financial statements do

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12 Statement of Problems Energy is one of the key factors to several economic movements Without it the

worldrsquos entire industrialized infrastructure would collapse (Liseadiratanakul and Uarkarn

2008) Moreover the opportunity that people would stop using oil natural gas or other

substitutions in next 10 years will not too much Therefore energy business would not be

disappeared (Vibul Perngprasert 2006)

As Asian economies bloomed their energy consumption grew by similar proportions

it will be the worldrsquos largest consumer of primary energy in the near year of 2010 (R

Manning 2000) In South Asia Thailand is considered to be the biggest consumer

Recently the total energy expenditure amounted closely to 17 of the GDP

In the past security in energy sector were mostly affected the performance of Thai

stock market Last year the resource sector including energy and mining industries had

also the highest capital which is 35 of all equity market The director of AWR Lloyd

(mining energy and metals advisory) Alexander Wood (2008) pointed out that by the year-

end of 2007 after generating total shareholder returns of around 70 the listed energy

sector had a total market capitalization around 25 trillion baht which is approximately 40

of the total equity capitalization of the entire Thai stock market Market capital data on SET

from 2003 to 2008 are compared shown as Figure 11 (Market capital data on SET from

2003 to 2008 is attached in Appendix A)

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6

000

50000000

100000000

150000000

200000000

250000000

Jan - Dec Jan - Dec Jan - Dec Jan - Dec Jan - Dec Jan - Dec

2008 2007 2006 2005 2004 2003

Period

Mill

ion

Baht

AgroConsumpFincialIndusPropconResourcServiceTech

Figure 11 Market Capitalizations on SET (2003-2008)

Source SET index

An emerging literature of analyze whether EVA is highly associated with stock

returns than traditional performance measures has addressed the empirical issue Tully

(1993) claimed that EVA has significant relationship with stock price returns and both are

remarkable tendency Some even claimed traditional accounting measures were inadequate

measures of a firmrsquos performance

So far there are few EVA relevant studies in Thailand covering the energy sector

Consequently this is an opportunity to begin a research in this area

13 Objectives of the Study The purpose of this study is to develop and test EVA as the performance measure in

the decision-making of investment by the management and in evaluation the future

performance of stock by the investor like Stern Stewart amp Co claimed The objectives of

this research are as follow

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1 To investigate if EVA can be suitable for applying to the Thai energy sector

2 Moreover to investigate if EVA can better affect the operational performance of

Thai energy sector than the traditional performance index (including EPS ROA and ROE)

in explaining Market Value Added( MVA) thereby stock returns

14 Expected Benefits 1 A better understanding of calculating EVA and MVA

2 International firms can take the finding of this study as a reference compared

between innovation measure - EVA and traditional performance measures

3 To make more investors sophisticate about the comprehension of EVA and MVA

as a practical tool of stock market investing

15 Scope and limitations

The sample firms are listed on the Stock Exchange of Thailand (SET) and are

gathered the quarterly financial reports in twenty quarters within the same organization and

cross the firms within the energy sector Assuming that the equity markets are efficient

eight companies of Thai energy sector is selected and completely qualified would be

employed in the empirical study

However due to the scope of the problem this research is obliged to make

limitations

16 Operation Definitions

Capital Asset Pricing Model (CAPM) - A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities

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Net Operating Profit After Tax (NOPAT) - The profit a company would generate if it had no debt and held only operating asset

Earnings before Interest and Taxes (EBIT) - When comparing companyrsquos operating performances it is essential to focus on their earnings before deducing taxes and interest payments And it is often referred to as operation income

Earning per share (EPS) - It is a bottom-line to denote that of all items on the income statement EPS shows that a companys profit allocated to each outstanding share of common stock EPS serves as an indicator of a companys profitability

Weighted Average Cost of Capital (WACC) ndash A weighted average of the component costs of debt preferred stock and common equity

Invested Capital - represents the total cash investment that shareholders and debt holders have made in a company

Economic Value Added (EVA) - The EVA is a registered trademark by its developer Stern Stewart amp Co that is an estimate of true economic profit after making corrective adjustments to GAAP accounting EVA can be measured as Net Operating Profit after Taxes (NOPAT) less the cost of capital

Market Value Added (MVA) ndash A measure to directly reflect the creation of shareholder value developed by Stern Stewart amp Co It shows the difference between the market value of a firmrsquos equity and the book value as shown on the balance sheet with market value found by multiplying the stock price by the number of shares outstanding Return on Total Assets (ROA) ndash The ratio of net income to total assets after interest and taxes Return in Common Equity (ROE) ndash The ratio of a fiscal years net income to common equity measures the rate of return on common stockholdersrsquo investment

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Thesis Title The Relationship between Economic Value Added and Stock Price Returns in Thai Energy Sector

Name Peng Fang-Fang Degree Master of Business Administration Major Field International Business Thesis Advisor Dr Kittiphun Khongsawatkiat Thesis Co-Advisor Dr Thasana Boonkwan Graduation Year 2008

ABSTRACT

In the eighties the rapid changes have led to a general dissatisfaction with traditional

performance measures One of the most popular mechanisms is Economic Value Added

(EVA) has been created by a US-based consulting firm called Stern Stewart amp Co The

company claimed that EVA can increase transparency for investors and managers

developed and trademarked Stern Stewart amp Co launched the concept of EVA and it

widespread as the financial management and incentive compensation system EVA has

been literally adopted by thousands of the leading firms all around the world EVA is not

constrained by the Generally Accepted Accounted Principle (or GAAP) so it also has its

critics Some experts suggested that EVA is not the best choice

An emerging literature of analyze whether EVA is highly associated with stock returns

than traditional performance measures has addressed the empirical issue Until now there

are only few EVA relevant studies in Thailand Thus this is an opportunity to

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iv

start a research in this field The purpose of this study is to investigate if EVA can be

suitable for applying to the Thai energy sector which is were mostly affected the

performance of the Stock Exchange of Thailand (SET) and to investigate if EVA can

better affect the operational performance than the traditional performance index

(including EPS ROA and ROE) in explaining Market Value Added (MVA) thereby

stock returns

The evidence of this research shows that EVA may not be suitable for applying to

the Thai energy sector the correlation of MVA depends on all variables show EPS has

the most significant relevance and finally one is EVA EVA has relationship with MVA

but can not affect MVA by regression analysis Thus EVA is not a superior

performance measure in explaining market price returns compared with traditional

performance index of the Thai energy sector However the researcher suggests that

any managers shareholders and participants can use EVA as an assistant tool with

traditional performance measures instant of replacing anyone

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ACKNOWLEDGEMENTS I would like to express my gratitude to the people who have played especially

important role in the development of this research First of all let me pay my deepest

acknowledgement to my supervisors DrKittiphun Khongsawatkiat and Dr Thassna

Boonkwan for their valuable advice and recommendations The excellent research method

course taught by Dr Phusit Wonglorsaichon helps me out Next I need to single out my

key thinking partner MrWeera Weerakhajornsak for his professional directions and

generous contributions Also I acknowledge all committees Dr Phusit Wonglorsaichon Dr

Pussadee Polsaram and Assoc Prof Sriaroon Resanond to turn this research into its

final shape with their kindness critique

Perhaps the most important is the courage from my parents Mr Peng Han-Qing

and Mrs Nancy Pen whose comfort and support always keep me wrestling with all hard

times Of course my appreciation goes to all my friends whose sharing ideas and

comments are woven into the research I wish I could express my sincerely thanks for how

they have enriched my life

Peng Fang-Fang

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TABLE OF CONTENTS

Page ENGLISH ABSTRACT iv

THAI ABSTRACT vi

ACKNOWLEDGEMENTS viii

TABLE OF CONTENTShelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip xi

LIST OF ABBREVIATION helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip xii

LIST OF TABLES xiv

LIST OF FIGURES helliphelliphellip xv

Chapter 1 Introduction 1

State of the Problems 5 Objectives of the Study 6

Expected Benefits 7 Scope and limitations 7 Operation Definition 7 Organization of the Study 9

2 Literature Review 10 Traditional Performance Measures 11 Value-Based Management (VBM) 13 Market Value Added (MVA) 15

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TABLE OF CONTENTS (COUNTINUED)

Chapter Page From MVA to EVA 16 Economic Value Added (EVA)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 18 The Originsndash Residual Income (RI)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 17 The EVA Metric helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 19 The Elements of EVA helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 21 Accounting Adjustmentshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 24 Advantages and Disadvantageshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 26 Related Research helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 33 Research in support of EVA as the best driver of MVAhelliphelliphelliphelliphelliphellip 33 Criticisms of EVA and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 37

3 Research Methodology 42 Conceptual Frameworkhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 43 Research Designhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44 Population helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44 Data Collectionhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 45

Hypotheseshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 49 Data Analysishelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 50

4 Results of Analysis hellip 52 Analyze the innovation measure ndashEVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 56

Analyze the traditional measures (EPS ROA and ROE) helliphelliphellip 58 The results of all independent variableshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 59

5 Conclusion Discussion and Suggestion 62 Conclusion helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 62

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TABLE OF CONTENTS (COUNTINED)

Page

Discussion helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 65 Limitations of this study helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 68 Suggestions for further study helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 68 BIBLIOGRAPHY 71

APPENDICES 85

A Market Capital from 2003-2008 on SET 86 B Company Profile 87 C Statistics Analysis Resultshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 92

BIOGRAPHY 105

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xii

LIST OF ABBREVIATION

Capital asset pricing model CAPM

Cash flow return on investment CFROI

Discounted cash flow DCF

Dividends per share DPS

Earnings before interest and taxes EBIT

EBIT plus depreciation and amortization EBITDA

Earnings per share EPS

Economic Value Added EVA

Free cash flow FCF

Market Value Added MVA

Net income NI

Net operation profit after tax NOPAT

Profit after tax PAT

Residual income RI

Return on total assets ROA

Return on common equity ROE

Return on investment ROI

Return on invested capital ROIC

Return on net worth RONW

Return on sales ROS

Weighted average cost of capital WACC

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xiv

LIST OF TABLES Table Page 21 Accounting items under GAAP and adjustments in EVA method

Young and OrsquoByrne (2001)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 25

22 The relationship between EVA and other financial performance measures

Stern (1993)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 34

23 The relationship between EVA and other financial performance measures

Uyemura Kantor and Pettit (1996)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 35

32 A Regular Balance Sheet vs The EVA Balance Sheet helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 48

41 Descriptive statistics matrix of this study (2006Q4-2008Q3)helliphelliphelliphelliphelliphelliphelliphelliphelliphellip 53

42 Comparison of average MVA and EVA helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 54

43 Correlation statistics matrix of this study (2006Q4-2008Q3)helliphelliphelliphelliphelliphelliphelliphelliphellip 55

44 Summary of regression matrix between EVA and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 56

45 Selected coefficients for total sample EGCO RATCH and PTTEPhelliphelliphelliphelliphelliphellip 57

46 Summary of regression matrix between traditional accounting measures

and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 58

47 Summary of regression matrix MVA depends on all independent variableshelliphelliphelliphellip 59

48 Summary of regression matrix between all variables for each companyhelliphelliphelliphellip 60

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xv

LIST OF FIGURES Figure Page 11 Market Capitalization on SET (2003-2008) helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 6

21 A typical bonus plan helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 28

22 The EVA bonus plan helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 29

31 The conceptual frameworkhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44

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CHAPTER 1

INTRODUCTION

11 Introduction In the 1980rsquos while investors started to express interest in stock market the publicly

listed companies had to pursue the creation of value for their shareholders as the most

significant goal Many different interpretations of shareholder-value seem to wildly exist

throughout the public discussion and the press Although chairmen of big corporations have

taken up the talk of aiming at an increase of shareholder value they have not made exactly

clear how they will attempt to reach this goal or how success on this step shall be

measured (Young and OrsquoByrne 2001) Thus the rapid changes have led to a general

dissatisfaction with traditional performance measures (Needly et al 1999) new

mechanisms for measuring value have been created For example John Kay (1993)

developed the concept of Valued Added which measures the different between the

comprehensively accounted valued of the input and the output of a firm And one of the

most popular mechanisms is Economic Value Added (EVA) which increases transparency

for investors and managers developed and trademarked by a US-based consulting firm

called Stern Stewart amp Co

Stern Stewart amp Co launched the concept in order to motivate managers and other

employees in 1989 (Stern and Shiely 2001) Stewart revised through numbers of

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accounting adjustments and relabeled EVA in 2001 (Anderson et al 2005) But it

widespread as the financial management and incentive compensation system began with

Fortune Magazine proclaimed EVA asrdquo todayrsquos hottest financial idea and getting hotterrdquordquo

The real key to creating wealthrdquo (September 1993) ldquoA new Way to Find Bargainsrdquo

(December 1996) ldquoAmericarsquos greatest wealth creatorsrdquo(November1997) and even today ldquoA

new way to value the marketrdquo (February2008) the management guru Peter F Drucker

(1993) described it as ldquoa vital measure of total factor productivityrdquo in Harvard Business

Review

Originally in the United States EVA has been ldquoliterally adopted by hundreds of the

leading firms such as Coca-Cola Eli Lilly Quaker Oats AT amp T and the Postal Service in

the United Statesrdquo (Biddle et al 1998) and also by investment banks like Credit Suisse

First Boston or Goldman Sachs have supplements traditional valuation methods with EVA

The CEO of Coca-Cola Roberto Goizuera believed that adopted EVA in turning the firm

become the number one Market Value Added Company when itrsquos stock price increased

form $3 to over $60 in the early 1980s James Meenan the CFO of AT amp T long-term

business declared that EVA has an almost perfect correlation with stock price tracked back

the calculation to 1984 from 1994 and used it to be the lead indicator including ldquopeople and

customer value addedrdquo of their performance measurement

EVA has been world wildly promoted in UK Australia Canada Brazil Germany

Mexico Turkey and France that it has adopted by several international firms (Stern

Steward 1999) For example the ABSA Banking Group in South Africa

(Weldeghiorgis 2004) the ANZ Banking Group Fletcher Challenge Limited James Hardie

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Industries and the Wrighton Group in Australia have implemented EVA for many years

(Rennie1997) Furthermore the big European conglomerated such as Siemens has put

EVA to completely change the company since introduced there in 1998 and lately more

spreading to Latin American and Asia (Young and OrsquoByrne 2001)

In Asia the Japanrsquos financial magazine Toyokeizai mentioned that EVA is not only

a financial tool but also a mind-set creator for the managers and employees Many

international firms were actively to implement it such as Kao Corporation Asahi Kasei Kirin

BeerSonyhellipetc(Toyokeizai magazine 2000) In China state-owned assets supervision

and administration commission of Peoplersquos Government announced in the upcoming 2010

EVA will be one of the evaluation standards for senior managers (China Business News

2008)

The concept of EVA is definitely not new EVA is a modified computation of residual

income with a series of accounting adjustments to how one calculates income and capital

EVA is the net operation minus an appropriate charge for the ldquoopportunity costrdquo which

means the cost of capital by Stewart in an enterprise or projects (Maumlkelaumlinen and Roztocki

1998) In addition Stewart (1991) claimed that EVA is not only the financial measure

which comes closer than any other to capturing the true economic profit of an enterprise

but also the performance measure most directly linked to the creation of shareholder wealth

over time Stewart (1994) also stated that ldquoEVA stands well out from the crowed as the

single best measure of wealth creation on a contemporaneous basis and is almost 50

better than its closer accounting-based competitors in explaining changed in shareholders

wealthrdquo

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EVA basically stands for appeal to common sense although underlying application

can be complex But it is the way to show what ldquovaluerdquo was made from what capital was

used By using EVA is to help the firm to achieve more with as little capital as necessary

which points managers and firms toward efficiency It transforms employees into

entrepreneurs via incentive complementation and just simplest application needs commonly

financial statements

Managers can also used EVA as a diagnostic likely tool to show which one of the

departments needs more work to increase a firmrsquos value for the next period (Maumlkelaumlinen amp

Roztocki 1998) In short the EVA management system covers all managerial decisions

including strategic planning capital allocating setting day-to-day operating decisions

There is no absolute perfect measurement tool EVA also has its critics In fact EVA

is not constrained by the Generally Accepted Accounted Principle (or GAAP) Some experts

suggested that EVA is not the best choice for all companies which is not universal suitable

since it has no official standards about using the metric (Lars amp Clas 2001) OrsquoHanlon and

Peasnell (1966) stated that EVA provides a valuable transformation from wrong accounting

numbers into correct estimates of value But there is no theory to guide how to select

accounting adjustment of the most relevant items which depend on the financial structure

and industrial nature (Anderson et al 2005)

Brewer (1999) mentioned that ldquosize differencesrdquo across plants or division will effects

the EVA It is based on financial accounting method it is possible manipulated by

managers EVA provides immediate results which diminish innovation moreover it offers no

solutions in much the same way as historical financial statements do

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12 Statement of Problems Energy is one of the key factors to several economic movements Without it the

worldrsquos entire industrialized infrastructure would collapse (Liseadiratanakul and Uarkarn

2008) Moreover the opportunity that people would stop using oil natural gas or other

substitutions in next 10 years will not too much Therefore energy business would not be

disappeared (Vibul Perngprasert 2006)

As Asian economies bloomed their energy consumption grew by similar proportions

it will be the worldrsquos largest consumer of primary energy in the near year of 2010 (R

Manning 2000) In South Asia Thailand is considered to be the biggest consumer

Recently the total energy expenditure amounted closely to 17 of the GDP

In the past security in energy sector were mostly affected the performance of Thai

stock market Last year the resource sector including energy and mining industries had

also the highest capital which is 35 of all equity market The director of AWR Lloyd

(mining energy and metals advisory) Alexander Wood (2008) pointed out that by the year-

end of 2007 after generating total shareholder returns of around 70 the listed energy

sector had a total market capitalization around 25 trillion baht which is approximately 40

of the total equity capitalization of the entire Thai stock market Market capital data on SET

from 2003 to 2008 are compared shown as Figure 11 (Market capital data on SET from

2003 to 2008 is attached in Appendix A)

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6

000

50000000

100000000

150000000

200000000

250000000

Jan - Dec Jan - Dec Jan - Dec Jan - Dec Jan - Dec Jan - Dec

2008 2007 2006 2005 2004 2003

Period

Mill

ion

Baht

AgroConsumpFincialIndusPropconResourcServiceTech

Figure 11 Market Capitalizations on SET (2003-2008)

Source SET index

An emerging literature of analyze whether EVA is highly associated with stock

returns than traditional performance measures has addressed the empirical issue Tully

(1993) claimed that EVA has significant relationship with stock price returns and both are

remarkable tendency Some even claimed traditional accounting measures were inadequate

measures of a firmrsquos performance

So far there are few EVA relevant studies in Thailand covering the energy sector

Consequently this is an opportunity to begin a research in this area

13 Objectives of the Study The purpose of this study is to develop and test EVA as the performance measure in

the decision-making of investment by the management and in evaluation the future

performance of stock by the investor like Stern Stewart amp Co claimed The objectives of

this research are as follow

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1 To investigate if EVA can be suitable for applying to the Thai energy sector

2 Moreover to investigate if EVA can better affect the operational performance of

Thai energy sector than the traditional performance index (including EPS ROA and ROE)

in explaining Market Value Added( MVA) thereby stock returns

14 Expected Benefits 1 A better understanding of calculating EVA and MVA

2 International firms can take the finding of this study as a reference compared

between innovation measure - EVA and traditional performance measures

3 To make more investors sophisticate about the comprehension of EVA and MVA

as a practical tool of stock market investing

15 Scope and limitations

The sample firms are listed on the Stock Exchange of Thailand (SET) and are

gathered the quarterly financial reports in twenty quarters within the same organization and

cross the firms within the energy sector Assuming that the equity markets are efficient

eight companies of Thai energy sector is selected and completely qualified would be

employed in the empirical study

However due to the scope of the problem this research is obliged to make

limitations

16 Operation Definitions

Capital Asset Pricing Model (CAPM) - A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities

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Net Operating Profit After Tax (NOPAT) - The profit a company would generate if it had no debt and held only operating asset

Earnings before Interest and Taxes (EBIT) - When comparing companyrsquos operating performances it is essential to focus on their earnings before deducing taxes and interest payments And it is often referred to as operation income

Earning per share (EPS) - It is a bottom-line to denote that of all items on the income statement EPS shows that a companys profit allocated to each outstanding share of common stock EPS serves as an indicator of a companys profitability

Weighted Average Cost of Capital (WACC) ndash A weighted average of the component costs of debt preferred stock and common equity

Invested Capital - represents the total cash investment that shareholders and debt holders have made in a company

Economic Value Added (EVA) - The EVA is a registered trademark by its developer Stern Stewart amp Co that is an estimate of true economic profit after making corrective adjustments to GAAP accounting EVA can be measured as Net Operating Profit after Taxes (NOPAT) less the cost of capital

Market Value Added (MVA) ndash A measure to directly reflect the creation of shareholder value developed by Stern Stewart amp Co It shows the difference between the market value of a firmrsquos equity and the book value as shown on the balance sheet with market value found by multiplying the stock price by the number of shares outstanding Return on Total Assets (ROA) ndash The ratio of net income to total assets after interest and taxes Return in Common Equity (ROE) ndash The ratio of a fiscal years net income to common equity measures the rate of return on common stockholdersrsquo investment

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iv

start a research in this field The purpose of this study is to investigate if EVA can be

suitable for applying to the Thai energy sector which is were mostly affected the

performance of the Stock Exchange of Thailand (SET) and to investigate if EVA can

better affect the operational performance than the traditional performance index

(including EPS ROA and ROE) in explaining Market Value Added (MVA) thereby

stock returns

The evidence of this research shows that EVA may not be suitable for applying to

the Thai energy sector the correlation of MVA depends on all variables show EPS has

the most significant relevance and finally one is EVA EVA has relationship with MVA

but can not affect MVA by regression analysis Thus EVA is not a superior

performance measure in explaining market price returns compared with traditional

performance index of the Thai energy sector However the researcher suggests that

any managers shareholders and participants can use EVA as an assistant tool with

traditional performance measures instant of replacing anyone

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ACKNOWLEDGEMENTS I would like to express my gratitude to the people who have played especially

important role in the development of this research First of all let me pay my deepest

acknowledgement to my supervisors DrKittiphun Khongsawatkiat and Dr Thassna

Boonkwan for their valuable advice and recommendations The excellent research method

course taught by Dr Phusit Wonglorsaichon helps me out Next I need to single out my

key thinking partner MrWeera Weerakhajornsak for his professional directions and

generous contributions Also I acknowledge all committees Dr Phusit Wonglorsaichon Dr

Pussadee Polsaram and Assoc Prof Sriaroon Resanond to turn this research into its

final shape with their kindness critique

Perhaps the most important is the courage from my parents Mr Peng Han-Qing

and Mrs Nancy Pen whose comfort and support always keep me wrestling with all hard

times Of course my appreciation goes to all my friends whose sharing ideas and

comments are woven into the research I wish I could express my sincerely thanks for how

they have enriched my life

Peng Fang-Fang

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TABLE OF CONTENTS

Page ENGLISH ABSTRACT iv

THAI ABSTRACT vi

ACKNOWLEDGEMENTS viii

TABLE OF CONTENTShelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip xi

LIST OF ABBREVIATION helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip xii

LIST OF TABLES xiv

LIST OF FIGURES helliphelliphellip xv

Chapter 1 Introduction 1

State of the Problems 5 Objectives of the Study 6

Expected Benefits 7 Scope and limitations 7 Operation Definition 7 Organization of the Study 9

2 Literature Review 10 Traditional Performance Measures 11 Value-Based Management (VBM) 13 Market Value Added (MVA) 15

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TABLE OF CONTENTS (COUNTINUED)

Chapter Page From MVA to EVA 16 Economic Value Added (EVA)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 18 The Originsndash Residual Income (RI)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 17 The EVA Metric helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 19 The Elements of EVA helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 21 Accounting Adjustmentshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 24 Advantages and Disadvantageshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 26 Related Research helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 33 Research in support of EVA as the best driver of MVAhelliphelliphelliphelliphelliphellip 33 Criticisms of EVA and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 37

3 Research Methodology 42 Conceptual Frameworkhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 43 Research Designhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44 Population helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44 Data Collectionhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 45

Hypotheseshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 49 Data Analysishelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 50

4 Results of Analysis hellip 52 Analyze the innovation measure ndashEVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 56

Analyze the traditional measures (EPS ROA and ROE) helliphelliphellip 58 The results of all independent variableshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 59

5 Conclusion Discussion and Suggestion 62 Conclusion helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 62

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TABLE OF CONTENTS (COUNTINED)

Page

Discussion helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 65 Limitations of this study helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 68 Suggestions for further study helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 68 BIBLIOGRAPHY 71

APPENDICES 85

A Market Capital from 2003-2008 on SET 86 B Company Profile 87 C Statistics Analysis Resultshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 92

BIOGRAPHY 105

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LIST OF ABBREVIATION

Capital asset pricing model CAPM

Cash flow return on investment CFROI

Discounted cash flow DCF

Dividends per share DPS

Earnings before interest and taxes EBIT

EBIT plus depreciation and amortization EBITDA

Earnings per share EPS

Economic Value Added EVA

Free cash flow FCF

Market Value Added MVA

Net income NI

Net operation profit after tax NOPAT

Profit after tax PAT

Residual income RI

Return on total assets ROA

Return on common equity ROE

Return on investment ROI

Return on invested capital ROIC

Return on net worth RONW

Return on sales ROS

Weighted average cost of capital WACC

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xiv

LIST OF TABLES Table Page 21 Accounting items under GAAP and adjustments in EVA method

Young and OrsquoByrne (2001)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 25

22 The relationship between EVA and other financial performance measures

Stern (1993)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 34

23 The relationship between EVA and other financial performance measures

Uyemura Kantor and Pettit (1996)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 35

32 A Regular Balance Sheet vs The EVA Balance Sheet helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 48

41 Descriptive statistics matrix of this study (2006Q4-2008Q3)helliphelliphelliphelliphelliphelliphelliphelliphelliphellip 53

42 Comparison of average MVA and EVA helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 54

43 Correlation statistics matrix of this study (2006Q4-2008Q3)helliphelliphelliphelliphelliphelliphelliphelliphellip 55

44 Summary of regression matrix between EVA and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 56

45 Selected coefficients for total sample EGCO RATCH and PTTEPhelliphelliphelliphelliphelliphellip 57

46 Summary of regression matrix between traditional accounting measures

and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 58

47 Summary of regression matrix MVA depends on all independent variableshelliphelliphelliphellip 59

48 Summary of regression matrix between all variables for each companyhelliphelliphelliphellip 60

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LIST OF FIGURES Figure Page 11 Market Capitalization on SET (2003-2008) helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 6

21 A typical bonus plan helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 28

22 The EVA bonus plan helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 29

31 The conceptual frameworkhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44

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1

CHAPTER 1

INTRODUCTION

11 Introduction In the 1980rsquos while investors started to express interest in stock market the publicly

listed companies had to pursue the creation of value for their shareholders as the most

significant goal Many different interpretations of shareholder-value seem to wildly exist

throughout the public discussion and the press Although chairmen of big corporations have

taken up the talk of aiming at an increase of shareholder value they have not made exactly

clear how they will attempt to reach this goal or how success on this step shall be

measured (Young and OrsquoByrne 2001) Thus the rapid changes have led to a general

dissatisfaction with traditional performance measures (Needly et al 1999) new

mechanisms for measuring value have been created For example John Kay (1993)

developed the concept of Valued Added which measures the different between the

comprehensively accounted valued of the input and the output of a firm And one of the

most popular mechanisms is Economic Value Added (EVA) which increases transparency

for investors and managers developed and trademarked by a US-based consulting firm

called Stern Stewart amp Co

Stern Stewart amp Co launched the concept in order to motivate managers and other

employees in 1989 (Stern and Shiely 2001) Stewart revised through numbers of

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2

accounting adjustments and relabeled EVA in 2001 (Anderson et al 2005) But it

widespread as the financial management and incentive compensation system began with

Fortune Magazine proclaimed EVA asrdquo todayrsquos hottest financial idea and getting hotterrdquordquo

The real key to creating wealthrdquo (September 1993) ldquoA new Way to Find Bargainsrdquo

(December 1996) ldquoAmericarsquos greatest wealth creatorsrdquo(November1997) and even today ldquoA

new way to value the marketrdquo (February2008) the management guru Peter F Drucker

(1993) described it as ldquoa vital measure of total factor productivityrdquo in Harvard Business

Review

Originally in the United States EVA has been ldquoliterally adopted by hundreds of the

leading firms such as Coca-Cola Eli Lilly Quaker Oats AT amp T and the Postal Service in

the United Statesrdquo (Biddle et al 1998) and also by investment banks like Credit Suisse

First Boston or Goldman Sachs have supplements traditional valuation methods with EVA

The CEO of Coca-Cola Roberto Goizuera believed that adopted EVA in turning the firm

become the number one Market Value Added Company when itrsquos stock price increased

form $3 to over $60 in the early 1980s James Meenan the CFO of AT amp T long-term

business declared that EVA has an almost perfect correlation with stock price tracked back

the calculation to 1984 from 1994 and used it to be the lead indicator including ldquopeople and

customer value addedrdquo of their performance measurement

EVA has been world wildly promoted in UK Australia Canada Brazil Germany

Mexico Turkey and France that it has adopted by several international firms (Stern

Steward 1999) For example the ABSA Banking Group in South Africa

(Weldeghiorgis 2004) the ANZ Banking Group Fletcher Challenge Limited James Hardie

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3

Industries and the Wrighton Group in Australia have implemented EVA for many years

(Rennie1997) Furthermore the big European conglomerated such as Siemens has put

EVA to completely change the company since introduced there in 1998 and lately more

spreading to Latin American and Asia (Young and OrsquoByrne 2001)

In Asia the Japanrsquos financial magazine Toyokeizai mentioned that EVA is not only

a financial tool but also a mind-set creator for the managers and employees Many

international firms were actively to implement it such as Kao Corporation Asahi Kasei Kirin

BeerSonyhellipetc(Toyokeizai magazine 2000) In China state-owned assets supervision

and administration commission of Peoplersquos Government announced in the upcoming 2010

EVA will be one of the evaluation standards for senior managers (China Business News

2008)

The concept of EVA is definitely not new EVA is a modified computation of residual

income with a series of accounting adjustments to how one calculates income and capital

EVA is the net operation minus an appropriate charge for the ldquoopportunity costrdquo which

means the cost of capital by Stewart in an enterprise or projects (Maumlkelaumlinen and Roztocki

1998) In addition Stewart (1991) claimed that EVA is not only the financial measure

which comes closer than any other to capturing the true economic profit of an enterprise

but also the performance measure most directly linked to the creation of shareholder wealth

over time Stewart (1994) also stated that ldquoEVA stands well out from the crowed as the

single best measure of wealth creation on a contemporaneous basis and is almost 50

better than its closer accounting-based competitors in explaining changed in shareholders

wealthrdquo

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EVA basically stands for appeal to common sense although underlying application

can be complex But it is the way to show what ldquovaluerdquo was made from what capital was

used By using EVA is to help the firm to achieve more with as little capital as necessary

which points managers and firms toward efficiency It transforms employees into

entrepreneurs via incentive complementation and just simplest application needs commonly

financial statements

Managers can also used EVA as a diagnostic likely tool to show which one of the

departments needs more work to increase a firmrsquos value for the next period (Maumlkelaumlinen amp

Roztocki 1998) In short the EVA management system covers all managerial decisions

including strategic planning capital allocating setting day-to-day operating decisions

There is no absolute perfect measurement tool EVA also has its critics In fact EVA

is not constrained by the Generally Accepted Accounted Principle (or GAAP) Some experts

suggested that EVA is not the best choice for all companies which is not universal suitable

since it has no official standards about using the metric (Lars amp Clas 2001) OrsquoHanlon and

Peasnell (1966) stated that EVA provides a valuable transformation from wrong accounting

numbers into correct estimates of value But there is no theory to guide how to select

accounting adjustment of the most relevant items which depend on the financial structure

and industrial nature (Anderson et al 2005)

Brewer (1999) mentioned that ldquosize differencesrdquo across plants or division will effects

the EVA It is based on financial accounting method it is possible manipulated by

managers EVA provides immediate results which diminish innovation moreover it offers no

solutions in much the same way as historical financial statements do

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12 Statement of Problems Energy is one of the key factors to several economic movements Without it the

worldrsquos entire industrialized infrastructure would collapse (Liseadiratanakul and Uarkarn

2008) Moreover the opportunity that people would stop using oil natural gas or other

substitutions in next 10 years will not too much Therefore energy business would not be

disappeared (Vibul Perngprasert 2006)

As Asian economies bloomed their energy consumption grew by similar proportions

it will be the worldrsquos largest consumer of primary energy in the near year of 2010 (R

Manning 2000) In South Asia Thailand is considered to be the biggest consumer

Recently the total energy expenditure amounted closely to 17 of the GDP

In the past security in energy sector were mostly affected the performance of Thai

stock market Last year the resource sector including energy and mining industries had

also the highest capital which is 35 of all equity market The director of AWR Lloyd

(mining energy and metals advisory) Alexander Wood (2008) pointed out that by the year-

end of 2007 after generating total shareholder returns of around 70 the listed energy

sector had a total market capitalization around 25 trillion baht which is approximately 40

of the total equity capitalization of the entire Thai stock market Market capital data on SET

from 2003 to 2008 are compared shown as Figure 11 (Market capital data on SET from

2003 to 2008 is attached in Appendix A)

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6

000

50000000

100000000

150000000

200000000

250000000

Jan - Dec Jan - Dec Jan - Dec Jan - Dec Jan - Dec Jan - Dec

2008 2007 2006 2005 2004 2003

Period

Mill

ion

Baht

AgroConsumpFincialIndusPropconResourcServiceTech

Figure 11 Market Capitalizations on SET (2003-2008)

Source SET index

An emerging literature of analyze whether EVA is highly associated with stock

returns than traditional performance measures has addressed the empirical issue Tully

(1993) claimed that EVA has significant relationship with stock price returns and both are

remarkable tendency Some even claimed traditional accounting measures were inadequate

measures of a firmrsquos performance

So far there are few EVA relevant studies in Thailand covering the energy sector

Consequently this is an opportunity to begin a research in this area

13 Objectives of the Study The purpose of this study is to develop and test EVA as the performance measure in

the decision-making of investment by the management and in evaluation the future

performance of stock by the investor like Stern Stewart amp Co claimed The objectives of

this research are as follow

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7

1 To investigate if EVA can be suitable for applying to the Thai energy sector

2 Moreover to investigate if EVA can better affect the operational performance of

Thai energy sector than the traditional performance index (including EPS ROA and ROE)

in explaining Market Value Added( MVA) thereby stock returns

14 Expected Benefits 1 A better understanding of calculating EVA and MVA

2 International firms can take the finding of this study as a reference compared

between innovation measure - EVA and traditional performance measures

3 To make more investors sophisticate about the comprehension of EVA and MVA

as a practical tool of stock market investing

15 Scope and limitations

The sample firms are listed on the Stock Exchange of Thailand (SET) and are

gathered the quarterly financial reports in twenty quarters within the same organization and

cross the firms within the energy sector Assuming that the equity markets are efficient

eight companies of Thai energy sector is selected and completely qualified would be

employed in the empirical study

However due to the scope of the problem this research is obliged to make

limitations

16 Operation Definitions

Capital Asset Pricing Model (CAPM) - A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities

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Net Operating Profit After Tax (NOPAT) - The profit a company would generate if it had no debt and held only operating asset

Earnings before Interest and Taxes (EBIT) - When comparing companyrsquos operating performances it is essential to focus on their earnings before deducing taxes and interest payments And it is often referred to as operation income

Earning per share (EPS) - It is a bottom-line to denote that of all items on the income statement EPS shows that a companys profit allocated to each outstanding share of common stock EPS serves as an indicator of a companys profitability

Weighted Average Cost of Capital (WACC) ndash A weighted average of the component costs of debt preferred stock and common equity

Invested Capital - represents the total cash investment that shareholders and debt holders have made in a company

Economic Value Added (EVA) - The EVA is a registered trademark by its developer Stern Stewart amp Co that is an estimate of true economic profit after making corrective adjustments to GAAP accounting EVA can be measured as Net Operating Profit after Taxes (NOPAT) less the cost of capital

Market Value Added (MVA) ndash A measure to directly reflect the creation of shareholder value developed by Stern Stewart amp Co It shows the difference between the market value of a firmrsquos equity and the book value as shown on the balance sheet with market value found by multiplying the stock price by the number of shares outstanding Return on Total Assets (ROA) ndash The ratio of net income to total assets after interest and taxes Return in Common Equity (ROE) ndash The ratio of a fiscal years net income to common equity measures the rate of return on common stockholdersrsquo investment

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viii

ACKNOWLEDGEMENTS I would like to express my gratitude to the people who have played especially

important role in the development of this research First of all let me pay my deepest

acknowledgement to my supervisors DrKittiphun Khongsawatkiat and Dr Thassna

Boonkwan for their valuable advice and recommendations The excellent research method

course taught by Dr Phusit Wonglorsaichon helps me out Next I need to single out my

key thinking partner MrWeera Weerakhajornsak for his professional directions and

generous contributions Also I acknowledge all committees Dr Phusit Wonglorsaichon Dr

Pussadee Polsaram and Assoc Prof Sriaroon Resanond to turn this research into its

final shape with their kindness critique

Perhaps the most important is the courage from my parents Mr Peng Han-Qing

and Mrs Nancy Pen whose comfort and support always keep me wrestling with all hard

times Of course my appreciation goes to all my friends whose sharing ideas and

comments are woven into the research I wish I could express my sincerely thanks for how

they have enriched my life

Peng Fang-Fang

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TABLE OF CONTENTS

Page ENGLISH ABSTRACT iv

THAI ABSTRACT vi

ACKNOWLEDGEMENTS viii

TABLE OF CONTENTShelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip xi

LIST OF ABBREVIATION helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip xii

LIST OF TABLES xiv

LIST OF FIGURES helliphelliphellip xv

Chapter 1 Introduction 1

State of the Problems 5 Objectives of the Study 6

Expected Benefits 7 Scope and limitations 7 Operation Definition 7 Organization of the Study 9

2 Literature Review 10 Traditional Performance Measures 11 Value-Based Management (VBM) 13 Market Value Added (MVA) 15

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TABLE OF CONTENTS (COUNTINUED)

Chapter Page From MVA to EVA 16 Economic Value Added (EVA)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 18 The Originsndash Residual Income (RI)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 17 The EVA Metric helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 19 The Elements of EVA helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 21 Accounting Adjustmentshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 24 Advantages and Disadvantageshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 26 Related Research helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 33 Research in support of EVA as the best driver of MVAhelliphelliphelliphelliphelliphellip 33 Criticisms of EVA and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 37

3 Research Methodology 42 Conceptual Frameworkhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 43 Research Designhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44 Population helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44 Data Collectionhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 45

Hypotheseshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 49 Data Analysishelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 50

4 Results of Analysis hellip 52 Analyze the innovation measure ndashEVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 56

Analyze the traditional measures (EPS ROA and ROE) helliphelliphellip 58 The results of all independent variableshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 59

5 Conclusion Discussion and Suggestion 62 Conclusion helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 62

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TABLE OF CONTENTS (COUNTINED)

Page

Discussion helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 65 Limitations of this study helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 68 Suggestions for further study helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 68 BIBLIOGRAPHY 71

APPENDICES 85

A Market Capital from 2003-2008 on SET 86 B Company Profile 87 C Statistics Analysis Resultshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 92

BIOGRAPHY 105

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xii

LIST OF ABBREVIATION

Capital asset pricing model CAPM

Cash flow return on investment CFROI

Discounted cash flow DCF

Dividends per share DPS

Earnings before interest and taxes EBIT

EBIT plus depreciation and amortization EBITDA

Earnings per share EPS

Economic Value Added EVA

Free cash flow FCF

Market Value Added MVA

Net income NI

Net operation profit after tax NOPAT

Profit after tax PAT

Residual income RI

Return on total assets ROA

Return on common equity ROE

Return on investment ROI

Return on invested capital ROIC

Return on net worth RONW

Return on sales ROS

Weighted average cost of capital WACC

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xiv

LIST OF TABLES Table Page 21 Accounting items under GAAP and adjustments in EVA method

Young and OrsquoByrne (2001)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 25

22 The relationship between EVA and other financial performance measures

Stern (1993)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 34

23 The relationship between EVA and other financial performance measures

Uyemura Kantor and Pettit (1996)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 35

32 A Regular Balance Sheet vs The EVA Balance Sheet helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 48

41 Descriptive statistics matrix of this study (2006Q4-2008Q3)helliphelliphelliphelliphelliphelliphelliphelliphelliphellip 53

42 Comparison of average MVA and EVA helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 54

43 Correlation statistics matrix of this study (2006Q4-2008Q3)helliphelliphelliphelliphelliphelliphelliphelliphellip 55

44 Summary of regression matrix between EVA and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 56

45 Selected coefficients for total sample EGCO RATCH and PTTEPhelliphelliphelliphelliphelliphellip 57

46 Summary of regression matrix between traditional accounting measures

and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 58

47 Summary of regression matrix MVA depends on all independent variableshelliphelliphelliphellip 59

48 Summary of regression matrix between all variables for each companyhelliphelliphelliphellip 60

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LIST OF FIGURES Figure Page 11 Market Capitalization on SET (2003-2008) helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 6

21 A typical bonus plan helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 28

22 The EVA bonus plan helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 29

31 The conceptual frameworkhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44

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1

CHAPTER 1

INTRODUCTION

11 Introduction In the 1980rsquos while investors started to express interest in stock market the publicly

listed companies had to pursue the creation of value for their shareholders as the most

significant goal Many different interpretations of shareholder-value seem to wildly exist

throughout the public discussion and the press Although chairmen of big corporations have

taken up the talk of aiming at an increase of shareholder value they have not made exactly

clear how they will attempt to reach this goal or how success on this step shall be

measured (Young and OrsquoByrne 2001) Thus the rapid changes have led to a general

dissatisfaction with traditional performance measures (Needly et al 1999) new

mechanisms for measuring value have been created For example John Kay (1993)

developed the concept of Valued Added which measures the different between the

comprehensively accounted valued of the input and the output of a firm And one of the

most popular mechanisms is Economic Value Added (EVA) which increases transparency

for investors and managers developed and trademarked by a US-based consulting firm

called Stern Stewart amp Co

Stern Stewart amp Co launched the concept in order to motivate managers and other

employees in 1989 (Stern and Shiely 2001) Stewart revised through numbers of

ลขสท

ธ มหาว

ทยาลย

หอการ

คาไท

ย

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right

by U

TCC

All rig

hts re

serve

d

2

accounting adjustments and relabeled EVA in 2001 (Anderson et al 2005) But it

widespread as the financial management and incentive compensation system began with

Fortune Magazine proclaimed EVA asrdquo todayrsquos hottest financial idea and getting hotterrdquordquo

The real key to creating wealthrdquo (September 1993) ldquoA new Way to Find Bargainsrdquo

(December 1996) ldquoAmericarsquos greatest wealth creatorsrdquo(November1997) and even today ldquoA

new way to value the marketrdquo (February2008) the management guru Peter F Drucker

(1993) described it as ldquoa vital measure of total factor productivityrdquo in Harvard Business

Review

Originally in the United States EVA has been ldquoliterally adopted by hundreds of the

leading firms such as Coca-Cola Eli Lilly Quaker Oats AT amp T and the Postal Service in

the United Statesrdquo (Biddle et al 1998) and also by investment banks like Credit Suisse

First Boston or Goldman Sachs have supplements traditional valuation methods with EVA

The CEO of Coca-Cola Roberto Goizuera believed that adopted EVA in turning the firm

become the number one Market Value Added Company when itrsquos stock price increased

form $3 to over $60 in the early 1980s James Meenan the CFO of AT amp T long-term

business declared that EVA has an almost perfect correlation with stock price tracked back

the calculation to 1984 from 1994 and used it to be the lead indicator including ldquopeople and

customer value addedrdquo of their performance measurement

EVA has been world wildly promoted in UK Australia Canada Brazil Germany

Mexico Turkey and France that it has adopted by several international firms (Stern

Steward 1999) For example the ABSA Banking Group in South Africa

(Weldeghiorgis 2004) the ANZ Banking Group Fletcher Challenge Limited James Hardie

ลขสท

ธ มหาว

ทยาลย

หอการ

คาไท

ย

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right

by U

TCC

All rig

hts re

serve

d

3

Industries and the Wrighton Group in Australia have implemented EVA for many years

(Rennie1997) Furthermore the big European conglomerated such as Siemens has put

EVA to completely change the company since introduced there in 1998 and lately more

spreading to Latin American and Asia (Young and OrsquoByrne 2001)

In Asia the Japanrsquos financial magazine Toyokeizai mentioned that EVA is not only

a financial tool but also a mind-set creator for the managers and employees Many

international firms were actively to implement it such as Kao Corporation Asahi Kasei Kirin

BeerSonyhellipetc(Toyokeizai magazine 2000) In China state-owned assets supervision

and administration commission of Peoplersquos Government announced in the upcoming 2010

EVA will be one of the evaluation standards for senior managers (China Business News

2008)

The concept of EVA is definitely not new EVA is a modified computation of residual

income with a series of accounting adjustments to how one calculates income and capital

EVA is the net operation minus an appropriate charge for the ldquoopportunity costrdquo which

means the cost of capital by Stewart in an enterprise or projects (Maumlkelaumlinen and Roztocki

1998) In addition Stewart (1991) claimed that EVA is not only the financial measure

which comes closer than any other to capturing the true economic profit of an enterprise

but also the performance measure most directly linked to the creation of shareholder wealth

over time Stewart (1994) also stated that ldquoEVA stands well out from the crowed as the

single best measure of wealth creation on a contemporaneous basis and is almost 50

better than its closer accounting-based competitors in explaining changed in shareholders

wealthrdquo

ลขสท

ธ มหาว

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คาไท

ย

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right

by U

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hts re

serve

d

4

EVA basically stands for appeal to common sense although underlying application

can be complex But it is the way to show what ldquovaluerdquo was made from what capital was

used By using EVA is to help the firm to achieve more with as little capital as necessary

which points managers and firms toward efficiency It transforms employees into

entrepreneurs via incentive complementation and just simplest application needs commonly

financial statements

Managers can also used EVA as a diagnostic likely tool to show which one of the

departments needs more work to increase a firmrsquos value for the next period (Maumlkelaumlinen amp

Roztocki 1998) In short the EVA management system covers all managerial decisions

including strategic planning capital allocating setting day-to-day operating decisions

There is no absolute perfect measurement tool EVA also has its critics In fact EVA

is not constrained by the Generally Accepted Accounted Principle (or GAAP) Some experts

suggested that EVA is not the best choice for all companies which is not universal suitable

since it has no official standards about using the metric (Lars amp Clas 2001) OrsquoHanlon and

Peasnell (1966) stated that EVA provides a valuable transformation from wrong accounting

numbers into correct estimates of value But there is no theory to guide how to select

accounting adjustment of the most relevant items which depend on the financial structure

and industrial nature (Anderson et al 2005)

Brewer (1999) mentioned that ldquosize differencesrdquo across plants or division will effects

the EVA It is based on financial accounting method it is possible manipulated by

managers EVA provides immediate results which diminish innovation moreover it offers no

solutions in much the same way as historical financial statements do

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12 Statement of Problems Energy is one of the key factors to several economic movements Without it the

worldrsquos entire industrialized infrastructure would collapse (Liseadiratanakul and Uarkarn

2008) Moreover the opportunity that people would stop using oil natural gas or other

substitutions in next 10 years will not too much Therefore energy business would not be

disappeared (Vibul Perngprasert 2006)

As Asian economies bloomed their energy consumption grew by similar proportions

it will be the worldrsquos largest consumer of primary energy in the near year of 2010 (R

Manning 2000) In South Asia Thailand is considered to be the biggest consumer

Recently the total energy expenditure amounted closely to 17 of the GDP

In the past security in energy sector were mostly affected the performance of Thai

stock market Last year the resource sector including energy and mining industries had

also the highest capital which is 35 of all equity market The director of AWR Lloyd

(mining energy and metals advisory) Alexander Wood (2008) pointed out that by the year-

end of 2007 after generating total shareholder returns of around 70 the listed energy

sector had a total market capitalization around 25 trillion baht which is approximately 40

of the total equity capitalization of the entire Thai stock market Market capital data on SET

from 2003 to 2008 are compared shown as Figure 11 (Market capital data on SET from

2003 to 2008 is attached in Appendix A)

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6

000

50000000

100000000

150000000

200000000

250000000

Jan - Dec Jan - Dec Jan - Dec Jan - Dec Jan - Dec Jan - Dec

2008 2007 2006 2005 2004 2003

Period

Mill

ion

Baht

AgroConsumpFincialIndusPropconResourcServiceTech

Figure 11 Market Capitalizations on SET (2003-2008)

Source SET index

An emerging literature of analyze whether EVA is highly associated with stock

returns than traditional performance measures has addressed the empirical issue Tully

(1993) claimed that EVA has significant relationship with stock price returns and both are

remarkable tendency Some even claimed traditional accounting measures were inadequate

measures of a firmrsquos performance

So far there are few EVA relevant studies in Thailand covering the energy sector

Consequently this is an opportunity to begin a research in this area

13 Objectives of the Study The purpose of this study is to develop and test EVA as the performance measure in

the decision-making of investment by the management and in evaluation the future

performance of stock by the investor like Stern Stewart amp Co claimed The objectives of

this research are as follow

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1 To investigate if EVA can be suitable for applying to the Thai energy sector

2 Moreover to investigate if EVA can better affect the operational performance of

Thai energy sector than the traditional performance index (including EPS ROA and ROE)

in explaining Market Value Added( MVA) thereby stock returns

14 Expected Benefits 1 A better understanding of calculating EVA and MVA

2 International firms can take the finding of this study as a reference compared

between innovation measure - EVA and traditional performance measures

3 To make more investors sophisticate about the comprehension of EVA and MVA

as a practical tool of stock market investing

15 Scope and limitations

The sample firms are listed on the Stock Exchange of Thailand (SET) and are

gathered the quarterly financial reports in twenty quarters within the same organization and

cross the firms within the energy sector Assuming that the equity markets are efficient

eight companies of Thai energy sector is selected and completely qualified would be

employed in the empirical study

However due to the scope of the problem this research is obliged to make

limitations

16 Operation Definitions

Capital Asset Pricing Model (CAPM) - A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities

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Net Operating Profit After Tax (NOPAT) - The profit a company would generate if it had no debt and held only operating asset

Earnings before Interest and Taxes (EBIT) - When comparing companyrsquos operating performances it is essential to focus on their earnings before deducing taxes and interest payments And it is often referred to as operation income

Earning per share (EPS) - It is a bottom-line to denote that of all items on the income statement EPS shows that a companys profit allocated to each outstanding share of common stock EPS serves as an indicator of a companys profitability

Weighted Average Cost of Capital (WACC) ndash A weighted average of the component costs of debt preferred stock and common equity

Invested Capital - represents the total cash investment that shareholders and debt holders have made in a company

Economic Value Added (EVA) - The EVA is a registered trademark by its developer Stern Stewart amp Co that is an estimate of true economic profit after making corrective adjustments to GAAP accounting EVA can be measured as Net Operating Profit after Taxes (NOPAT) less the cost of capital

Market Value Added (MVA) ndash A measure to directly reflect the creation of shareholder value developed by Stern Stewart amp Co It shows the difference between the market value of a firmrsquos equity and the book value as shown on the balance sheet with market value found by multiplying the stock price by the number of shares outstanding Return on Total Assets (ROA) ndash The ratio of net income to total assets after interest and taxes Return in Common Equity (ROE) ndash The ratio of a fiscal years net income to common equity measures the rate of return on common stockholdersrsquo investment

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TABLE OF CONTENTS

Page ENGLISH ABSTRACT iv

THAI ABSTRACT vi

ACKNOWLEDGEMENTS viii

TABLE OF CONTENTShelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip xi

LIST OF ABBREVIATION helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip xii

LIST OF TABLES xiv

LIST OF FIGURES helliphelliphellip xv

Chapter 1 Introduction 1

State of the Problems 5 Objectives of the Study 6

Expected Benefits 7 Scope and limitations 7 Operation Definition 7 Organization of the Study 9

2 Literature Review 10 Traditional Performance Measures 11 Value-Based Management (VBM) 13 Market Value Added (MVA) 15

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TABLE OF CONTENTS (COUNTINUED)

Chapter Page From MVA to EVA 16 Economic Value Added (EVA)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 18 The Originsndash Residual Income (RI)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 17 The EVA Metric helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 19 The Elements of EVA helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 21 Accounting Adjustmentshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 24 Advantages and Disadvantageshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 26 Related Research helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 33 Research in support of EVA as the best driver of MVAhelliphelliphelliphelliphelliphellip 33 Criticisms of EVA and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 37

3 Research Methodology 42 Conceptual Frameworkhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 43 Research Designhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44 Population helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44 Data Collectionhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 45

Hypotheseshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 49 Data Analysishelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 50

4 Results of Analysis hellip 52 Analyze the innovation measure ndashEVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 56

Analyze the traditional measures (EPS ROA and ROE) helliphelliphellip 58 The results of all independent variableshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 59

5 Conclusion Discussion and Suggestion 62 Conclusion helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 62

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TABLE OF CONTENTS (COUNTINED)

Page

Discussion helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 65 Limitations of this study helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 68 Suggestions for further study helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 68 BIBLIOGRAPHY 71

APPENDICES 85

A Market Capital from 2003-2008 on SET 86 B Company Profile 87 C Statistics Analysis Resultshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 92

BIOGRAPHY 105

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LIST OF ABBREVIATION

Capital asset pricing model CAPM

Cash flow return on investment CFROI

Discounted cash flow DCF

Dividends per share DPS

Earnings before interest and taxes EBIT

EBIT plus depreciation and amortization EBITDA

Earnings per share EPS

Economic Value Added EVA

Free cash flow FCF

Market Value Added MVA

Net income NI

Net operation profit after tax NOPAT

Profit after tax PAT

Residual income RI

Return on total assets ROA

Return on common equity ROE

Return on investment ROI

Return on invested capital ROIC

Return on net worth RONW

Return on sales ROS

Weighted average cost of capital WACC

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xiv

LIST OF TABLES Table Page 21 Accounting items under GAAP and adjustments in EVA method

Young and OrsquoByrne (2001)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 25

22 The relationship between EVA and other financial performance measures

Stern (1993)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 34

23 The relationship between EVA and other financial performance measures

Uyemura Kantor and Pettit (1996)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 35

32 A Regular Balance Sheet vs The EVA Balance Sheet helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 48

41 Descriptive statistics matrix of this study (2006Q4-2008Q3)helliphelliphelliphelliphelliphelliphelliphelliphelliphellip 53

42 Comparison of average MVA and EVA helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 54

43 Correlation statistics matrix of this study (2006Q4-2008Q3)helliphelliphelliphelliphelliphelliphelliphelliphellip 55

44 Summary of regression matrix between EVA and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 56

45 Selected coefficients for total sample EGCO RATCH and PTTEPhelliphelliphelliphelliphelliphellip 57

46 Summary of regression matrix between traditional accounting measures

and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 58

47 Summary of regression matrix MVA depends on all independent variableshelliphelliphelliphellip 59

48 Summary of regression matrix between all variables for each companyhelliphelliphelliphellip 60

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LIST OF FIGURES Figure Page 11 Market Capitalization on SET (2003-2008) helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 6

21 A typical bonus plan helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 28

22 The EVA bonus plan helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 29

31 The conceptual frameworkhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44

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1

CHAPTER 1

INTRODUCTION

11 Introduction In the 1980rsquos while investors started to express interest in stock market the publicly

listed companies had to pursue the creation of value for their shareholders as the most

significant goal Many different interpretations of shareholder-value seem to wildly exist

throughout the public discussion and the press Although chairmen of big corporations have

taken up the talk of aiming at an increase of shareholder value they have not made exactly

clear how they will attempt to reach this goal or how success on this step shall be

measured (Young and OrsquoByrne 2001) Thus the rapid changes have led to a general

dissatisfaction with traditional performance measures (Needly et al 1999) new

mechanisms for measuring value have been created For example John Kay (1993)

developed the concept of Valued Added which measures the different between the

comprehensively accounted valued of the input and the output of a firm And one of the

most popular mechanisms is Economic Value Added (EVA) which increases transparency

for investors and managers developed and trademarked by a US-based consulting firm

called Stern Stewart amp Co

Stern Stewart amp Co launched the concept in order to motivate managers and other

employees in 1989 (Stern and Shiely 2001) Stewart revised through numbers of

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accounting adjustments and relabeled EVA in 2001 (Anderson et al 2005) But it

widespread as the financial management and incentive compensation system began with

Fortune Magazine proclaimed EVA asrdquo todayrsquos hottest financial idea and getting hotterrdquordquo

The real key to creating wealthrdquo (September 1993) ldquoA new Way to Find Bargainsrdquo

(December 1996) ldquoAmericarsquos greatest wealth creatorsrdquo(November1997) and even today ldquoA

new way to value the marketrdquo (February2008) the management guru Peter F Drucker

(1993) described it as ldquoa vital measure of total factor productivityrdquo in Harvard Business

Review

Originally in the United States EVA has been ldquoliterally adopted by hundreds of the

leading firms such as Coca-Cola Eli Lilly Quaker Oats AT amp T and the Postal Service in

the United Statesrdquo (Biddle et al 1998) and also by investment banks like Credit Suisse

First Boston or Goldman Sachs have supplements traditional valuation methods with EVA

The CEO of Coca-Cola Roberto Goizuera believed that adopted EVA in turning the firm

become the number one Market Value Added Company when itrsquos stock price increased

form $3 to over $60 in the early 1980s James Meenan the CFO of AT amp T long-term

business declared that EVA has an almost perfect correlation with stock price tracked back

the calculation to 1984 from 1994 and used it to be the lead indicator including ldquopeople and

customer value addedrdquo of their performance measurement

EVA has been world wildly promoted in UK Australia Canada Brazil Germany

Mexico Turkey and France that it has adopted by several international firms (Stern

Steward 1999) For example the ABSA Banking Group in South Africa

(Weldeghiorgis 2004) the ANZ Banking Group Fletcher Challenge Limited James Hardie

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Industries and the Wrighton Group in Australia have implemented EVA for many years

(Rennie1997) Furthermore the big European conglomerated such as Siemens has put

EVA to completely change the company since introduced there in 1998 and lately more

spreading to Latin American and Asia (Young and OrsquoByrne 2001)

In Asia the Japanrsquos financial magazine Toyokeizai mentioned that EVA is not only

a financial tool but also a mind-set creator for the managers and employees Many

international firms were actively to implement it such as Kao Corporation Asahi Kasei Kirin

BeerSonyhellipetc(Toyokeizai magazine 2000) In China state-owned assets supervision

and administration commission of Peoplersquos Government announced in the upcoming 2010

EVA will be one of the evaluation standards for senior managers (China Business News

2008)

The concept of EVA is definitely not new EVA is a modified computation of residual

income with a series of accounting adjustments to how one calculates income and capital

EVA is the net operation minus an appropriate charge for the ldquoopportunity costrdquo which

means the cost of capital by Stewart in an enterprise or projects (Maumlkelaumlinen and Roztocki

1998) In addition Stewart (1991) claimed that EVA is not only the financial measure

which comes closer than any other to capturing the true economic profit of an enterprise

but also the performance measure most directly linked to the creation of shareholder wealth

over time Stewart (1994) also stated that ldquoEVA stands well out from the crowed as the

single best measure of wealth creation on a contemporaneous basis and is almost 50

better than its closer accounting-based competitors in explaining changed in shareholders

wealthrdquo

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EVA basically stands for appeal to common sense although underlying application

can be complex But it is the way to show what ldquovaluerdquo was made from what capital was

used By using EVA is to help the firm to achieve more with as little capital as necessary

which points managers and firms toward efficiency It transforms employees into

entrepreneurs via incentive complementation and just simplest application needs commonly

financial statements

Managers can also used EVA as a diagnostic likely tool to show which one of the

departments needs more work to increase a firmrsquos value for the next period (Maumlkelaumlinen amp

Roztocki 1998) In short the EVA management system covers all managerial decisions

including strategic planning capital allocating setting day-to-day operating decisions

There is no absolute perfect measurement tool EVA also has its critics In fact EVA

is not constrained by the Generally Accepted Accounted Principle (or GAAP) Some experts

suggested that EVA is not the best choice for all companies which is not universal suitable

since it has no official standards about using the metric (Lars amp Clas 2001) OrsquoHanlon and

Peasnell (1966) stated that EVA provides a valuable transformation from wrong accounting

numbers into correct estimates of value But there is no theory to guide how to select

accounting adjustment of the most relevant items which depend on the financial structure

and industrial nature (Anderson et al 2005)

Brewer (1999) mentioned that ldquosize differencesrdquo across plants or division will effects

the EVA It is based on financial accounting method it is possible manipulated by

managers EVA provides immediate results which diminish innovation moreover it offers no

solutions in much the same way as historical financial statements do

ลขสท

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12 Statement of Problems Energy is one of the key factors to several economic movements Without it the

worldrsquos entire industrialized infrastructure would collapse (Liseadiratanakul and Uarkarn

2008) Moreover the opportunity that people would stop using oil natural gas or other

substitutions in next 10 years will not too much Therefore energy business would not be

disappeared (Vibul Perngprasert 2006)

As Asian economies bloomed their energy consumption grew by similar proportions

it will be the worldrsquos largest consumer of primary energy in the near year of 2010 (R

Manning 2000) In South Asia Thailand is considered to be the biggest consumer

Recently the total energy expenditure amounted closely to 17 of the GDP

In the past security in energy sector were mostly affected the performance of Thai

stock market Last year the resource sector including energy and mining industries had

also the highest capital which is 35 of all equity market The director of AWR Lloyd

(mining energy and metals advisory) Alexander Wood (2008) pointed out that by the year-

end of 2007 after generating total shareholder returns of around 70 the listed energy

sector had a total market capitalization around 25 trillion baht which is approximately 40

of the total equity capitalization of the entire Thai stock market Market capital data on SET

from 2003 to 2008 are compared shown as Figure 11 (Market capital data on SET from

2003 to 2008 is attached in Appendix A)

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d

6

000

50000000

100000000

150000000

200000000

250000000

Jan - Dec Jan - Dec Jan - Dec Jan - Dec Jan - Dec Jan - Dec

2008 2007 2006 2005 2004 2003

Period

Mill

ion

Baht

AgroConsumpFincialIndusPropconResourcServiceTech

Figure 11 Market Capitalizations on SET (2003-2008)

Source SET index

An emerging literature of analyze whether EVA is highly associated with stock

returns than traditional performance measures has addressed the empirical issue Tully

(1993) claimed that EVA has significant relationship with stock price returns and both are

remarkable tendency Some even claimed traditional accounting measures were inadequate

measures of a firmrsquos performance

So far there are few EVA relevant studies in Thailand covering the energy sector

Consequently this is an opportunity to begin a research in this area

13 Objectives of the Study The purpose of this study is to develop and test EVA as the performance measure in

the decision-making of investment by the management and in evaluation the future

performance of stock by the investor like Stern Stewart amp Co claimed The objectives of

this research are as follow

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hts re

serve

d

7

1 To investigate if EVA can be suitable for applying to the Thai energy sector

2 Moreover to investigate if EVA can better affect the operational performance of

Thai energy sector than the traditional performance index (including EPS ROA and ROE)

in explaining Market Value Added( MVA) thereby stock returns

14 Expected Benefits 1 A better understanding of calculating EVA and MVA

2 International firms can take the finding of this study as a reference compared

between innovation measure - EVA and traditional performance measures

3 To make more investors sophisticate about the comprehension of EVA and MVA

as a practical tool of stock market investing

15 Scope and limitations

The sample firms are listed on the Stock Exchange of Thailand (SET) and are

gathered the quarterly financial reports in twenty quarters within the same organization and

cross the firms within the energy sector Assuming that the equity markets are efficient

eight companies of Thai energy sector is selected and completely qualified would be

employed in the empirical study

However due to the scope of the problem this research is obliged to make

limitations

16 Operation Definitions

Capital Asset Pricing Model (CAPM) - A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities

ลขสท

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ย

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d

8

Net Operating Profit After Tax (NOPAT) - The profit a company would generate if it had no debt and held only operating asset

Earnings before Interest and Taxes (EBIT) - When comparing companyrsquos operating performances it is essential to focus on their earnings before deducing taxes and interest payments And it is often referred to as operation income

Earning per share (EPS) - It is a bottom-line to denote that of all items on the income statement EPS shows that a companys profit allocated to each outstanding share of common stock EPS serves as an indicator of a companys profitability

Weighted Average Cost of Capital (WACC) ndash A weighted average of the component costs of debt preferred stock and common equity

Invested Capital - represents the total cash investment that shareholders and debt holders have made in a company

Economic Value Added (EVA) - The EVA is a registered trademark by its developer Stern Stewart amp Co that is an estimate of true economic profit after making corrective adjustments to GAAP accounting EVA can be measured as Net Operating Profit after Taxes (NOPAT) less the cost of capital

Market Value Added (MVA) ndash A measure to directly reflect the creation of shareholder value developed by Stern Stewart amp Co It shows the difference between the market value of a firmrsquos equity and the book value as shown on the balance sheet with market value found by multiplying the stock price by the number of shares outstanding Return on Total Assets (ROA) ndash The ratio of net income to total assets after interest and taxes Return in Common Equity (ROE) ndash The ratio of a fiscal years net income to common equity measures the rate of return on common stockholdersrsquo investment

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xi

TABLE OF CONTENTS (COUNTINUED)

Chapter Page From MVA to EVA 16 Economic Value Added (EVA)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 18 The Originsndash Residual Income (RI)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 17 The EVA Metric helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 19 The Elements of EVA helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 21 Accounting Adjustmentshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 24 Advantages and Disadvantageshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 26 Related Research helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 33 Research in support of EVA as the best driver of MVAhelliphelliphelliphelliphelliphellip 33 Criticisms of EVA and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 37

3 Research Methodology 42 Conceptual Frameworkhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 43 Research Designhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44 Population helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44 Data Collectionhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 45

Hypotheseshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 49 Data Analysishelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 50

4 Results of Analysis hellip 52 Analyze the innovation measure ndashEVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 56

Analyze the traditional measures (EPS ROA and ROE) helliphelliphellip 58 The results of all independent variableshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 59

5 Conclusion Discussion and Suggestion 62 Conclusion helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 62

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TABLE OF CONTENTS (COUNTINED)

Page

Discussion helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 65 Limitations of this study helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 68 Suggestions for further study helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 68 BIBLIOGRAPHY 71

APPENDICES 85

A Market Capital from 2003-2008 on SET 86 B Company Profile 87 C Statistics Analysis Resultshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 92

BIOGRAPHY 105

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LIST OF ABBREVIATION

Capital asset pricing model CAPM

Cash flow return on investment CFROI

Discounted cash flow DCF

Dividends per share DPS

Earnings before interest and taxes EBIT

EBIT plus depreciation and amortization EBITDA

Earnings per share EPS

Economic Value Added EVA

Free cash flow FCF

Market Value Added MVA

Net income NI

Net operation profit after tax NOPAT

Profit after tax PAT

Residual income RI

Return on total assets ROA

Return on common equity ROE

Return on investment ROI

Return on invested capital ROIC

Return on net worth RONW

Return on sales ROS

Weighted average cost of capital WACC

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xiv

LIST OF TABLES Table Page 21 Accounting items under GAAP and adjustments in EVA method

Young and OrsquoByrne (2001)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 25

22 The relationship between EVA and other financial performance measures

Stern (1993)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 34

23 The relationship between EVA and other financial performance measures

Uyemura Kantor and Pettit (1996)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 35

32 A Regular Balance Sheet vs The EVA Balance Sheet helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 48

41 Descriptive statistics matrix of this study (2006Q4-2008Q3)helliphelliphelliphelliphelliphelliphelliphelliphelliphellip 53

42 Comparison of average MVA and EVA helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 54

43 Correlation statistics matrix of this study (2006Q4-2008Q3)helliphelliphelliphelliphelliphelliphelliphelliphellip 55

44 Summary of regression matrix between EVA and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 56

45 Selected coefficients for total sample EGCO RATCH and PTTEPhelliphelliphelliphelliphelliphellip 57

46 Summary of regression matrix between traditional accounting measures

and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 58

47 Summary of regression matrix MVA depends on all independent variableshelliphelliphelliphellip 59

48 Summary of regression matrix between all variables for each companyhelliphelliphelliphellip 60

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LIST OF FIGURES Figure Page 11 Market Capitalization on SET (2003-2008) helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 6

21 A typical bonus plan helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 28

22 The EVA bonus plan helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 29

31 The conceptual frameworkhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44

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CHAPTER 1

INTRODUCTION

11 Introduction In the 1980rsquos while investors started to express interest in stock market the publicly

listed companies had to pursue the creation of value for their shareholders as the most

significant goal Many different interpretations of shareholder-value seem to wildly exist

throughout the public discussion and the press Although chairmen of big corporations have

taken up the talk of aiming at an increase of shareholder value they have not made exactly

clear how they will attempt to reach this goal or how success on this step shall be

measured (Young and OrsquoByrne 2001) Thus the rapid changes have led to a general

dissatisfaction with traditional performance measures (Needly et al 1999) new

mechanisms for measuring value have been created For example John Kay (1993)

developed the concept of Valued Added which measures the different between the

comprehensively accounted valued of the input and the output of a firm And one of the

most popular mechanisms is Economic Value Added (EVA) which increases transparency

for investors and managers developed and trademarked by a US-based consulting firm

called Stern Stewart amp Co

Stern Stewart amp Co launched the concept in order to motivate managers and other

employees in 1989 (Stern and Shiely 2001) Stewart revised through numbers of

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2

accounting adjustments and relabeled EVA in 2001 (Anderson et al 2005) But it

widespread as the financial management and incentive compensation system began with

Fortune Magazine proclaimed EVA asrdquo todayrsquos hottest financial idea and getting hotterrdquordquo

The real key to creating wealthrdquo (September 1993) ldquoA new Way to Find Bargainsrdquo

(December 1996) ldquoAmericarsquos greatest wealth creatorsrdquo(November1997) and even today ldquoA

new way to value the marketrdquo (February2008) the management guru Peter F Drucker

(1993) described it as ldquoa vital measure of total factor productivityrdquo in Harvard Business

Review

Originally in the United States EVA has been ldquoliterally adopted by hundreds of the

leading firms such as Coca-Cola Eli Lilly Quaker Oats AT amp T and the Postal Service in

the United Statesrdquo (Biddle et al 1998) and also by investment banks like Credit Suisse

First Boston or Goldman Sachs have supplements traditional valuation methods with EVA

The CEO of Coca-Cola Roberto Goizuera believed that adopted EVA in turning the firm

become the number one Market Value Added Company when itrsquos stock price increased

form $3 to over $60 in the early 1980s James Meenan the CFO of AT amp T long-term

business declared that EVA has an almost perfect correlation with stock price tracked back

the calculation to 1984 from 1994 and used it to be the lead indicator including ldquopeople and

customer value addedrdquo of their performance measurement

EVA has been world wildly promoted in UK Australia Canada Brazil Germany

Mexico Turkey and France that it has adopted by several international firms (Stern

Steward 1999) For example the ABSA Banking Group in South Africa

(Weldeghiorgis 2004) the ANZ Banking Group Fletcher Challenge Limited James Hardie

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3

Industries and the Wrighton Group in Australia have implemented EVA for many years

(Rennie1997) Furthermore the big European conglomerated such as Siemens has put

EVA to completely change the company since introduced there in 1998 and lately more

spreading to Latin American and Asia (Young and OrsquoByrne 2001)

In Asia the Japanrsquos financial magazine Toyokeizai mentioned that EVA is not only

a financial tool but also a mind-set creator for the managers and employees Many

international firms were actively to implement it such as Kao Corporation Asahi Kasei Kirin

BeerSonyhellipetc(Toyokeizai magazine 2000) In China state-owned assets supervision

and administration commission of Peoplersquos Government announced in the upcoming 2010

EVA will be one of the evaluation standards for senior managers (China Business News

2008)

The concept of EVA is definitely not new EVA is a modified computation of residual

income with a series of accounting adjustments to how one calculates income and capital

EVA is the net operation minus an appropriate charge for the ldquoopportunity costrdquo which

means the cost of capital by Stewart in an enterprise or projects (Maumlkelaumlinen and Roztocki

1998) In addition Stewart (1991) claimed that EVA is not only the financial measure

which comes closer than any other to capturing the true economic profit of an enterprise

but also the performance measure most directly linked to the creation of shareholder wealth

over time Stewart (1994) also stated that ldquoEVA stands well out from the crowed as the

single best measure of wealth creation on a contemporaneous basis and is almost 50

better than its closer accounting-based competitors in explaining changed in shareholders

wealthrdquo

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EVA basically stands for appeal to common sense although underlying application

can be complex But it is the way to show what ldquovaluerdquo was made from what capital was

used By using EVA is to help the firm to achieve more with as little capital as necessary

which points managers and firms toward efficiency It transforms employees into

entrepreneurs via incentive complementation and just simplest application needs commonly

financial statements

Managers can also used EVA as a diagnostic likely tool to show which one of the

departments needs more work to increase a firmrsquos value for the next period (Maumlkelaumlinen amp

Roztocki 1998) In short the EVA management system covers all managerial decisions

including strategic planning capital allocating setting day-to-day operating decisions

There is no absolute perfect measurement tool EVA also has its critics In fact EVA

is not constrained by the Generally Accepted Accounted Principle (or GAAP) Some experts

suggested that EVA is not the best choice for all companies which is not universal suitable

since it has no official standards about using the metric (Lars amp Clas 2001) OrsquoHanlon and

Peasnell (1966) stated that EVA provides a valuable transformation from wrong accounting

numbers into correct estimates of value But there is no theory to guide how to select

accounting adjustment of the most relevant items which depend on the financial structure

and industrial nature (Anderson et al 2005)

Brewer (1999) mentioned that ldquosize differencesrdquo across plants or division will effects

the EVA It is based on financial accounting method it is possible manipulated by

managers EVA provides immediate results which diminish innovation moreover it offers no

solutions in much the same way as historical financial statements do

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12 Statement of Problems Energy is one of the key factors to several economic movements Without it the

worldrsquos entire industrialized infrastructure would collapse (Liseadiratanakul and Uarkarn

2008) Moreover the opportunity that people would stop using oil natural gas or other

substitutions in next 10 years will not too much Therefore energy business would not be

disappeared (Vibul Perngprasert 2006)

As Asian economies bloomed their energy consumption grew by similar proportions

it will be the worldrsquos largest consumer of primary energy in the near year of 2010 (R

Manning 2000) In South Asia Thailand is considered to be the biggest consumer

Recently the total energy expenditure amounted closely to 17 of the GDP

In the past security in energy sector were mostly affected the performance of Thai

stock market Last year the resource sector including energy and mining industries had

also the highest capital which is 35 of all equity market The director of AWR Lloyd

(mining energy and metals advisory) Alexander Wood (2008) pointed out that by the year-

end of 2007 after generating total shareholder returns of around 70 the listed energy

sector had a total market capitalization around 25 trillion baht which is approximately 40

of the total equity capitalization of the entire Thai stock market Market capital data on SET

from 2003 to 2008 are compared shown as Figure 11 (Market capital data on SET from

2003 to 2008 is attached in Appendix A)

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6

000

50000000

100000000

150000000

200000000

250000000

Jan - Dec Jan - Dec Jan - Dec Jan - Dec Jan - Dec Jan - Dec

2008 2007 2006 2005 2004 2003

Period

Mill

ion

Baht

AgroConsumpFincialIndusPropconResourcServiceTech

Figure 11 Market Capitalizations on SET (2003-2008)

Source SET index

An emerging literature of analyze whether EVA is highly associated with stock

returns than traditional performance measures has addressed the empirical issue Tully

(1993) claimed that EVA has significant relationship with stock price returns and both are

remarkable tendency Some even claimed traditional accounting measures were inadequate

measures of a firmrsquos performance

So far there are few EVA relevant studies in Thailand covering the energy sector

Consequently this is an opportunity to begin a research in this area

13 Objectives of the Study The purpose of this study is to develop and test EVA as the performance measure in

the decision-making of investment by the management and in evaluation the future

performance of stock by the investor like Stern Stewart amp Co claimed The objectives of

this research are as follow

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1 To investigate if EVA can be suitable for applying to the Thai energy sector

2 Moreover to investigate if EVA can better affect the operational performance of

Thai energy sector than the traditional performance index (including EPS ROA and ROE)

in explaining Market Value Added( MVA) thereby stock returns

14 Expected Benefits 1 A better understanding of calculating EVA and MVA

2 International firms can take the finding of this study as a reference compared

between innovation measure - EVA and traditional performance measures

3 To make more investors sophisticate about the comprehension of EVA and MVA

as a practical tool of stock market investing

15 Scope and limitations

The sample firms are listed on the Stock Exchange of Thailand (SET) and are

gathered the quarterly financial reports in twenty quarters within the same organization and

cross the firms within the energy sector Assuming that the equity markets are efficient

eight companies of Thai energy sector is selected and completely qualified would be

employed in the empirical study

However due to the scope of the problem this research is obliged to make

limitations

16 Operation Definitions

Capital Asset Pricing Model (CAPM) - A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities

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Net Operating Profit After Tax (NOPAT) - The profit a company would generate if it had no debt and held only operating asset

Earnings before Interest and Taxes (EBIT) - When comparing companyrsquos operating performances it is essential to focus on their earnings before deducing taxes and interest payments And it is often referred to as operation income

Earning per share (EPS) - It is a bottom-line to denote that of all items on the income statement EPS shows that a companys profit allocated to each outstanding share of common stock EPS serves as an indicator of a companys profitability

Weighted Average Cost of Capital (WACC) ndash A weighted average of the component costs of debt preferred stock and common equity

Invested Capital - represents the total cash investment that shareholders and debt holders have made in a company

Economic Value Added (EVA) - The EVA is a registered trademark by its developer Stern Stewart amp Co that is an estimate of true economic profit after making corrective adjustments to GAAP accounting EVA can be measured as Net Operating Profit after Taxes (NOPAT) less the cost of capital

Market Value Added (MVA) ndash A measure to directly reflect the creation of shareholder value developed by Stern Stewart amp Co It shows the difference between the market value of a firmrsquos equity and the book value as shown on the balance sheet with market value found by multiplying the stock price by the number of shares outstanding Return on Total Assets (ROA) ndash The ratio of net income to total assets after interest and taxes Return in Common Equity (ROE) ndash The ratio of a fiscal years net income to common equity measures the rate of return on common stockholdersrsquo investment

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TABLE OF CONTENTS (COUNTINED)

Page

Discussion helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 65 Limitations of this study helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 68 Suggestions for further study helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 68 BIBLIOGRAPHY 71

APPENDICES 85

A Market Capital from 2003-2008 on SET 86 B Company Profile 87 C Statistics Analysis Resultshelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 92

BIOGRAPHY 105

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LIST OF ABBREVIATION

Capital asset pricing model CAPM

Cash flow return on investment CFROI

Discounted cash flow DCF

Dividends per share DPS

Earnings before interest and taxes EBIT

EBIT plus depreciation and amortization EBITDA

Earnings per share EPS

Economic Value Added EVA

Free cash flow FCF

Market Value Added MVA

Net income NI

Net operation profit after tax NOPAT

Profit after tax PAT

Residual income RI

Return on total assets ROA

Return on common equity ROE

Return on investment ROI

Return on invested capital ROIC

Return on net worth RONW

Return on sales ROS

Weighted average cost of capital WACC

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xiv

LIST OF TABLES Table Page 21 Accounting items under GAAP and adjustments in EVA method

Young and OrsquoByrne (2001)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 25

22 The relationship between EVA and other financial performance measures

Stern (1993)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 34

23 The relationship between EVA and other financial performance measures

Uyemura Kantor and Pettit (1996)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 35

32 A Regular Balance Sheet vs The EVA Balance Sheet helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 48

41 Descriptive statistics matrix of this study (2006Q4-2008Q3)helliphelliphelliphelliphelliphelliphelliphelliphelliphellip 53

42 Comparison of average MVA and EVA helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 54

43 Correlation statistics matrix of this study (2006Q4-2008Q3)helliphelliphelliphelliphelliphelliphelliphelliphellip 55

44 Summary of regression matrix between EVA and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 56

45 Selected coefficients for total sample EGCO RATCH and PTTEPhelliphelliphelliphelliphelliphellip 57

46 Summary of regression matrix between traditional accounting measures

and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 58

47 Summary of regression matrix MVA depends on all independent variableshelliphelliphelliphellip 59

48 Summary of regression matrix between all variables for each companyhelliphelliphelliphellip 60

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LIST OF FIGURES Figure Page 11 Market Capitalization on SET (2003-2008) helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 6

21 A typical bonus plan helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 28

22 The EVA bonus plan helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 29

31 The conceptual frameworkhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44

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1

CHAPTER 1

INTRODUCTION

11 Introduction In the 1980rsquos while investors started to express interest in stock market the publicly

listed companies had to pursue the creation of value for their shareholders as the most

significant goal Many different interpretations of shareholder-value seem to wildly exist

throughout the public discussion and the press Although chairmen of big corporations have

taken up the talk of aiming at an increase of shareholder value they have not made exactly

clear how they will attempt to reach this goal or how success on this step shall be

measured (Young and OrsquoByrne 2001) Thus the rapid changes have led to a general

dissatisfaction with traditional performance measures (Needly et al 1999) new

mechanisms for measuring value have been created For example John Kay (1993)

developed the concept of Valued Added which measures the different between the

comprehensively accounted valued of the input and the output of a firm And one of the

most popular mechanisms is Economic Value Added (EVA) which increases transparency

for investors and managers developed and trademarked by a US-based consulting firm

called Stern Stewart amp Co

Stern Stewart amp Co launched the concept in order to motivate managers and other

employees in 1989 (Stern and Shiely 2001) Stewart revised through numbers of

ลขสท

ธ มหาว

ทยาลย

หอการ

คาไท

ย

Copy

right

by U

TCC

All rig

hts re

serve

d

2

accounting adjustments and relabeled EVA in 2001 (Anderson et al 2005) But it

widespread as the financial management and incentive compensation system began with

Fortune Magazine proclaimed EVA asrdquo todayrsquos hottest financial idea and getting hotterrdquordquo

The real key to creating wealthrdquo (September 1993) ldquoA new Way to Find Bargainsrdquo

(December 1996) ldquoAmericarsquos greatest wealth creatorsrdquo(November1997) and even today ldquoA

new way to value the marketrdquo (February2008) the management guru Peter F Drucker

(1993) described it as ldquoa vital measure of total factor productivityrdquo in Harvard Business

Review

Originally in the United States EVA has been ldquoliterally adopted by hundreds of the

leading firms such as Coca-Cola Eli Lilly Quaker Oats AT amp T and the Postal Service in

the United Statesrdquo (Biddle et al 1998) and also by investment banks like Credit Suisse

First Boston or Goldman Sachs have supplements traditional valuation methods with EVA

The CEO of Coca-Cola Roberto Goizuera believed that adopted EVA in turning the firm

become the number one Market Value Added Company when itrsquos stock price increased

form $3 to over $60 in the early 1980s James Meenan the CFO of AT amp T long-term

business declared that EVA has an almost perfect correlation with stock price tracked back

the calculation to 1984 from 1994 and used it to be the lead indicator including ldquopeople and

customer value addedrdquo of their performance measurement

EVA has been world wildly promoted in UK Australia Canada Brazil Germany

Mexico Turkey and France that it has adopted by several international firms (Stern

Steward 1999) For example the ABSA Banking Group in South Africa

(Weldeghiorgis 2004) the ANZ Banking Group Fletcher Challenge Limited James Hardie

ลขสท

ธ มหาว

ทยาลย

หอการ

คาไท

ย

Copy

right

by U

TCC

All rig

hts re

serve

d

3

Industries and the Wrighton Group in Australia have implemented EVA for many years

(Rennie1997) Furthermore the big European conglomerated such as Siemens has put

EVA to completely change the company since introduced there in 1998 and lately more

spreading to Latin American and Asia (Young and OrsquoByrne 2001)

In Asia the Japanrsquos financial magazine Toyokeizai mentioned that EVA is not only

a financial tool but also a mind-set creator for the managers and employees Many

international firms were actively to implement it such as Kao Corporation Asahi Kasei Kirin

BeerSonyhellipetc(Toyokeizai magazine 2000) In China state-owned assets supervision

and administration commission of Peoplersquos Government announced in the upcoming 2010

EVA will be one of the evaluation standards for senior managers (China Business News

2008)

The concept of EVA is definitely not new EVA is a modified computation of residual

income with a series of accounting adjustments to how one calculates income and capital

EVA is the net operation minus an appropriate charge for the ldquoopportunity costrdquo which

means the cost of capital by Stewart in an enterprise or projects (Maumlkelaumlinen and Roztocki

1998) In addition Stewart (1991) claimed that EVA is not only the financial measure

which comes closer than any other to capturing the true economic profit of an enterprise

but also the performance measure most directly linked to the creation of shareholder wealth

over time Stewart (1994) also stated that ldquoEVA stands well out from the crowed as the

single best measure of wealth creation on a contemporaneous basis and is almost 50

better than its closer accounting-based competitors in explaining changed in shareholders

wealthrdquo

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4

EVA basically stands for appeal to common sense although underlying application

can be complex But it is the way to show what ldquovaluerdquo was made from what capital was

used By using EVA is to help the firm to achieve more with as little capital as necessary

which points managers and firms toward efficiency It transforms employees into

entrepreneurs via incentive complementation and just simplest application needs commonly

financial statements

Managers can also used EVA as a diagnostic likely tool to show which one of the

departments needs more work to increase a firmrsquos value for the next period (Maumlkelaumlinen amp

Roztocki 1998) In short the EVA management system covers all managerial decisions

including strategic planning capital allocating setting day-to-day operating decisions

There is no absolute perfect measurement tool EVA also has its critics In fact EVA

is not constrained by the Generally Accepted Accounted Principle (or GAAP) Some experts

suggested that EVA is not the best choice for all companies which is not universal suitable

since it has no official standards about using the metric (Lars amp Clas 2001) OrsquoHanlon and

Peasnell (1966) stated that EVA provides a valuable transformation from wrong accounting

numbers into correct estimates of value But there is no theory to guide how to select

accounting adjustment of the most relevant items which depend on the financial structure

and industrial nature (Anderson et al 2005)

Brewer (1999) mentioned that ldquosize differencesrdquo across plants or division will effects

the EVA It is based on financial accounting method it is possible manipulated by

managers EVA provides immediate results which diminish innovation moreover it offers no

solutions in much the same way as historical financial statements do

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5

12 Statement of Problems Energy is one of the key factors to several economic movements Without it the

worldrsquos entire industrialized infrastructure would collapse (Liseadiratanakul and Uarkarn

2008) Moreover the opportunity that people would stop using oil natural gas or other

substitutions in next 10 years will not too much Therefore energy business would not be

disappeared (Vibul Perngprasert 2006)

As Asian economies bloomed their energy consumption grew by similar proportions

it will be the worldrsquos largest consumer of primary energy in the near year of 2010 (R

Manning 2000) In South Asia Thailand is considered to be the biggest consumer

Recently the total energy expenditure amounted closely to 17 of the GDP

In the past security in energy sector were mostly affected the performance of Thai

stock market Last year the resource sector including energy and mining industries had

also the highest capital which is 35 of all equity market The director of AWR Lloyd

(mining energy and metals advisory) Alexander Wood (2008) pointed out that by the year-

end of 2007 after generating total shareholder returns of around 70 the listed energy

sector had a total market capitalization around 25 trillion baht which is approximately 40

of the total equity capitalization of the entire Thai stock market Market capital data on SET

from 2003 to 2008 are compared shown as Figure 11 (Market capital data on SET from

2003 to 2008 is attached in Appendix A)

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6

000

50000000

100000000

150000000

200000000

250000000

Jan - Dec Jan - Dec Jan - Dec Jan - Dec Jan - Dec Jan - Dec

2008 2007 2006 2005 2004 2003

Period

Mill

ion

Baht

AgroConsumpFincialIndusPropconResourcServiceTech

Figure 11 Market Capitalizations on SET (2003-2008)

Source SET index

An emerging literature of analyze whether EVA is highly associated with stock

returns than traditional performance measures has addressed the empirical issue Tully

(1993) claimed that EVA has significant relationship with stock price returns and both are

remarkable tendency Some even claimed traditional accounting measures were inadequate

measures of a firmrsquos performance

So far there are few EVA relevant studies in Thailand covering the energy sector

Consequently this is an opportunity to begin a research in this area

13 Objectives of the Study The purpose of this study is to develop and test EVA as the performance measure in

the decision-making of investment by the management and in evaluation the future

performance of stock by the investor like Stern Stewart amp Co claimed The objectives of

this research are as follow

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serve

d

7

1 To investigate if EVA can be suitable for applying to the Thai energy sector

2 Moreover to investigate if EVA can better affect the operational performance of

Thai energy sector than the traditional performance index (including EPS ROA and ROE)

in explaining Market Value Added( MVA) thereby stock returns

14 Expected Benefits 1 A better understanding of calculating EVA and MVA

2 International firms can take the finding of this study as a reference compared

between innovation measure - EVA and traditional performance measures

3 To make more investors sophisticate about the comprehension of EVA and MVA

as a practical tool of stock market investing

15 Scope and limitations

The sample firms are listed on the Stock Exchange of Thailand (SET) and are

gathered the quarterly financial reports in twenty quarters within the same organization and

cross the firms within the energy sector Assuming that the equity markets are efficient

eight companies of Thai energy sector is selected and completely qualified would be

employed in the empirical study

However due to the scope of the problem this research is obliged to make

limitations

16 Operation Definitions

Capital Asset Pricing Model (CAPM) - A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities

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8

Net Operating Profit After Tax (NOPAT) - The profit a company would generate if it had no debt and held only operating asset

Earnings before Interest and Taxes (EBIT) - When comparing companyrsquos operating performances it is essential to focus on their earnings before deducing taxes and interest payments And it is often referred to as operation income

Earning per share (EPS) - It is a bottom-line to denote that of all items on the income statement EPS shows that a companys profit allocated to each outstanding share of common stock EPS serves as an indicator of a companys profitability

Weighted Average Cost of Capital (WACC) ndash A weighted average of the component costs of debt preferred stock and common equity

Invested Capital - represents the total cash investment that shareholders and debt holders have made in a company

Economic Value Added (EVA) - The EVA is a registered trademark by its developer Stern Stewart amp Co that is an estimate of true economic profit after making corrective adjustments to GAAP accounting EVA can be measured as Net Operating Profit after Taxes (NOPAT) less the cost of capital

Market Value Added (MVA) ndash A measure to directly reflect the creation of shareholder value developed by Stern Stewart amp Co It shows the difference between the market value of a firmrsquos equity and the book value as shown on the balance sheet with market value found by multiplying the stock price by the number of shares outstanding Return on Total Assets (ROA) ndash The ratio of net income to total assets after interest and taxes Return in Common Equity (ROE) ndash The ratio of a fiscal years net income to common equity measures the rate of return on common stockholdersrsquo investment

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xii

LIST OF ABBREVIATION

Capital asset pricing model CAPM

Cash flow return on investment CFROI

Discounted cash flow DCF

Dividends per share DPS

Earnings before interest and taxes EBIT

EBIT plus depreciation and amortization EBITDA

Earnings per share EPS

Economic Value Added EVA

Free cash flow FCF

Market Value Added MVA

Net income NI

Net operation profit after tax NOPAT

Profit after tax PAT

Residual income RI

Return on total assets ROA

Return on common equity ROE

Return on investment ROI

Return on invested capital ROIC

Return on net worth RONW

Return on sales ROS

Weighted average cost of capital WACC

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xiv

LIST OF TABLES Table Page 21 Accounting items under GAAP and adjustments in EVA method

Young and OrsquoByrne (2001)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 25

22 The relationship between EVA and other financial performance measures

Stern (1993)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 34

23 The relationship between EVA and other financial performance measures

Uyemura Kantor and Pettit (1996)helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 35

32 A Regular Balance Sheet vs The EVA Balance Sheet helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 48

41 Descriptive statistics matrix of this study (2006Q4-2008Q3)helliphelliphelliphelliphelliphelliphelliphelliphelliphellip 53

42 Comparison of average MVA and EVA helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 54

43 Correlation statistics matrix of this study (2006Q4-2008Q3)helliphelliphelliphelliphelliphelliphelliphelliphellip 55

44 Summary of regression matrix between EVA and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 56

45 Selected coefficients for total sample EGCO RATCH and PTTEPhelliphelliphelliphelliphelliphellip 57

46 Summary of regression matrix between traditional accounting measures

and MVAhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 58

47 Summary of regression matrix MVA depends on all independent variableshelliphelliphelliphellip 59

48 Summary of regression matrix between all variables for each companyhelliphelliphelliphellip 60

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xv

LIST OF FIGURES Figure Page 11 Market Capitalization on SET (2003-2008) helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 6

21 A typical bonus plan helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 28

22 The EVA bonus plan helliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 29

31 The conceptual frameworkhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip 44

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1

CHAPTER 1

INTRODUCTION

11 Introduction In the 1980rsquos while investors started to express interest in stock market the publicly

listed companies had to pursue the creation of value for their shareholders as the most

significant goal Many different interpretations of shareholder-value seem to wildly exist

throughout the public discussion and the press Although chairmen of big corporations have

taken up the talk of aiming at an increase of shareholder value they have not made exactly

clear how they will attempt to reach this goal or how success on this step shall be

measured (Young and OrsquoByrne 2001) Thus the rapid changes have led to a general

dissatisfaction with traditional performance measures (Needly et al 1999) new

mechanisms for measuring value have been created For example John Kay (1993)

developed the concept of Valued Added which measures the different between the

comprehensively accounted valued of the input and the output of a firm And one of the

most popular mechanisms is Economic Value Added (EVA) which increases transparency

for investors and managers developed and trademarked by a US-based consulting firm

called Stern Stewart amp Co

Stern Stewart amp Co launched the concept in order to motivate managers and other

employees in 1989 (Stern and Shiely 2001) Stewart revised through numbers of

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2

accounting adjustments and relabeled EVA in 2001 (Anderson et al 2005) But it

widespread as the financial management and incentive compensation system began with

Fortune Magazine proclaimed EVA asrdquo todayrsquos hottest financial idea and getting hotterrdquordquo

The real key to creating wealthrdquo (September 1993) ldquoA new Way to Find Bargainsrdquo

(December 1996) ldquoAmericarsquos greatest wealth creatorsrdquo(November1997) and even today ldquoA

new way to value the marketrdquo (February2008) the management guru Peter F Drucker

(1993) described it as ldquoa vital measure of total factor productivityrdquo in Harvard Business

Review

Originally in the United States EVA has been ldquoliterally adopted by hundreds of the

leading firms such as Coca-Cola Eli Lilly Quaker Oats AT amp T and the Postal Service in

the United Statesrdquo (Biddle et al 1998) and also by investment banks like Credit Suisse

First Boston or Goldman Sachs have supplements traditional valuation methods with EVA

The CEO of Coca-Cola Roberto Goizuera believed that adopted EVA in turning the firm

become the number one Market Value Added Company when itrsquos stock price increased

form $3 to over $60 in the early 1980s James Meenan the CFO of AT amp T long-term

business declared that EVA has an almost perfect correlation with stock price tracked back

the calculation to 1984 from 1994 and used it to be the lead indicator including ldquopeople and

customer value addedrdquo of their performance measurement

EVA has been world wildly promoted in UK Australia Canada Brazil Germany

Mexico Turkey and France that it has adopted by several international firms (Stern

Steward 1999) For example the ABSA Banking Group in South Africa

(Weldeghiorgis 2004) the ANZ Banking Group Fletcher Challenge Limited James Hardie

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3

Industries and the Wrighton Group in Australia have implemented EVA for many years

(Rennie1997) Furthermore the big European conglomerated such as Siemens has put

EVA to completely change the company since introduced there in 1998 and lately more

spreading to Latin American and Asia (Young and OrsquoByrne 2001)

In Asia the Japanrsquos financial magazine Toyokeizai mentioned that EVA is not only

a financial tool but also a mind-set creator for the managers and employees Many

international firms were actively to implement it such as Kao Corporation Asahi Kasei Kirin

BeerSonyhellipetc(Toyokeizai magazine 2000) In China state-owned assets supervision

and administration commission of Peoplersquos Government announced in the upcoming 2010

EVA will be one of the evaluation standards for senior managers (China Business News

2008)

The concept of EVA is definitely not new EVA is a modified computation of residual

income with a series of accounting adjustments to how one calculates income and capital

EVA is the net operation minus an appropriate charge for the ldquoopportunity costrdquo which

means the cost of capital by Stewart in an enterprise or projects (Maumlkelaumlinen and Roztocki

1998) In addition Stewart (1991) claimed that EVA is not only the financial measure

which comes closer than any other to capturing the true economic profit of an enterprise

but also the performance measure most directly linked to the creation of shareholder wealth

over time Stewart (1994) also stated that ldquoEVA stands well out from the crowed as the

single best measure of wealth creation on a contemporaneous basis and is almost 50

better than its closer accounting-based competitors in explaining changed in shareholders

wealthrdquo

ลขสท

ธ มหาว

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ย

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d

4

EVA basically stands for appeal to common sense although underlying application

can be complex But it is the way to show what ldquovaluerdquo was made from what capital was

used By using EVA is to help the firm to achieve more with as little capital as necessary

which points managers and firms toward efficiency It transforms employees into

entrepreneurs via incentive complementation and just simplest application needs commonly

financial statements

Managers can also used EVA as a diagnostic likely tool to show which one of the

departments needs more work to increase a firmrsquos value for the next period (Maumlkelaumlinen amp

Roztocki 1998) In short the EVA management system covers all managerial decisions

including strategic planning capital allocating setting day-to-day operating decisions

There is no absolute perfect measurement tool EVA also has its critics In fact EVA

is not constrained by the Generally Accepted Accounted Principle (or GAAP) Some experts

suggested that EVA is not the best choice for all companies which is not universal suitable

since it has no official standards about using the metric (Lars amp Clas 2001) OrsquoHanlon and

Peasnell (1966) stated that EVA provides a valuable transformation from wrong accounting

numbers into correct estimates of value But there is no theory to guide how to select

accounting adjustment of the most relevant items which depend on the financial structure

and industrial nature (Anderson et al 2005)

Brewer (1999) mentioned that ldquosize differencesrdquo across plants or division will effects

the EVA It is based on financial accounting method it is possible manipulated by

managers EVA provides immediate results which diminish innovation moreover it offers no

solutions in much the same way as historical financial statements do

ลขสท

ธ มหาว

ทยาลย

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ย

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right

by U

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d

5

12 Statement of Problems Energy is one of the key factors to several economic movements Without it the

worldrsquos entire industrialized infrastructure would collapse (Liseadiratanakul and Uarkarn

2008) Moreover the opportunity that people would stop using oil natural gas or other

substitutions in next 10 years will not too much Therefore energy business would not be

disappeared (Vibul Perngprasert 2006)

As Asian economies bloomed their energy consumption grew by similar proportions

it will be the worldrsquos largest consumer of primary energy in the near year of 2010 (R

Manning 2000) In South Asia Thailand is considered to be the biggest consumer

Recently the total energy expenditure amounted closely to 17 of the GDP

In the past security in energy sector were mostly affected the performance of Thai

stock market Last year the resource sector including energy and mining industries had

also the highest capital which is 35 of all equity market The director of AWR Lloyd

(mining energy and metals advisory) Alexander Wood (2008) pointed out that by the year-

end of 2007 after generating total shareholder returns of around 70 the listed energy

sector had a total market capitalization around 25 trillion baht which is approximately 40

of the total equity capitalization of the entire Thai stock market Market capital data on SET

from 2003 to 2008 are compared shown as Figure 11 (Market capital data on SET from

2003 to 2008 is attached in Appendix A)

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ธ มหาว

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serve

d

6

000

50000000

100000000

150000000

200000000

250000000

Jan - Dec Jan - Dec Jan - Dec Jan - Dec Jan - Dec Jan - Dec

2008 2007 2006 2005 2004 2003

Period

Mill

ion

Baht

AgroConsumpFincialIndusPropconResourcServiceTech

Figure 11 Market Capitalizations on SET (2003-2008)

Source SET index

An emerging literature of analyze whether EVA is highly associated with stock

returns than traditional performance measures has addressed the empirical issue Tully

(1993) claimed that EVA has significant relationship with stock price returns and both are

remarkable tendency Some even claimed traditional accounting measures were inadequate

measures of a firmrsquos performance

So far there are few EVA relevant studies in Thailand covering the energy sector

Consequently this is an opportunity to begin a research in this area

13 Objectives of the Study The purpose of this study is to develop and test EVA as the performance measure in

the decision-making of investment by the management and in evaluation the future

performance of stock by the investor like Stern Stewart amp Co claimed The objectives of

this research are as follow

ลขสท

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ย

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right

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hts re

serve

d

7

1 To investigate if EVA can be suitable for applying to the Thai energy sector

2 Moreover to investigate if EVA can better affect the operational performance of

Thai energy sector than the traditional performance index (including EPS ROA and ROE)

in explaining Market Value Added( MVA) thereby stock returns

14 Expected Benefits 1 A better understanding of calculating EVA and MVA

2 International firms can take the finding of this study as a reference compared

between innovation measure - EVA and traditional performance measures

3 To make more investors sophisticate about the comprehension of EVA and MVA

as a practical tool of stock market investing

15 Scope and limitations

The sample firms are listed on the Stock Exchange of Thailand (SET) and are

gathered the quarterly financial reports in twenty quarters within the same organization and

cross the firms within the energy sector Assuming that the equity markets are efficient

eight companies of Thai energy sector is selected and completely qualified would be

employed in the empirical study

However due to the scope of the problem this research is obliged to make

limitations

16 Operation Definitions

Capital Asset Pricing Model (CAPM) - A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities

ลขสท

ธ มหาว

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ย

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d

8

Net Operating Profit After Tax (NOPAT) - The profit a company would generate if it had no debt and held only operating asset

Earnings before Interest and Taxes (EBIT) - When comparing companyrsquos operating performances it is essential to focus on their earnings before deducing taxes and interest payments And it is often referred to as operation income

Earning per share (EPS) - It is a bottom-line to denote that of all items on the income statement EPS shows that a companys profit allocated to each outstanding share of common stock EPS serves as an indicator of a companys profitability

Weighted Average Cost of Capital (WACC) ndash A weighted average of the component costs of debt preferred stock and common equity

Invested Capital - represents the total cash investment that shareholders and debt holders have made in a company

Economic Value Added (EVA) - The EVA is a registered trademark by its developer Stern Stewart amp Co that is an estimate of true economic profit after making corrective adjustments to GAAP accounting EVA can be measured as Net Operating Profit after Taxes (NOPAT) less the cost of capital

Market Value Added (MVA) ndash A measure to directly reflect the creation of shareholder value developed by Stern Stewart amp Co It shows the difference between the market value of a firmrsquos equity and the book value as shown on the balance sheet with market value found by multiplying the stock price by the number of shares outstanding Return on Total Assets (ROA) ndash The ratio of net income to total assets after interest and taxes Return in Common Equity (ROE) ndash The ratio of a fiscal years net income to common equity measures the rate of return on common stockholdersrsquo investment

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