Effectiveness of Economic Value Added measure in the South African banking sector.

Abstract

Banks are fundamentally different from manufacturing companies in that bulk of the assets they use to generate revenue are financial assets (loans/ advances to companies and consumers, trading portfolio assets, investment securities, loans/ advances to other banks etc) which are not subject to the traditional manufacturing physical assets factors such as depreciation, shrinkage and damage. The main factor impacting the financial assets in banking is primarily credit impairments. Despite their unique asset base, banks have shareholders who expect returns and therefore similar to all other corporations, banks have to prove that shareholder value is created in order to keep shareholders on board. This study aims to ascertain if Economic Value Added (EVA) is a potential alternative reliable shareholder value creation measure and determine how it compares to the traditional accounting measures (ROA and ROE) in the South African banking sector context. Using the banks’ financial reports data, the regression modelling empirical study results indicate that EVA is not a reliable shareholder value creation measure and it is not better at predicting shareholder value creation than the traditional accounting measures. The study concludes that EVA does not present a reliable alternative for measuring shareholder value creation in the South African banking sector. Banks’ managers, shareholders and potential investors would probably have to continue relying on the traditional accounting, efficiency, liquidity and credit risk measures as indicators for potential shareholder value being created.