# VALUE BASED FINANCIAL PERFORMANCE MEASURES: AN EVALUATION OF RELATIVE AND INCREMENTAL INFORMATION CONTENT

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6 In order o invesigae he incremenal informaion conen of he componens of measure i, i is necessary o decompose i ino is conribuing componens: i = Y 1 + Y 2 + Y 3 Y n The following null hypohesis is hen formulaed (Biddle e al., 1997: 308): H INC : Componen Y 1 does no provide informaion conen beyond ha provided by he remaining componens Y 2 -Y n where Y 1 -Y n are he various componens of he measure i invesigaed. Pairwise comparisons of he componens are conduced o evaluae he incremenal informaion conen. Rejecion of he null hypohesis indicaes ha he inclusion of he componen under invesigaion will conribue significan addiional informaion conen. 3.2 Saisical Techniques In order o evaluae he informaion conen of he measures, he relaionships beween he measures and marke adjused share reurns are invesigaed. For his purpose, regression analyses wih he share reurn as dependen variable and he various measures as he independen variables are conduced. The saisical echnique employed in his sudy focuses on he forecas errors of he various measures (calculaed as he difference beween he acual and expeced values), which are sandardised o size. When assessing he informaion conen of a measure, he saisical significance of he slope coefficien b 1 from he following ordinary-leas squares regression is examined (Biddle e al., 1997: 308): D = b 0 + b 1 FE / MVE -1 + e (1) where D (he dependen variable) is a measure of reurn for ime period ; FE / MVE -1 is he unexpeced realisaion (or forecas error) of he measure (FE ), divided by he he financial year (MVE -1 ); while e is a random disurbance erm. The unexpeced realisaion of he measure for ime period is defined as he difference beween he observed value of he measure ( expeced value of he measure (E( )): FE = E( ) (2) formed according o a discree linear sochasic process in auoregressive form, E( ) may be defined as: E( ) = (3) auoregressive parameers. Subsiuing Equaions (2) and (3) ino Equaion (1) yields: D = b 0 + b 1 [ / MVE -1 + e = b / b ' ' ' ' 0 b1 / MVE b2 / MVE b3 2 / MVE... e ' 4 3 MVE (4) E E b ' b, and where E b ' 0 b0 b1, 1 1 ' i bi i 1 b for i > 1. Equaion (4) provides he relaionship beween abnormal reurns (D ), and he lagged measures of accouning performance () scaled by MVE. For he purpose of his sudy, Equaion (5) is limied o one lag: ' ' ' D = b0 b1 / MVE b2 / MVE e (5) Tess for Relaive Informaion Conen The relaive informaion conens of he measures are assessed by means of a saisical es developed by Biddle, Seow and Siegel (1995: 9). The independen variables are included in individual regressions agains he dependen variable based on he following equaion: ' ' ' D = b0 b1 / MVE b2 / MVE e (6) where D is he marke-adjused reurn on a, is one of he measures invesigaed, and MVE is he marke value According o he es, pairwise comparisons of he adjused R 2 values from he individual regressions are conduced. Saisically significan differences beween wo adjused R 2 values resul in he rejecion of he null hypohesis H REL. This indicaes a saisically significan difference in he abiliy of he wo measures under invesigaion o explain he variaion in he dependen variable (Biddle e al., 1997: 310) Tess for Incremenal Informaion Conen In order o evaluae he incremenal informaion conen of he componens of he measures invesigaed in his sudy, he following regression is conduced (Biddle e al., 1997: 311): D = d 0 + d 1 Y 1; / MVE -1 + d 2 Y 1;-1 / MVE -1 + d 3 Y 2; / MVE -1 + d 4 Y 2;-1 / MVE -1 + e (7) where Y 1 and Y 2 are wo differen componens of he measure under invesigaion. The individual regression coefficiens are assessed by means of - ess o invesigae he conribuion of he specific componen. F-ess are used o assess he following join null hypoheses: H : d 1 = d 2 = 0 0Y 1 H 0Y 2 : d 3 = d 4 = 0 Rejecion of he null hypoheses indicaes ha he inclusion of a componen provides significan incremenal informaion. 3.3 Measures Dependen Variable The relaive and incremenal informaion conen ess applied in his sudy focus on he relaionship beween 71

12 References 1. Bacidore, J.M., Boquis, J.A., Milbourn, T.T., & Thakor, A.V. (1997). The search for he bes performance measure. Financial Analyss Journal, 53(3), Biddle, G.C., Bowen, R.M., & Wallace, J.S. (1999). Evidence on EVA. Journal of Applied Corporae Finance, 12(2), Biddle, G.C., Seow, G.S., & Siegel, A.F. (1995). Relaive versus incremenal informaion conen. Conemporary Accouning Research, 12(1), Burgsahler, D., & Dichev, I. (1997). Earnings, adapaion and equiy value. The Accouning Review, 72(2), Collins, D., Pincus, M., & ie, H. (1997). Equiy valuaion and negaive earnings: The role of book value of equiy. Unpublished paper, Universiy of Iowa, Iowa Ciy, IA. 6. Dzamba, A. (2003). Focus on CFROI analysis o Financial Analysis, Planning & Reporing, 3(11), Ehrbar, A. (1998). EVA: The real key o creaing wealh. New York: John Wiley & Sons. 8. Erasmus, P.D. (2008). The relaive and incremenal informaion conen of he value based financial performance measure cash value added (CVA). Managemen Dynamics, 17(2), (Forhcoming). 9. Fabozzi, F.J., & Gran, J.L. (ed.). (2000). Valuebased merics: Foundaions and pracice. New Hope: Frank J. Fabozzi Associaes. 10. Gran, J.L. (2003). Foundaions of economic value added (2 nd ed.). Hoboken, New Jersey: John Wiley and Sons. 11. Gran, J.L. (1996). Foundaions of EVA TM for invesmen managers. Journal of Porfolio Managemen, 23(1), Hayn, C. (1995). The informaion conen of losses. Journal of Accouning and Economics, 20(2), Lehn, K.L., & Makhija, A.K. (1996). EVA and MVA as performance measures and signals for sraegic change. Sraegy and Leadership, 24(3), McGregor BFA (Py.) Ld. (2005). McGregor BFA Version Madden, B.J. (1998). The CFROI valuaion model. Journal of Invesing, 17(1), Madden, B.J. (1999). CFROI valuaion: A oal sysem approach o valuing he firm. Boson: Buerworh-Heinemann. 17. Marin, J.D., & Pey, J.W. (2000). Value based managemen: The corporae response o he shareholder revoluion. Boson: Harvard Business School Press. 18. Journal of Applied Corporae Finance, 12(2), and marke value. Journal of Applied Corporae Finance, 9(1), Peerson, P.P., & Peerson, D.R. (1996). Company performance and measures of value added. Charloesville: The Research Foundaion of The Insiue of Charered Financial Analyss. 21. Sewar, G.B. (1994). EVA TM : Fac and fanasy. Journal of Applied Corporae Finance, 7(2), Sewar, G.B. (1991). The Ques for value: The EVA TM managemen guide. New York: HarperBusiness. 23. Worhingon, A.C., & Wes, T. (2004). Ausralian evidence considering he informaion conen of economic value added. Ausralian Journal of Managemen, 29(2), EVA and value-based managemen: A pracical guide o implemenaion. New York: McGraw Hill. 77

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