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October 1, 2010


The Monarch Management Review is the scholarly journal of management research and practice from UGSM-Monarch Business School.

Monarch Management Review Management Research UGSM-Monarch Business School - Volume 1, Number 1, October 1, 2010

Research & Review

Featured Article

CSR As Mythology - Dr. Jeffrey Henderson


EVA: Pros And Cons - Dr. Igor Pustylnick


Empirical Testing of Technology Spillovers Among Trading Partners - Dr. Fadi Fawaz


The Subjective Field of Ethics: A Philosophical Panorama - Dr. Norman Madarasz


The Value Added of the Human Resource Function of the Enterprise- Dr. Ali Mabrouk


Comparing The Five Factors of Production In Southeast Wisconsin - Dr. Gary Keller


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The Monarch Management Review Volume 1, Number 1 - October 1, 2010 Contents

From The Editor ............................................................................................................................................ New Researcher Contribution Program ............................................................................................ Abstracts ............................................................................................................................................

2 3 4

Articles CSR As Mythology by Dr. Jeffrey Henderson .................................................................................................................................


EVA: Pros And Cons by Dr. Igor Pustylnick .......................................................................................................................................


Empirical Testing of Technology Spillovers Among Trading Partners by Dr. Fadi Fawaz ...........................................................................................................................................


The Subjective Field of Ethics: A Philosophical Panorama by Dr. Norman Madarasz .................................................................................................................................


The Value Added of the Human Resource Function of the Enterprise by Dr. Aki Mabrouk .........................................................................................................................................


Featured Article - Exemplary Contribution Comparing The Five factors of Production of For-Profit Firms And Not-For-Profit Organizations in Southeast Wisconsin by Dr. Gary Keller ............................................................................................................................................

Editorial Policy


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“Senior Executives often include a slide of Maslow’s hierarchy in their presentations. They know that employees will find fulfillment only if they’ve been given the chance to exercise their higher order capabilities --- initiative, imagination, and passion.” ! ! ! ! ! ! Management Guru - Gary Hamel

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The Monarch Management Review Volume 1, Number 1 - October 1, 2010 Abstracts CSR As Mythology - Dr. Jeffrey Henderson In “CSR As Mythology� author, Dr. Jeffrey Henderson, brings to the foreground several issues existing within the state of affairs of CSR study that force a re-evaluation of the efforts produced by academics and scholars within the domain. Principally, the issue that academics since the early 1950s have felt the need to take a secular view of an inherently moral discourse is shown to have yielded sparse advances in the field of business in society literature up to present day. Coupled with the application of adherence to anachronistic social myths the domain of CSR study has been stripped of its soul by those very people charged with its livelihood. This fact is illustrated by Dr. Henderson to be the limiting factor behind the study of CSR and the primary reason why many investigators claim that the domain of CSR study is presently bankrupt. Within the article, Dr. Henderson reviews the contributions of Dr. Joseph Campbell and his theories of mythos as applied to the domain of CSR studies. The premise is addressed that true social change will not take place until society replaces the anachronistic archetypical myths that reinforce the orientation of conflict based economic systems for those of a more cooperative form. Inspiration for change can be found in the timeless writings of major figures such as management Guru Peter Drucker who is shown to have taken a homo-centric view of the practice of management, as compared to the often cited writings of Milton Freidman who champions the profit-centered view that tends to deny corporate social responsibility. EVA: Pros And Cons - Dr. Igor Pustylnick EVA is a proprietary analysis tool trademarked by Stern Stewart. In the recent years many consulting companies attempt to use EVA for the evaluation of the company performance. This short paper discusses pros and cons of using EVA and gives the reader an idea of when and where the use of EVA makes the most sense.

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Comparing The Five Factors Of Production Of For Profit Firms And Not For Profit Organizations In Southeast Wisconsin - Dr. Gary Keller Assessing and explaining how corporate leaders utilize the factors of production at their disposal has been researched and debated traditionally by scholars but more recently the popular media. Over the centuries numerous economic and management theories have been proposed to resolve why some companies with equal access to labor, capital, land and ideas have succeeded while others collapsed. Traditionally, examinations of how managers classify and utilize the factors of production have centered on the private (i.e. for-profit) sector. However, on a global basis not-for-profit organizations (NPOs) or non-governmental organizations (NGOs) are

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The Monarch Management Review Volume 1, Number 1 - October 1, 2010 Abstracts making an increasingly important contribution to their national economies. For example, in the United States in 2007 there were 1,569,572 tax-exempt organizations accounting for 8.11% of all wages and salaries paid with $2.6 trillion in total assets (National Center for Charitable Statistics, 2010). This study compares and contrasts how managers in the private and public sectors located in two counties in southeast Wisconsin ranked the factors of production, defined as: financial resources, employees, management practices, materials, and technology. The data for this research project was derived from two studies designed to correlate firm/organizational management practices and economic outcomes of for-profit (Keller 2009) and not-for-profit firms (Keller, 2010) located in two counties located in the state of Wisconsin (USA) Racine and Kenosha. Empirical Testing of Technology Spillovers Among Trading Partners - Dr. Fadi Fawaz Previous literature suggests that trade contributes to knowledge and technology spillovers among trading partners. Using panel data and country-specific fixed effects, we show that the technology of a country is explained by existing technology of its major trading partners. We build an endogenous growth model for OECD countries for the 1960-2000 period; we draw the residuals to measure the Total Factor Productivity (TFP) of each country. Then using spatial econometrics, we regress the TFP of each country on previous TFP of its major trading partners. In addition, we run a Random Coefficient Model, to let this relationship vary randomly by country. Finally, we run the endogenous growth model again, but now it includes the Spatial lag term as an explanatory variable.

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The Subjective Field of Ethics: A philosophical Panorama - Dr. Norman Madarasz Most approaches of ethics in disciplines other than philosophy do not tend to emphasize the singular dimension in which it acquires its binding force and consequential implications. This dimension is the field of the subject. Subjectivity today is a vast concern in the social sciences. Most models of subjectivity stipulate the existence of at least a minimal concept of mind, i.e. of an interior field in which language, perception, intentionality and higher order inferences merge into synthesized experience. Often this mental synthesis projects a purpose that then translates into action. Inevitably, when one contemplates the field of the subjective conditions behind ethical conduct, one considers the philosophical models at the origin of the paradigms prevailing in the contemporary epistemological field. Our aim will be to distinguish some of the main paradigms of subjectivity generally encountered in ethics.

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Volume 1, Number 1 - October 1, 2010 Abstracts The Value Added of the Human Resource Function of the Enterprise: Dr. Ali Mabrouk HRM forms one of the most significant areas in determinig the success of the enterprise. A number of studies have noted the importance of HRM activities in the success or failure of a company, where business survival is directly correlated with the HRM function. People are increasingly being seen as the most critical asset of a company. The strategic role attributed to the HRM department demands that it should be well managed in order to get the best out of the organization. Managing the human resource department demands measuring the performance of that department. HRM measurements transform human resources capabilities into measurable strategic value-add items that are then made transparent to the organization in order to improve connection with leadership across the company. In order to demonstrate the added value of HRM to the entire company, several possibilities have to be taken into consideration. In this article Dr. Mabrouk takes the reader through a review of these methodologies which include: measurement, linking, aligning of employees and the use of the HR balanced scorecard.

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EVA Pros And Cons by Dr. Igor Pustylnick Dr. Igor Pustylnick holds the position of Professor of Finance at UGSMMonarch Business School. He presently teaches postgraduate courses in Humber Institute of Technology and Advanced Learning in Toronto, Ontario and at the RCC Institute of Canada. He is a recent graduate of SMC University with the degree of Doctor of Finance. Dr. Pustylnick also holds an MBA degree from Athabasca University in Alberta, Canada. His research interests are in the area of fraud and manipulations with financial statements. Dr. Pustylnick’s scientific interests have always rotated around the use of computers in many aspects of business. His doctoral dissertation entitled “The set of financial data used in computerized fraud detection” researched the methods of potential automation of manipulation detection in financial statements. He continues working in this direction.

Introduction Economic Value Added (EVA) is a term introduced and trademarked by Stern Stewart1, a consulting company specializing in performance consulting. EVA is a relatively new performance metric and was designed to replace the older ROI which was in use up until recently by most companies.

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Definition of EVA The definition of EVA would not make much sense if it were defined in isolation from economic profit. Economic profit is calculated as a difference between: 1. A firm’s revenue, 2. The sum of accounting costs, 3. Economic costs.

Economic costs include the costs, which are not accounted for by GAAP, such as implicit costs (costs of the alternatives) and replacement costs (costs of replacing machinery). As a result, economic profit is always smaller than the normal accounting profit. In the other words, the firm showing a profit in accounting terms may at the same time be operating at an economic loss. The advantage of the economic profit over the standard accounting cash flow calculation is in the present consideration of future costs, which cannot be determined via regular accounting methodology. When we consider the value of a firm in the traditional sense we typically consider the present value of all future cash flows. This value would reflect the financial position of the firm if nothing

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EVA Pros And Cons by Dr. Igor Pustylnick changes in the firm’s operations. On the graph shown below the sum of all

discounted present values of the cash flows is equal to $40 (Harper, 2005).

Figure 1

If we look at the same firm from an economic perspective, we would see that the value of the firm is the present value of its economic profits plus all invested capital, as taken from the

general methodology of EVA. From the economic perspective this figure would give a better indication of the firm value.

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Figure 2

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EVA Pros And Cons by Dr. Igor Pustylnick • Equity capital has costs, which On the graph above (Harper, 2005) there is a differentiation between the have to be deducted from the numbers for invested capital and future cash flows. discounted economic profits. The “upper” $20 of the present firm value If we put it all together we then arrive at represents the sum of all discounted formula (1): economic profits or Market Value Added (MVA)2. (1) EP = NOPAT - Capital Charge When we calculate Economic Profit we use certain assumptions which cannot be derived from the financial statements based on GAAP. The majority of companies in today’s market calculate the statement of revenues based on the principles of accrual. Although these calculations are correct from the accounting perspective, they do not reflect economic profits. In order to turn them into economic profit figures the following must be done: •

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Accounting cash flows are not accurately calculated in terms of economic profit. The closest element to the true calculations is (Earnings before income tax), which should be corrected and used as NOPAT (Net Operating Profit after Tax).

Calculation of NOPAT The calculation of NOPAT starts from determining the EBIT value while adding in several non cash adjustments. The first adjustment to be made is the addition of an allowance for LIFO use of inventory. LIFO allowance reflects the potential sale of the newest inventory first thus increasing COGS and decreasing operating profit. This is an assumption and often does not happen therefore it is not accounted for in the NOPAT calculation. Secondly, GAAP prescribes having allowances for bad debt connected with unpaid accounts receivable, AR. This debt is a non-cash item and should not be a deduction within the definition of economic profits.

The person calculating economic profits must take into consideration that some expenses must be capitalized because they are in fact Thirdly, when accounting for investments into the future profit economic profit the analyst with the and must be a part of the equity economics background must treat of the balance sheet. operating leases as capital leases or as assets funded using debt like

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EVA Pros And Cons by Dr. Igor Pustylnick obligations. Hence, the interest on operating leases should be added back to the cash flows.



EBIT + LIFO Allowance + Bad Debt Allowance + Interest on Operating Leases

The first part of this equation is equal to NOPAT and the second – to capital charge. Therefore, economic profit and EVA are the same value and must represent the same meaning in the evaluation process. Frequently, EVA is also denoted as the real value of cash in the company’s possession without accounting adjustments prescribed through GAAP.

Calculating Capital Charge

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Formula (2) would summarize NOPAT calculations:

Invested book capital is the equity value of the firm. It is very important to add the value of operating leases to this figure because they now become capital leases. The consistency between the NOPAT calculations and the calculations of the invested capital is very important for obtaining a proper value of the economic profit. In order to The diagram above, Figure 3, calculate the capital charge we need to adopted from D. Harper’s Investopedia know the Weighted Average Cost of article (Harper, 2005), shows the Capital (WACC). It is a historical value, stages of analysis of the firm’s position. which is calculated as Formula (3): The last residual position corresponds to EVA. It shows that the EVA metric corresponds to the real residual cash, ! Rate * remaining in the company after all (3) WACC = (Part Borrowed) economic costs are accounted. Some economists consider EVA as the only true value of the firm. Interpretations of EVA Many economists calculate EVA as shown in Formula (4):



(Return on Capital - Cost of Capital) * Total Capital

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EVA Pros And Cons by Dr. Igor Pustylnick Figure 4

Source: Harper, 2005

investment would fit in the ROI strategy of the whole company the division may refuse to make this investment because EVA has generally replaced ROI as a performance metric. In the case of it would unfavorably change the ROI of the division. ROI the investment into a certain business was gauged solely against the On the other hand, EVA or cost of borrowing. Created in the early th economic profit analysis would be very 20 century ROI worked well when the similar to the financial NPV analysis of cost of borrowing was steady and the the viability of the project. The viability sources of capital were quite limited. of an investment into a certain initiative On the other hand, ROI as the only would correspond to the positive EVA performance metric of a certain figure resulting in rejected investments, company division may superimpose the which would correspondingly have a goals of a division upon the goals of the negative EVA value. In this case the company as a whole, and vise versa. goals of the company and its divisions would always coincide and all This can happen for instance if the investments made would benefit both anticipated ROI from the particular the company and an investing division. division was less than originally It streamlines the investment process planned. Despite the fact that the

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Advantages of EVA

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EVA Pros And Cons by Dr. Igor Pustylnick and creates a very easy set of For instance, the larger orders would investment guidelines. be given an automatic preference because they would generate larger EVA can be a very useful metric amounts of cash. Managers of the when employed in the scope of the divisions would delay or cancel certain balance scorecard, BSC. In fact, EVA expenditures in favor of better financial can be both a unifying and a discerning results. For instance maintenance work metric because it would be able to in the plant can be delayed if it show the overall position of the decreases EVA for the period below the company as the sum of all its divisions. regulated point. EVA would be able also to help discern between the leading and trailing Further, one of the biggest revenue producing divisions and point problems connected with EVA is the out where improvements may be use of fully depreciated assets. needed. Although BSC is a very good Depreciation time is set based on the application for EVA, it can only be used average lifespan of the asset. However, as a high level analysis tool. The rest of one can argue that a fully depreciated the operational and financial analysis asset should not be replaced when it’s must follow and can be based on the still operational because it automatically obtained EVA metrics. increases EVA3.

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Limitations of EVA There are several limitations to the EVA methodology. First, because EVA is based on the total size of the invested capital, the EVA for the larger division with more capitalization would always be greater than the EVA for a smaller division with the smaller capitalization, all other things equal. Because of this the larger division would always have more leverage in pooling investment funds. Secondly, EVA is very financially oriented. Managers of various divisions of a company have a lot of power to control the financial inputs and outputs.

EVA is oriented to short-term gains and uses discounted values. Long-term projects usually generate profit at the tail end when discounted value of cash is the smallest. Therefore, these projects usually have lower NPV than those projects that start generating positive cash flows in the shortly after their commencement. The managers in charge of the companies and divisions, which are evaluated based on the EVA values generated by their operations, tend to consider short-term cash generating projects to the exclusion of long-term projects that might have a significant strategic significance for their companies. Hence, managers are under pressure to forgo R&D oriented projects which may not produce returns in the short run. This may cause

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EVA Pros And Cons by Dr. Igor Pustylnick companies to abandon a significant number of strategic investments which could improve the company’s future competitive position. Moreover, from an operations perspective the usefulness of the EVA methodology is questionable. In the case when a company exhibits sluggish performance EVA can only point towards the division(s) which does not generate enough cash. It cannot point to any operational problem, inefficiency or bottleneck, which cannot be expressed in the financial terms. Moreover, if the performance of managers is judged based on perceived EVA value, the “endpoint� production divisions would bear the biggest brunt because they produce the actual products, which are supposed to generate revenue on which the EVA calculation is based. However, one of the overall largest drawbacks of EVA is its inability to properly gauge the value of companies that have large off-balance sheet value. Among these companies are R&D shops, which do not have any revenue producing items. It is common knowledge that many software companies stay in the red for several years because they are engaged in the early-staged development of products which in turn requires large amounts of invested capital. These products may only become profitable sometime in the far future. Although these companies have a large amount of intellectual

value stored in the developed software algorithms or technology patents, they cannot easily account for this value on the balance sheet. However there is some evidence that EVA can play a positive role when used as a measurement of performance of some IT organizations that operate as Cost Centers (Yao et al, 2009). It is important to note that EVA can only be calculated for the companies that have historically confirmed expectations of future profitability. The new ventures may consider this tool only if they intend to operate in the markets, which have a very low speculative component and the analysts researching such markets, can predict the future state of the market, costs of capital, price of finished goods and/or services, etc. EVA of real-estate projects, for instance, cannot serve as a viable indicator of the project performance because the value of real-estate objects (buildings, lots, etc.) can undergo large fluctuations based on the factors, which are not a part of the underlying market conditions4. Conclusion Economic value added is a relatively new tool, which was created by a proprietary firm for its own proprietary needs. As such, EVA plays an important role in the analysis of firm value and firm profitability. Since EVA is

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EVA Pros And Cons by Dr. Igor Pustylnick calculated quite easily based on the comprehensive and full picture of the financial statements, it can be used to health and competitive positioning of estimate the real worth of the public the firm may be obtained. companies. The cost of capital used in the calculations is practically always known or can be derived from the Endnotes: values known for the companies of the 1. same size. EVA has become a replacement for the older ROI/ROE 2. MVA is “the difference between the metrics that were used previously and market value of a firm and the capital contributed by investors. A higher MVA had a number of drawbacks.

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On the other hand, EVA also has a number of shortcomings, which make its use very limited to companies with established operations who perform in a set mode for the number of years. Although EVA was originally used as an alternative performance tool with time it became a singular performance metric that favored quick results obtained on the short run. Designed as a measure against excessive spending with time it started producing a stifling effect by denying R&D spending or long-term spending in favor of the short-term performance gains.

indicates that a company has added more value than what has been contributed to it by shareholders, while a negative MVA indicates that the company has destroyed value�. From http:// market_value_added_MVA.html

3. This seems to explain why some large companies have so many obsolete computers, which are well past their depreciation period of 3 years. 4. The recent crisis of 2007-2009, created by non-market related conditions, resulted in the large drop in the prices of real estate (Pustylnick, 2009). 5. The metrics used in detection of manipulation inside the financial statements of a company use similar data to the one used in the EVA calculations (Pustylnick, 2009b).

EVA is one of the tools that any manager or business consultant may use. The results obtained by applying it to the financial figures of a company must be taken in perspective and used with caution. Also it must be pointed out that excessively good EVA can be a result of fraud or creative accounting used by the company in order to enhance its position as a source of investment opportunities5. The use of EVA must be followed with the use of alternative metrics so that a

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EVA Pros And Cons by Dr. Igor Pustylnick References !" /" 0" Y" S" ^" _" 8" O" !7" !!" !/" !0" !Y"

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Citation: This article may be cited as: Pustylnick, I. “EVA Pros And Cons”, The Monarch Management Review, UGSM-Monarch Business School, Vol. 1, Num. 1, Oct. 2010, pp. 16-24

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The goal of The Monarch Management Review is to provide a vehicle for both the faculty and guest authors of UGSM-Monarch Business School to publish scholarly work in journal form to help advance the field of management research. It provides an Limitations opportunity for its authors to act as “thoughtThe Monarch Management Review is a leaders” within the field of management scholarly journal that expresses the views, scholarship. thoughts, ideas and opinions of its contributing The Monarch Management Review is authors. These thoughts and views are not considered an open publication where authors necessarily those held by the Monarch are encouraged to submit articles covering Management Review and should be seen as traditional and non-traditional subjects on a independent of the journal. Further, The wide-range of interests within the domain of Monarch Management Review makes no endorsement concerning the accuracy of the management study and economics. information contained herein. Moreover, The Monarch Management Review disclaims any General Submissions and all responsibility or liability resulting from Authors interested in publishing in the the information contained herein. Monarch Management Review should submit an article abstract detailing their project, Editorial Board approach and manuscript. However, authors Editor-In-Chief: are encouraged to send in a short proposal in Dr. Jeffrey Henderson, Ph.D. advance of sending in a complete manuscript. A short proposal of approximately 3 pages in Associate Editors: length outlining the article and general Dr. Christos Antoniou, Ph.D. submission structure is expected. Proposals Dr. Gary Keller, Ph.D. may be submitted directly to: mmr@ugsmDr. Ali Mabrouk, Ph.D. Additional questions may also be Dr. Norman Madarasz, Ph.D. directed to the same email address. Manuscripts should be formatted as MS Photocopying Word files, double spaced with no more than 30 pages in length, including figures and tables. Single photocopies of individual articles Cover sheets including the author or authors may be made for personal use as allowed by names and complete contact information should national copyright laws. Permission of the

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The Monarch Management Review 104

Monarch Management Review, Vol1.,Num1,Oct-2010-Pustylnick  

EVA is a proprietary analysis tool trademarked by Stern Stewart. In the recent years many consulting companies attempt to use EVA for the ev...

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