1. finance
2. accounting and auditing

Applied mathematics in Engineering, Management and Technology 2 (3) 2014:94-102
www.amiemt-journal.com
Corporate governance and the relationship between EVA and
created shareholder value
Peyman Imanzadeh
Department of Accounting, Talesh Branch, Islamic Azad University, Talesh, Iran
Abstract
If managers have the ability to increase company efficiency, it is expected that the
benefits will go directly to the shareholders. However, corporate governance is the
most important tool for owners to monitor and control managers. The basic
objective of this study is to investigate the impact of corporate governance on the
gap between economic values added (EVA) and created wealth for shareholders in
listed companies in the market of Tehran Stock Exchange. The sample of present
study includes 76 companies from 11 industries in stock whose data,, for 5
consecutive years, from 2007 to 2011, was collected and statistically analyzed.
Based on the results, the EVA has direct link with the created wealth for
shareholders. About the role of corporate governance, findings show that the
percentage of independent directors have had negative effect on the gap between
the wealth created for shareholders and EVA. This finding can confirm the
favorable role of this group of managers in protecting the interests of shareholders
and effective monitoring on managers to for the value creation for shareholders. Also, according to the results, audit
quality variables and the managers’ ownership percentage have had a positive impact on the gap between the created
wealth for shareholders and EVA. These results can be explained in terms of representation theory and profit-seeking
motivation of managers in profit entities.
1.Introduction
The massive flood of corporate scandals in recent years has challenged the role of corporate governance in
effective monitoring of management decisions and companies’ performance. Rectifying this situation requires
increased effective monitoring on companies’ performance and the decisions taken by their managers (Marcia
Millon et al., 2007).
Promoted by various factors, not least among which the wave of corporate scandals such as those of Adelphia,
Enron and WorldCom in the USA, Marconi in the UK, and most recently Royal Ahold in The Netherlands,
corporate governance has received increased attention by the financial community. The scandals clearly pointed
to the need to improve corporate governance practices and accounting transparency. In the USA, the relevant
context for this study, Congress enacted new laws such as the Sarbanes-Oxley Act and more stringent
conditions for listing on the stock markets were introduced. New institutions such as the Public Company
Accounting Oversight Board were created, audit committees were empowered, and internal control systems
were strengthened. The importance of better corporate governance practices in guaranteeing the quality of
financial and accounting information, improving corporate performance and thereby, increasing market value,
has been widely recognized.
In the recent literature, Gompers et al. (2003) examine the relationship between corporate governance and longterm equity returns, firm value and accounting measures of performance. Their results reveal that well-governed
firms have higher equity returns, command higher values and their accounting statements show a better
operating performance compared to their poorly governed counterparts. These findings are likely to encourage
investors to consider corporate governance in their investment decisions.
Similarly, Brown and Caylor (2005) find that better-governed firms are relatively more profitable, more highly
priced, and pay out more cash to their shareholders. In a similar vein, Drobetz et al. (2004) document a positive
relationship between governance practices and firm valuation for German public firms. They report that for the
median firm, a one standard deviation change in the governance rating results in a 24 percent increase in the
value of
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P. Imanzadeh
Tobin’s Q. Black et al. (2006) find a positive relationship between their corporate governance index and
Tobin’s Q for a sample of 526 Korean public firms. Durnev and Kim (2005) find that firms with better
corporate governance and better disclosure standards have, on average, higher Tobin’s Qs and larger
investments.
The main purpose of this paper is to investigate the relationship between economic value added (EVA) and
created shareholder value (CSV). Also, it is going to be shown that the differences between EVA and CSV can
be explained by corporate governance mechanisms, in general, and the features of the board of directors, audit
quality, ownership structure, and managers’ reward in particular. So, first, the relationship
between EVA and CSV are determined, and, then, using multiple regression analysis, the hypotheses of the
study are tested to show whether corporate governance mechanisms can affect the relationship
between EVA and CSV or not?
First, a summary of the theoretical principles of corporate governance mechanisms and their impact on
corporate value and research methodology and definitions of variables is presented. And, finally, the results of
testing research hypotheses are presented and compared with the studies done in this field, and, then, the overall
conclusion of the article is provided.
2.Literature review and hypotheses development
In most researches, corporate governance has been approved as an affecting factor on the performance and
reliability insurance of financial reporting and accounting of firms. So, it can be effective on accounting data
and market value of companies. Specifically, probably, the gap between market value and accounting data has
been documented primarily by previous researches (Cahan et al., 2002; Fernandez, 2001; Chen and Dodd,
2001), which can at least be relatively expressed by corporate governance mechanisms. As McKinsey &
Company (2002) show, 15 percent of investors consider corporate governance to be more important than
financial performance (such as profitability). According to this issue, the main research hypotheses are
formulated as follows:
2.1.The first main hypothesis:
There is a significant relationship Between EVA and created wealth for shareholders.
2.2.The second main hypotheses:
Corporate governance mechanisms affect on the gap between EVA and created wealth for shareholders.
In the following, the impact of each of the mechanisms of corporate governance on firm value is individually
examined and hypotheses derived from the second main hypotheses have been formulated:
3.Characteristics of the board of directors
The board of directors represents the apex of the control system, performing the dual roles of monitoring and
ratification (Fama and Jensen, 1983). Its role is to monitor and discipline the firm’s management, thereby
ensuring that managers pursue the interests of the shareholders. Lipton and Lorsch (1992) and Jensen (1993)
were the first to hypothesize that board size is an independent control mechanism. Specifically, they argue that
large boards may be less effective than small boards. The underlying idea is that beyond a given size, larger
boards are more difficult to coordinate. Jensen (1993) suggests an optimal board size of seven or eight directors.
The importance of the size of the board in improving performance and in restraining accounts manipulations
has been widely studied and no consensus has been reached. Yermack (1996) reports an inverse relationship
between board size and firm value, as measured by Tobin’s Q. Most recently, using a simultaneous equations
approach for a sample of Swiss firms, Beiner et al. (2004) did not detect a significant relationship between
board size and firm value.
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4.Accordingly, the first sub-hypothesis can be stated as follows:
4.1.The first sub-hypothesis:
Board size affects on the gap between EVA and created wealth for shareholders.
However, the board is much more efficient if the majority of its members are outside independent directors
(Beasley, 1996; Peasnell et al., 2003). These non-executive directors, eager to develop a reputation as experts in
decision control and monitoring (Fama and Jensen, 1983), can bring their know-how and their expertise,
acquired from others firms (Rindavo, 1999) to contribute to the development of value creating strategies.
Rosenstein and Wyatt (1990) provide evidence that the proportion of outside directors positively affects
shareholder wealth. In fact, they document a positive stock price reaction upon the announcement of the
appointment of an additional outside director. Additionally, the findings of Weisbach (1988) suggest that firms
with outsiders-dominated boards are significantly more likely to remove the CEO on the basis of bad
performance than firms with insiders-dominated boards. In contrast, Beiner et al. (2004) find no relationship
between the fraction of outside board members and Tobin’s Q for their sample of Swiss firms.
4.2.The second sub-hypothesis:
The ratio of independent manager's affects on the gap between EVA created wealth for shareholders.
Moreover, the board members can carry out their mission more freely if the manager is not the board chairman.
Indeed, the duality is indicative of a considerable concentration of power (Beasley and Salterio, 2001; Dechow
et al., 1996) which can affect negatively the value creation process and hinder managerial control (Morck et al.,
1989). The duality impact is further strengthened by the presence of an entrenched manager, who, having ‘‘an
excess of power compared to his partners’’ (Charreaux, 1997), and first hand inside knowledge, can develop
and use an expertise allowing him to get around any process of control.
4.3.The third sub-hypothesis:
The dual role of director affects on the gap between EVA created wealth for shareholders
4.4 Audit quality
An important assumption is representative theory that is the approved works of agent for a hard and complex
placement. Independent audit is one of the most important and yet the most effective ways to align the interests
of shareholders and managers. On the other hand, the good name and reputation of the audited entity has an
important impact on reliability and credibility of accounting data. In the theoretical foundation, audit firm size
will have a direct impact on the reputation of the institution. Francis and Simon (1987), Dey (1993), Yang
Jonathan and Lin (1993), and Hogan and Jeter (1997) showed that large audits institutions, compare with
smaller institutions, conduct higher quality audits (Hasanzadeh brothers et al. 2012). Accordingly, the fourth
research sub-hypothesis is expressed as follows:
4.5.The fourth sub-hypothesis:
The quality of auditors affect on the gap between EVA and created wealth for shareholders.
4.6.Ownership structure
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In spite of the pervasive theoretical claims, the empirical evidence on the relationship between insider
stockholdings and firm performance is mixed and somewhat contradictory.
For example, Morck et al. (1988), in their cross-section study of 371 Fortune 500 firms, find evidence of a
significant non-monotonic relationship between ownership and performance. Tobin’s Q first increases, then
declines, and finally increases slightly as ownership by the board of directors rises. For older firms, they find
evidence that Q is lower when the CEO is a member of the founding family than otherwise. Thus, at least when
the fraction of shares held by the board is small, as is the case for most firms in their sample, greater board
shareholding improves performance. However managerial entrenchment has a negative impact on corporate
performance. McConnell and Servaes (1990) find a similar nonlinear
relationship between insider shareholdings and firm value. Himmelberg et al. (1999) control for the endogeneity
of ownership by using panel data and find little evidence that changes in managerial ownership affect
performance. Finally, Schmid and Zimmermann (2005) use a simultaneous equations system and find a positive
effect of the percentage of share ownership by officers and directors on firm value for a sample of 145 Swiss
firms.
4.7.The fifth sub-hypothesis:
Management ownership affects on gap between EVA and created wealth for shareholders.
Stiglitz (1985) argued that one of the most important ways to ensure that managers pursue value maximizing
strategies is through concentrated ownership. Denis et al. (1997) show empirically that top executive turnover is
more sensitive to poor performance in firms with outside blockholders than in firms without outside
blockholders. They interpret this finding as evidence for a monitoring function of managers by outside
blockholders. However, the overall empirical evidence on the effects of block ownership on firm value is
mixed. Mikkelson and Ruback (1985) document positive abnormal returns for the acquired firm following the
announcement of the acquisition of a 5 percent or greater stake in one firm by another firm. Similarly,
McConnell and Servaes (1990) find a positive relationship between institutional ownership and Tobin’s Q. In
contrast, Demsetz and Lehn (1985) find no cross-sectional relationship between the concentration of
shareholdings and accounting rates of return. Schmid and Zimmermann (2005) find no statistically significant
effect of outside blockholdings on firm valuation for their sample of Swiss firms. Interestingly, Beiner et al.
(2004) even find a significantly negative relationship between blockholdings and firm performance for their
sample of Swiss firms.
4.8.The sixth sub-hypothesis:
Ownership concentration affect on the gap between EVA and created wealth for shareholders.
4.9. Managers’ Reward
Human and material resources to meet needs, whether in a country or an institution, are limited. Therefore, to
maximize revenue or maximize company profit, it is necessary to get the best and most effective use of these
resources. To do so, it is essential to have strong and motivated managers. Effective and efficient compensation
contract of the manager create an incentive to maximize firm value. Such contracts in companies are done to
align the interests of managers and owners of companies, and, through it, the manager has the necessary
impetus to efforts that the results benefit both sides. To sign an effective contract that can cause the desired
results, the data generated from the company's accounting system is important because this information is the
basis for evaluating the activities of managers and measures their success in creating value.
The incentive alignment aspect of stock-based compensation has been tested extensively. Hanlon et al. (2003)
find evidence that executive stocks options are associated with increased performance outcomes (that is,
increased operating income) and with increased stock return volatility (that is, increased risk taking). Similarly,
Francis et al. (2005) find that executive stock options are also associated with poorer accruals quality, which has
been shown to be related to increased returns volatility. In addition, Core and Guay (1999), Demsetz and Lehn
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(1985), Himmelberg et al. (1999), and Rajgopal and Shevlin (2002) confirm that granting options is consistent
with firm value maximization. Executive compensation has also been blamed for inducing earnings
management. This observation dates back to Healy’s (1985) study which predicted that managers would
opportunistically manage net income so as to maximize their bonuses under the firms’ compensation plans.
Many recent papers document that a higher extent of stock-based compensation also induces more earnings
management (Bergstressera and Philippon, 2006; Burns and Kedia, 2003; Cheng and Warfield, 2005). Louis
(2000) suggests that when you give a chief executive too much compensation in stock options, they concentrate
too much on stock price and there is perverse incentive to raise the stock price, particularly when the chief
executive wants to exercise his own options.
The findings of Cheng and Warfield (2005) confirm this idea. They show that stock-based compensation
contributes to the use of accounting accruals for earnings management purposes and that the earnings of high
stock-based compensation firms are less informative to the extent that they are less reflective of economic
performance. More specifically, the magnitude of annual abnormal accruals is positively related to the
magnitude of stock based compensation and they document a lower association between the earnings and
returns of firms with higher stock based compensation.
In a similar vein, Goldman and Slezak (2006) link executive stock compensation to fraudulent misreporting and
conclude that the public policy actions intended to reduce misrepresentation may sometimes increase fraudulent
behavior. They show that separating the provision of auditing and consulting services reduces fraud, but also
firm value. Finally, Guttman et al. (2004) show that executive stock compensation rationalizes the kink in
accounting earnings.
4.10.The seventh sub-hypothesis:
Managers’ reward affects on the gap between EVA and created wealth for shareholders.
5.Research method
The research is capital market research type regarding accounting researches and regarding the goal it is
considered to be applied. The methodology regarding the research title is descriptive and correlation type. It is
descriptive because the goal is to define the conditions or phenomena under investigation and it is used to know
more about the current situation and it is correlation because our aim is to investigate the relationships between
the variables.
Statistical society is selected from companies in the Tehran Stock Exchange in industries and various groups.
Study period is the financial information relating to the companies’ performance of the years 2008-2012 listed
in Tehran Stock Exchange in 5 years.
The sample systematic method has been selected. The conditions are:
1. Companies that lead to their financial year at the end of March each year.
2. Companies that during years 2008-2012 have not changed their financial period.
3. Companies that there is access to their financial information and other required
information.
4. Companies that are listed in Stoke Exchange before 2007.
5. Not to be among the Banks and credit and financial investment institutions.
6. Companies that their stop symbol do not have more than six month abeyance in the
With the application of above limitations, 76 companies listed in Tehran Stock Exchange from industries
(pharmaceuticals, electrical machinery, automobiles and parts, machinery and equipment, basic metals, food
except sugar, other non-metallic minerals, chemicals, wood products, metal products, computers , cement,
ceramic Hg) has been chosen.
6. The method to calculate the wealth created for shareholders and EVA
6.1.The wealth created for shareholders (CSV)
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Fernandez (2001) suggested that if company provides shareholder with returns exceeding stakeholder’s
expectations (cost of capital), it created value for shareholder. This author, based on this, achieved a measure of
the efficiency calculated as follows:
CSV = Company's stock market value × (Rate of expected return - real rate of return)
Real rate of return =
Rate of expected return = Rf + (RM- Rf ) × βi
Where:
Csv is the wealth created for shareholders; TEDPix is the cash index and total price of stock market, Rf is riskfree interest rate, RM is return rates of stock market, βi is systematic risk (Farzin and Ebanezhad, 2011).
6.2.Calculating Economic Added Value
EVA= NPPATt - [(TAT-1 – CLT-1) × WACCt ]
NOPATt =OP t × {1-t}
TA: is the total asset at the beginning of each financial period, CL t-1: is the total current liabilities at the
beginning of each financial period. NOPAT t: is the net operating profit after tax in financial period of
t, WACC t: is weighted average cost of capital in the financial period of t, OP t: is the gross operating profit in
the financial period of t.
7. Research findings
7.1. To test the normality of the data, Kolmogorov-Smirnov (K-S) test has been used.
Table (1) Kolmogorov-Smirnov (K-S) test
CSV- EVA
Variables
CSV
Kolmogorov-Smirnov z
0.65
1.627
P-value
0.792
0.049
8. Hypotheses test results
8.1.The results of testing first hypothesis
Table (2): The first hypothesis test
CSVi,t = β0+β1EVA i,t +β2VEVA i,t +€ i,t
Type of
variable
independent
controlling
variable
symbol
Coefficientβ
EVA
0.843
Economic Added Value
Four-year standard deviation of EVA
VEVA
-0.020
R2
statistic F
F(Sig)
D-W
Dependent variable:CSV
Independent variable :EVA
Controlling variable :VEVA
99
statistic t
P-value
30.507
-0.738
0.714
469.421
0.000
2.009
0.000
0.461
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P. Imanzadeh
Coefficient of determination regression model is 0/714 and it shows that this model could explain 71/4 percent
of the wealth created for shareholders through changes in the independent and control variables. Also, the
results show that Dorbin-Watson statistic is between 1/5 to 2/5 and, therefore, there is no strong correlation
between the its errors of the regression model and the lack of correlation between the errors will be accepted as
one of the basic assumptions of the regression about fitted model. Significance of F statistics for the model
under test error (α=0/05), and, hence, estimated regression, statistically, is significant and the relationships
between research variables is linear. Estimated coefficient for EVA variable, which shows the relationship
between the economic value added and created wealth for shareholders, is 0/843 and with a significance level
equals to 0/000, which is less than 0/05 (test error). These findings suggest direct and significant relationship
between these variables and are consistent with the claims of the first hypothesis.
8.2.The results of testing hypotheses 2 to 7
Table 3: The Test Result of the Second Hypothesis -Seventh Hypothesis
(CSV - EVA) i,t = β0+β1 LNSIZEBOARD i,t +β2OUTBOARD i,t +β3DUAL i,t +β4 OC i,t +β5MAN i,t +β6GI +
β7INS i,t + β8 Sysrisk + β9LEV+ β10LNSize+€ i,t
Type of
Coefficient
Symbol
statistics t
P-value
variable
β
LnSIZEBOARD
0/006
0/131
0/896
OUTBOARD
-0/072
-2/651
0/012
DUAL
0/012
0/271
0/787
independen
BIG
0/104
2/738
0/013
t
MAGOWN
0/082
2/784
0/016
BHOLD
0/000
-0/011
0/991
LnLNSTKOP
-0/003
-0/070
0/944
LnRD
-0/005
-0/108
0/914
Sysrisk
0/069
2/617
0/007
controlling
LnASSET
-0/058
-0/917
0/360
LEV
0/713
16/540
0/000
R2
0/507
statistics F
26/021
F(Sig)
0/000
D-W
1/929
Dependent variable: CSV-EVA (CSV created wealth for shareholders; EVA: Economic value added).
Independent variables: LNSIZEBOARD (If the number of board members is fewer than 7 is 1,
otherwise, zero); OUTBOARD (Percentage of independent directors on the board of directors); DUAL (If
the Managing Director is Chairman of the Board, the value will be one, otherwise, zero); BIG(If the
auditor is the audit organization, it will be one, otherwise, zero) MAGOWN: The percentage of shares
owned by the directors; STKOP : Logarithm of the bonuses paid to company’s
directors; BHOLD (percentage of ownership belonging to five major shareholders of the company).
Control variables: RD: Research and development costs; Sysrisk : Systematic risk; LNASSET :
Logarithm of assets; LEV: Ratio of total debt to total assets.
According to the results, the coefficient for the variable of independent directors’ percentage is negative and
significant. However, the coefficients of the variables of audit quality and the percentage of managers’
ownership are negative. These findings suggest that the independent directors have reduced the disparities
between created wealth for shareholders with EVA while the quality of audits and managers’ ownership
percentage exacerbate the disparities between created wealth for shareholders with EVA. Also, regarding other
indexes of company governance, significant evidence was not obtained. Regarding the control variables, the
results show that systematic risk and financial leverage have had positive impact on the differences between
created wealth for shareholders with EVA.
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9. Conclusion
According to the first hypothesis findings, it can be argued that capital market reactions play an important role
in created wealth for shareholders. Accordingly, one can find that the sample firms, in terms of capital market,
are considered a good place for investment and investors tend to invest in these companies.
Research findings indicate that the percentage of independent directors has had a negative effect on the
difference between the created wealth for shareholders with economic value added. These findings can confirm
the favorable role of this group of directors in maintaining shareholders’ benefits and controlling the manager to
create value for shareholders. In other words, it seems that the supervisory role of irresponsible directors in
firms is an appropriate tool for the alignment of interests of managers and shareholders; while, in consistent
with the results, audit quality variables and the percentage of managers’ ownership have had positive impact on
the difference between the created wealth for shareholders with EVA. It seems that higher audit quality causes
the difference between the created wealth for shareholders with EVA to increase that the higher audit quality
leads to more realistic standards and accounting numbers that may create a distance between the reported
figures and market figures. Also, the role of managerial ownership can be explained based on incentives for
managers to protect the interest in the company to develop the company. Accordingly, managers try to apply
benefit from company operation for new investments and enhancing the power and scope of their
administrations.
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