The EVA Challenge: Implementing Value-Added Change in an ...

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174 The EVA Challenge tend to rise faster than the costs because most of the costs are fixed and do not vary with the cost of oil. As a result, profits, cash flows and the present value of future cash flows will all rise faster than oil prices. Thus, although many oil executives lament it, the uncertainty in the price of oil, coupled with high operational leverage, is ironically what gives the options to develop undeveloped reserves much of their present value.” Forward-looking EVA for the extractive industries has two major purposes. The first is to create a measurement system that is in accord with market reality. The market responds exuberantly to news of large oil and gas discoveries; it translates the sudden increase in wealth into an upsurging share price. In their study of 25 large oil and gas companies, based only on publicly disclosed reserve values, McCormack and Vytheeswaran found that forward EVA calculations explained 49 percent of the change in shareholder wealth, whereas standard EVA, as already mentioned, explained only 8 percent. With a more sophisticated measure of reserves, forward EVA explained 66 percent of shareholder wealth. Moreover, with internal company data, the figure in some companies has gone as high as 90 percent. The second purpose of the change is to provide a realistic incentive system. Under the standard EVA measures, oil company managers who greatly enriched their shareholders would be meagerly compensated; the increase in EVA would derive only from the increase in earnings, not from the enlargement of the company’s capital base. It would be as unfair as rewarding the manager of a mutual fund for the dividend yield on investments, with nothing added for capital appreciation or total returns. Under the new dispensation, the mechanics of the standard EVA incentive program are the same: annual expected improvements, targets set in advance for three- or five-year periods, a bonus bank, no cap on bonuses. The difference is
New Frontiers: Real Options and Forward-Looking EVA 175 that annual increases in capital because of mineral strikes would be included in NOPAT and thus could greatly boost managerial rewards. The new system is already in place at Nuevo Energy, based in Houston, and in the oil and gas unit of Montana Power. There is one conceivable problem with the new bonus potential in forward-looking EVA: excessive rewards resulting from enormous rises in the price of oil, such as occurred because of OPEC’s action in 1973 and after the overthrow of the Shah of Iran in 1979—or the reverse, with the drastic decline in the price of oil in the mid- 1980s. One of the duties of top management, of course, is to hedge against price risk, but such enormous increases or declines in price have the quality of acts of God and might be regarded as beyond the ameliorative talents of mere mortals. Thus, employment of forwardlooking EVA inevitably raises fundamental questions about the quality of corporations’ risk management. Companies must face not only the issue of whether to hedge commodity prices but by whose authority within the corporation. It should be the responsibility of the highest levels. Forward-looking EVA need not be limited to extractive industries but could conceivably be applied in other fields that are subject to sudden, discontinuous increases in capital value. The pharmaceutical industry is frequently mentioned. It is similar to oil and gas in that companies are continually “prospecting”— seeking to discover new and improved drugs in the knowledge that every hit will bring a cascade of dollars during the 17-year period of patent protection. Every major drug company is pursuing a multiplicity of options: starting with initial R&D; pursuing further development if the lab results are favorable; animal testing, which, if successful, is followed by human trials; and finally, application to the FDA for approval. The option process means that, at every stage, management can cut its losses without betting the shop, and this leeway allows it to pursue a variety of opportunities at the
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The EVA Challenge Implementing Valu
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Advance Comments on The EVA Challen
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This book is printed on acid-free p
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Chapter 1 The Problem Back in the e
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The Problem 3 for systems to get ma
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The Problem 5 for a building, but i
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The Problem 7 Not only does EPS dis
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The Problem 9 significant and growi
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The Problem 11 admiring articles in
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The Problem 13 few years. Forstmann
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Chapter 2 The Solution What is Econ
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The Solution 17 There is a signific
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The Solution 19 than projections. E
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The Solution 21 (R&D) costs, (2) ad
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The Solution 23 capital, Tate & Lyl
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The Solution 25 is usually the chie
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Chapter 3 The Need for a Winning St
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The Need for a Winning Strategy and
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Chapter 4 The Road Map to Value Cre
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The Road Map to Value Creation 53 T
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The Road Map to Value Creation 55 i
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The Road Map to Value Creation 57 r
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The Road Map to Value Creation 59 o
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The Road Map to Value Creation 61 b
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Value Creation Capital Structure
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The Road Map to Value Creation 65 m
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The Road Map to Value Creation 67 2
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The Road Map to Value Creation 69 c
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Chapter 5 The Changes Wrought by EV
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The Changes Wrought by EVA 73 and t
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The Changes Wrought by EVA 75 all d
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The Changes Wrought by EVA 77 Even
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The Changes Wrought by EVA 79 Reduc
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The Changes Wrought by EVA 81 hardl
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The Changes Wrought by EVA 83 prese
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86 The EVA Challenge mechanical cou
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88 The EVA Challenge company fired
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90 The EVA Challenge skirmishes of
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92 The EVA Challenge but the reduct
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94 The EVA Challenge We now move on
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96 The EVA Challenge employees, man
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98 The EVA Challenge 3,500. The thr
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100 The EVA Challenge with economic
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102 The EVA Challenge November 1998
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104 The EVA Challenge their drawbac
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106 The EVA Challenge to establish
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108 The EVA Challenge It is helpful
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110 The EVA Challenge Managing for
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112 The EVA Challenge After a coffe
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114 The EVA Challenge EVA 101, the
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116 The EVA Challenge facilitator t
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118 The EVA Challenge The classroom
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Herman Miller—Continental North A
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122 The EVA Challenge in an organiz
Page 132 and 133: 124 The EVA Challenge In the modern
Page 134 and 135: 126 The EVA Challenge efficiencies
Page 136 and 137: 128 The EVA Challenge A company tha
Page 138 and 139: 130 The EVA Challenge units and imp
Page 140 and 141: 132 The EVA Challenge Witter’s re
Page 142 and 143: 134 The EVA Challenge $70.8125 eigh
Page 144 and 145: 136 The EVA Challenge companies wer
Page 146 and 147: 138 The EVA Challenge design, manuf
Page 148 and 149: 140 The EVA Challenge you can lose
Page 150 and 151: 142 The EVA Challenge Allen-Bradley
Page 152 and 153: 144 The EVA Challenge Disadvantages
Page 155 and 156: Chapter 9 EVA Incentives We revert
Page 157 and 158: EVA Incentives 149 EVA incentive pl
Page 159 and 160: EVA Incentives 151 For a typical di
Page 161 and 162: EVA Incentives 153 bonus by 10, div
Page 163 and 164: EVA Incentives 155 these approaches
Page 165 and 166: EVA Incentives 157 quarters of the
Page 167 and 168: Chapter 10 How EVA Can Fail What mo
Page 169 and 170: How EVA Can Fail 161 created by a d
Page 171 and 172: How EVA Can Fail 163 Stern Stewart
Page 173 and 174: How EVA Can Fail 165 pay. Monetary
Page 175 and 176: Chapter 11 New Frontiers: Real Opti
Page 177 and 178: New Frontiers: Real Options and For
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Page 188 and 189: 180 The EVA Challenge conflict betw
Page 190 and 191: 182 The EVA Challenge Question 2. W
Page 192 and 193: 184 The EVA Challenge managers will
Page 194 and 195: 186 The EVA Challenge Question 6. M
Page 196 and 197: 188 The EVA Challenge framework suf
Page 198 and 199: 190 The EVA Challenge problems ofte
Page 200 and 201: 192 The EVA Challenge Only after th
Page 202 and 203: 194 The EVA Challenge followed by a
Page 204 and 205: 196 The EVA Challenge There are two
Page 206 and 207: 198 The EVA Challenge floor, the fi
Page 208 and 209: 200 The EVA Challenge Consider the
Page 210 and 211: 202 The EVA Challenge 5. Provide bo
Page 212 and 213: 204 The EVA Challenge degree, but t
Page 214 and 215: 206 The EVA Challenge annual sales
Page 217 and 218: Epilogue EVA and the “New Economy
Page 219 and 220: EVA and the “New Economy” 211 W
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Page 225 and 226: EVA and the “New Economy” 217 d
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EVA and the “New Economy” 225 W
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EVA and the “New Economy” 227 O
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EVA and the “New Economy” 229 a
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EVA and the “New Economy” 231 o
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Acknowledgments This project has be
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Acknowledgments 235 monitoring mana
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Acknowledgments 237 Approximately s
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Acknowledgments 239 business and pr
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Acknowledgments 241 seemingly insur
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Acknowledgments 243 assignments to
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246 Index Competitive positions (Po
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248 Index Incentive plans based on
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250 Index Takeover artists, 11 Tate
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