Although EVA (Economic Value-Added or EP for Economic Profit) is a theoretically robust indicator for measuring financial performance, its use as a management and remuneration tool can paradoxically encourage managers to underinvest.

Here are the mechanisms and reasons that explain this phenomenon:

1. Mathematical mechanics: Reducing capital to boost the ratio

EVA is calculated by subtracting the cost of capital employed from after-tax operating income. EVA = Operating Profit (net of tax) – WACC Capital Employed

To maximize the EVA (and often their bonus), managers have two levers: increase the result or reduce the capital employed.

• The temptation of the denominator: It is often easier and faster to refuse an investment or reduce assets (stocks, equipment) than to increase turnover. By limiting the asset base, the capital burden ($WACC\times CE$) is mechanically reduced, which artificially inflates the EVA in the short run, to the detriment of future growth.

2. The Time Conflict: The “J-Curve” of Investment

Productive investment (new project, R&D, product launch) generally follows a “J” curve: it requires an immediate cash outflow (increasing the capital employed) while the revenues only come in later.

• Negative immediate impact: In the first few years, a new investment adds to the capital invested without yet generating enough profit to cover the cost of the additional capital. This degrades the current year’s EVA.
• The managerial decision: If managers are evaluated on the annual EVA, they will be rationally inclined to reject projects that are profitable in the long term and create value (positive Net Present Value) simply because they degrade short-term performance. A survey cited shows that more than half of CFOs are willing to reject a value-creating project if it compromises short-term outcome objectives.

3. Excessive outsourcing: The Coca-Cola case

The obsession with EVA and ROCE (Return On Capital Employed) can lead to excessive industrial disengagement strategies to lighten the balance sheet.

• The “49 solution”: The example of Coca-Cola in the 80s and 90s is very demonstrative. To improve its EVA and ROCE, the company took the capital-intensive bottling business off its balance sheet and housed it in separate entities (such as Coca-Cola Enterprises), of which it only owned 49% to avoid global consolidation.
• As a result, while the EVA and the stock price have temporarily exploded, protecting the company against a hostile takeover, this strategy has ended up destroying industrial value. Coca-Cola lost control of its distribution and customer relations, which forced it, years later (2010), to buy back these assets in order to focus on “industrial rationality” over the optimization of a financial indicator.

4. The confusion between “Input” and “Output”

Finally, EVA steering can fail when leaders confuse performance measurement (EVA as output) with the strategy itself.

• EVA should be the consequence of good investment decisions, not an end in itself. By focusing solely on the indicator, companies risk sacrificing the investment (input) necessary to build the company’s sustainability.
• This is why some companies have abandoned EVA for the remuneration of managers after having noticed these perverse effects of underinvestment and management in the short term.

In short, the EVA sanctions the immediate cost of capital. Without a governance system that values long-term growth, EVA incentivizes “starving” the company of capital to maximize apparent short-term returns.