Proceedings of Annual Paris Economics, Finance and Business Conference 7 - 8 April 2016, Espace Vocation Haussmann, Paris, France ISBN: 978-1-925488-04-3 A Study of Shareholders Value creation and measurement by Economic Value Added in Indian private sector banks Jyotindra Jani The Goal of Financial Management is to maximize the shareholder’s value. The shareholder’s wealth is measured by the returns they receive on their investment. Returns are in two parts. First part is in the form of dividend declared by the organization and second part in the form of capital appreciation reflected in the market value of shares of which market value is the dominant part. The market value of share is influenced by number of factors, many, of which, may not be fully influenced by the management of firm. However, one factor, which has a significant influence on the market value, is the expectation of shareholders regarding the return on their investment. There exist very measures like return on capital employed. Return on Equity, Earning per share. Net Profit and Operating Profit Margin evaluate the performance of business. The problem with these measures is that have lack of proper benchmark for comparison. The shareholders requires at least minimum rate of return on their investment depending on the risk in the investment. To overcome these problems the concept of EVA was developed. The report studies that profile of Indian bank demonstrate a direct correlation between the investment in stakeholder relationships and corporate performance. Many Indian banking seems to have destroyed shareholder’s wealth over a period of time and only few have positively contributed to their wealth. With the help of EVA (Economic Value Added) which shows what the institution is doing with investor’s hard earned money. The report examines an appropriate way of evaluating bank’s performance and also find out which IndianBanks havebeen able to create/ destroy shareholder’s wealth during research period in the present study. Key Word: ROIC; EVA; EPS; Ke; Indian Private Bank (I) Introduction: India is one of the top 10 economies of the world and has good potential for banking industry to grow in coming days. This is the era of financial institutions and financial market as the economic development of any economy depends on the banking structure it has. Moreover, the RBI’s new norms will provide incentives to banks to take corrective steps for bad loans. If we talk about the Indian banking structure, primarily two matters are to be considered (i) operational efficiency of the banks and (ii) risk management ability of top management in line with the RBI guidelines. The first matter is related to internal management and customer satisfaction by providing the best services. But the second matter is externally related and it focuses on balancing the balance sheet as well as increasing and maximising the share prices. The two main aspects than any bank has to focus are maintaining the capital adequacy requirements and lowering down the level of nonperforming assets. The primary objective of any organisation is to maximise the shareholder’s wealth. To measure the shareholders wealth various tools are available like Economic Value Added, Market Value Added, Total Shareholders return, Cash Value Added, Total Business Returns etc. among them for this paper EVA has been used for the measurement of shareholders value creation. Shareholder’s value means the value _____________________________________________________________________ Shri Sadguru Mahila Home Science and Late M.J.Kundalia English, Medium Mahila Commerce CollegeSaurashtra University, jyotindra1319@gmail.com 1 Proceedings of Annual Paris Economics, Finance and Business Conference 7 - 8 April 2016, Espace Vocation Haussmann, Paris, France ISBN: 978-1-925488-04-3 delivered to the shareholders because of management’s ability to grow earnings, dividends, and share prices. In other words shareholder’s value is sum of all strategic decisions that affects the firm’s ability to efficiently increase the amount of free cash flows over a time. (II)What is Economic Value Added (EVA)? : EVA is the profit earned by firm less cost of capital. This concept is similar to NPV; NPV calculates total value added over a life of project while EVA calculates net value added in a single period. If EVA is positive it means managements have increased the total wealth of the company and if EVA is negative it means the cost of capital is higher than the rate of return. The EVA concept has been registered by Stent Stewarts. The basic idea behind this concept is, if there is perfect market no company would be earning excess profit but because of imperfect market there may be advantage(s) of economies scale, economies of scope, cost advantage, product differentiation, access to distribution channel, government policy etc can be the cause of additional value to the firm. EVA can be calculated as follows. EVA = Net operating profit after tax – (WACC* capital employed) WACC = Kd + Ke The banks cost of debt is comprising of borrowing of the banks and large mounts funds get blocked in borrowing for yea baked are used for the same and hence here only cost of equity is considered for calculation weighted average cost of capital. cost of equity is calculated by CAPM and beta was calculated by considering the five years Sensex closing price. 2 Proceedings of Annual Paris Economics, Finance and Business Conference 7 - 8 April 2016, Espace Vocation Haussmann, Paris, France ISBN: 978-1-925488-04-3 (III) Literature Review: Shawn Tully (1993): A reporter of fortune magazine gives the concept of EVA and its effectiveness. He has highlighted the results of big corporate like Coca Cola, AT&T, Quaker Oats etc by using EVA concept given by Stern Stewart & Co. in titled “The real Key to Creating Wealth” EVA” Robbie Lewis & Hadely (1995): In the paper titled “Economic Value Add”, the authors have focused on the concept and need of EVA in coming days of global competition as measure of financial performance. The research shows that adoption of EVA improves the financial performance of a company. Dennis G. Uyemura, Charles Kantor, Justin M Pettit (1996): In their paper titled “EVA for Banks: Value creation, Risk Management, and Profitability Measurement, ranked America’s 100 largest bank holding companies according to their shareholder value added. It correlated market value of banks and EVA. They also provided a framework for calculating EVA at all level of organisation. Michael Durant (1999): He has given the concept of EVA and its uses. He has focused how EVA can be calculated and interpreted. According to the paper titled “EVA : invisible Hands at work” it changes the way managers run the business. Andrew Worthington & Tracy West (2001) The paper gives basic idea about EVA, its calculation, accounting adjustments and theoretical and empirical literature. Pablo Fernandez (2001): He analysed 582 American companies for 10 years using EVA, MVA, NOPAT and WACC. 210 companies have shown negative correlation between NOPAT and EVA. So according to this paper accounting based measures cannot measure value creation?And hence EVA, economic profit, and cash value added do not measure shareholder’s value. Raji George (2005): He calculated EVA for 21 public and private sector banks. he concluded that when there is positive EVA, productivity increases and NPA decreases in both type of banks. 3 Proceedings of Annual Paris Economics, Finance and Business Conference 7 - 8 April 2016, Espace Vocation Haussmann, Paris, France ISBN: 978-1-925488-04-3 R. K. Mittal, Neena Sinha, Archana Singh (2008): This paper focuses on the linkage between economic value added and corporate social responsibilities. It focuses on the ethical commitment and financial performance of Indian companies over the four years data using correlation and regression analysis. It was found that companies implementing CSR policy had higher EVA and MVA. Nikhil Chandra Shil (2009): In this study the author has focused on why EVA should be implemented, advantages, disadvantages, step wise calculation and superiority of EVA over other conventional financial performance measures. Jagdish Raiyani & Nilesh Joshi (2011): The study focuses on the performance measurement based in EVA as a case study of SBI & HDFC. EVA was higher in public sector banks compare to private sector banks due to higher rate of return on capital. Pratapsinh Chauhan (2012): This study examines the shareholder’s value creation in the Indian Petroleum industry. It was found high positive correlation between EVA and NOPAT for both public sector and private sector firms. George ray (2014): The traditional measures do not motivate internal management and employees to increase the value. EVA is an economic metric for performance. Sharing economic profit as an incentive is the first step in aligning employee action to shareholders interest. A plan base on increased economic profit will stimulate improvement. The detailed review of literature shows that very few research work has been done about effect of EVA as a financial performance measure on private sector banks in India. At present in India banking sector is one of the fastest growing sector and this industry will become more competitive because of entry of new private sector banks. The Indian banking industry may be classified into broadly two categories i.e. commercial banks and cooperative banks. Commercial banks are further classified as public sector and private sector and private sector is further classified as old private sector banks and new private sector banks. The private sector banks play very crucial role in providing services to the customers and its is more competition intensive industry. So the researcher has focused on the effect of EVA on private sector banks of India for this paper. 4 Proceedings of Annual Paris Economics, Finance and Business Conference 7 - 8 April 2016, Espace Vocation Haussmann, Paris, France ISBN: 978-1-925488-04-3 (IV) Objective of the Study: The primary objectives of the study are as under. To understand the concept of shareholders value creation and value base management To analyse the growth of shareholders value in private sector banks in India To know the average EVA among the private sector banks To analyse the standard deviations of EVA, ROIC and EPS (V)Sources Data: The research is based on the secondary data. To analyse the EVA required financial data is collected from the annual report of selected banks. (VI)Sample Design: For this research work all the new private sector banks have been considered. It includes EVA analysis of ICICI bank, Axis Bank, HDFC bank, Yes bank, DCB, IndusInd Bank and Kotak Mahindra bank. (VII)Tools of Data Analysis: For analysing trend in shareholders’ value, EVA, OP, NOPAT and EPS has been considered while mean, standard deviation have been considered as a statistical tools. (VIII)Data Analysis: The following table shows the Return on Invested Capital (ROIC), Cost of equity (Ke), Economic Value Added (EVA), Earning per Share (EPS) for sample selected for five years from 2009-10 to 2013-14. Banks Axis Bank ICICI Bank DCB Particulars ROIC (%) Ke (%) EVA EPS ROIC(%) Ke EVA EPS ROIC(%) Ke 2013-14 16.27 16.59 (1231.12) 132.33 13.40 16.84 (33960.21) 84.95 13.15 18.67 2012-13 15.64 Years 2011-12 18.60 2010-11 17.84 2009-10 15.67 (3131.61) 110.68 12.48 4582.68 102.67 10.70 2365.85 82.54 9.35 (1472.41) 62.06 7.80 (37074.73) (44314.18) (47869.76) (52869.70) 72.22 56.09 44.73 36.10 10.21 6.42 3.46 (13.10) 5 Proceedings of Annual Paris Economics, Finance and Business Conference 7 - 8 April 2016, Espace Vocation Haussmann, Paris, France ISBN: 978-1-925488-04-3 EVA EPS ROIC(%) Ke EVA EPS ROIC(%) Ke EVA EPS (635.30) 6.05 19.50 14.27 22739.97 35.34 12.24 16.09 (4725.42) 19.51 (846.45) 4.08 18.57 (1052.13) 2.29 17.27 (940.78) 1.07 15.47 (1902.80) (3.92) 13.70 15585.22 28.27 14.40 8968.61 22.02 13.66 3051.83 84.40 12.04 (1221.55) 64.42 12.51 (1592.98) 18.23 (1934.49) 14.65 (2573.70) 11.10 (1605.49) 16.12 IndusInd ROIC(%) Bank Ke EVA EPS Yes ROIC(%) Banks Ke EVA EPS 15.59 16.84 (1129.57) 26.80 22.72 18.54 2974.09 44.86 13.93 16.97 14.28 14.63 (2219.48) 20.30 22.40 59.52 17.17 20.89 (1033.87) 12.39 19.17 (530.16) 8.53 15.46 2239.39 36.27 1099.50 27.68 237.16 20.95 (950.63) 14.06 HDFC Bank Kotak Bank The following table shows the mean and standard deviations of EVA, ROIC and EPS for the selected banks. Parameter Mea n S.D. Axis ICICI DCB Banks HDFC EVA 222.68 ROI C (%) EPS EVA 16.80 (33960.21 ) 10.75 (1075.49 ) 4.02 9824.8 2 16.90 98.06 3155.9 8 13.44 58.82 7736.96 1.91 487.18 2.27 26.89 19.90 ROI C (%) EPS Kotak Yes (2522.42 ) 12.97 IndusIn d (970.70 ) 15.08 15.92 1318.80 17.04 843.22 10.26 46.89 9599.6 4 2.34 1.02 1.22 28.86 1561.8 9 2.96 3.76 26.51 3.28 7.07 12.18 1119.9 0 20.13 (IX)Data Interpretation: The calculation shows that only HDFC bank and Yes have been able to generate positive EVA for most of the years while remaining all banks have failed to generate the 6 Proceedings of Annual Paris Economics, Finance and Business Conference 7 - 8 April 2016, Espace Vocation Haussmann, Paris, France ISBN: 978-1-925488-04-3 positive EVA for almost four years out of five years. All the banks have shown upward trend for the EPS for all the years. Return on invested capital also shows the positive trends for all the banks for all the years. Cost of equity was highest for the Development credit bank at 18.67% while lowest for the HDFC bank at 14.27%. HDFC bank has the highest average EVA of Rs. 9824.82 while ICICI bank has the lowest EVA of Rs.(33960.21). The average rate of return on invested capital is highest for HDFC bank at 16.90% whiles it lowest for Development Credit bank of just 4.02%. Among all the new private sector bank Axis bank has the highest average EPS of Rs. 98.06. The standard deviation of EVA was found to be highest in case of HDFC bank at Rs. 9599.64 while lowest in case of DCB at Rs. 487.18. (X) Conclusion: The new private sector banks have shown increase in return on invested capital and EPS but not the same in case of EVA. There is no much increase in shareholders wealth by new private sector banks. The private sector banks need to focus on increasing EVA by increasing the NOPAT and decreasing the cost of capital. EVA shows the overall profitability of the firm and hence the bank should try to keep their standard deviation of EVA low as much as possible. References: Alfred Rapport 1986, “Creating Shareholder value, The new standard for Business Performance”; The Free Press Banerjee, A. 1997. Economic Value Added: A Better Performance Measures. The Management Accountant, December 1997, 886-88 Fernadez Pablo 2003, “EVA, Economic Profit and Cash Value Added Do Not Measure Share Holder Value Creation”, The IUP Journal ofApplied Finance, Vol. 9, No. 3 (May), pp. 74-94. Ramachandra Reddy, B. and Yuvaraja Reddy, B, 2007, “Financial Performance through Market Value Added (MVA) Approach”, The Management Accountant, January 2007, pp. 56-59. Raiyani, J. R., & Joshi, N. K. 2012 Eva Based Performance Measurement: A Case Study of SBI and HDFC Bank. Management Insight, 71 Sura Javir and Lather Anju 2013, “Indian Banking Information content of EVA and Traditional Measures”, IOSR Journal of Economic and Finance, May-June 2013, 48-61 7 Proceedings of Annual Paris Economics, Finance and Business Conference 7 - 8 April 2016, Espace Vocation Haussmann, Paris, France ISBN: 978-1-925488-04-3 Thampy Ashok and Rajiv Baheti, “Economic Value Added in Banks and Development Financial Institution” ; The IUP Journal of Applied Finance, Vol. 1 (January) pp. 44-45 8