Measuring value added : the case of the South African banking sector
Fouché, Casper Hendrik
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Companies all over the world attempt to create value for their owners. This is done by delivering profits over an extended period of time. South Africa is no different and has become a major emerging economy. The South African financial system has been much acclaimed in the international arena as one of the best in the world, second only to Canada. Therefore it is very important for banks in particular to ensure the ability to create shareholder value. If the goal of a company is to create value then the company needs measures to track performance. Traditional accounting measures have been used for a long time to indicate how much profit has been made in the financial period. These measures have been used in businesses around the world since the early 1900’s. Since the 1980’s however more and more concerns have been raised over these measures. One of the main issues seen with traditional accounting performance measures is that they do not take into consideration the cost of investment. Value-based management (VBM) was proposed to fill this gap of taking into consideration the cost of capital invested. VBM in theory involves two steps. A company first has to adopt an economic profit metric as a key measurement of performance, and secondly tie this measure to executive compensation. VBM metrics such as Economic Value Added (EVA), Economic Profit (EP) and Cash-flow Return on Investment (CFROI) have gained popularity since the late 1980’s. Managing for value has become of utmost importance for most executives around the world. The main goal of this study was to test what factors can be used to indicate how much value has been created in South African banks. In order to do this a quantitative study was performed on the banks listed in the McGregor BFA database. Regression models were run on the data for these banks over the period 2001 to 2010 to see the impact of specified metrics on value creation. The measures selected for value creation were the growth in Economic Value Added (EVA), the growth in Shareholder Value Analysis (SVA) and EVA/Invested Capital. The independent variables selected were Return on Equity (ROE), growth in assets, the impairment ratio and the growth in operating income per employee. Added to this was a dummy variable which indicated whether the bank outperformed the bank index (the proxy for industry performance) in the particular year. And finally an autoregressive term was added because of the nature of the data being a time series. The results clearly indicate that the chosen metrics works for half of the banks and fails for the other half. It was also found that the growth in EVA performed best as indicator for value creation. The independent variables which were most consistent were ROE, the impairment ratio and the growth in operating income per employee. The fact that the bank had outperformed the bank index was inconsistent, being significant in some cases but not always. The results indicate that value creation is dependent on the particular bank that is considered. When using the results care should be given to which bank is being analysed. Further studies can be performed using even more measures for the different banks. It is therefore recommended that each company find what is working for them, in particular, when searching for a value creation measure.