Stern, ’64, managing partner of New York City’s Stern Stewart & Company, was talking about economic value added (EVA), an increasingly popular financial evaluation tool his firm developed and refined over two decades.
With EVA, Stern Stewart helps growing numbers of corporate clients worldwide establish clear, accountable relationships between management action and shareholder wealth.
In a recent article on value-based pay systems, the Wall Street Journal explained EVA this way: "Take one year’s net operating profit
after taxes and subtract a theoretical charge for the cost of
capital used in the business. The final figure is supposed to
reflect what kind of return investors can expect on their money."
After implementing EVA and tying it to appropriate management
incentives, corporations like Eli Lilly and Guidant have watched
stock prices soar. And that only makes sense, notes Stern. "EVA
makes managers think more like shareholders because they have
a better understanding of what’s been invested to generate earnings,"
he has been quoted as saying. "Like entrepreneurs, they become
much more cost conscious, aggressively seeking ways to conserve
capital and operate more efficiently." That’s why EVA has become
a useful tool for setting executive compensation.
Not surprisingly, while winning growing numbers of adherents,
EVA has also spawned imitations among rival corporate financial
consulting and accounting firms and executive compensation specialists.
But no one launching EVA knock-offs has logged anywhere near the
time Stern has studying and championing the theory underpinning
EVA.
"The origin of the idea began when I studied at the University
of Chicago Graduate School of Business, especially when I studied
in the classes of Merton Miller," Stern says. "He was the first
person to show how to look at value from an economic standpoint
as opposed to an accounting standpoint. That led me to question
the usefulness of orthodox (unadjusted) accounting information
in making critical business decisions."
Stern’s questioning engendered his early and lasting disdain for
earnings per share as a tool of investment analysis. "The rules
people were using in all the major brokerage firms, investment
banks, and major money management firms appeared to me preposterous,
because they were so at odds with what was being taught at the
University of Chicago," he says. "You’d think there was some god
out there called Earnings Per Share that was driving decisions."
He developed the concept of free cash flow, which that later lead
to EVA, in an 18-year career at Chase Manhattan Bank, where he
served as president of Chase Financial Policy, the bank’s financial
advisory arm. "I was coming into contact with chief executives
and chief financial officers of manufacturing firms all over the
world," he recalls. "I listened to the questions they raised to
make sure the idea I was developing was not only theoretically
pure, as Merton Miller would want it, but could be implemented
in a practical sense in the real world."
Finding it could, he and colleagues set out to sell the concept
to corporations. They developed a two-day short course on the
economic model of the firm, Stern remembers. Companies dispatched
their CFOs, financial analysts, and even their CEOs to attend
the seminars, then gradually began inviting Stern and his colleagues
to make presentations to their executive or management committees,
and occasionally to their boards of directors.
Stern would go on in the 1970s to write more than 100 articles
on modern finance for Financial Times in which he continued to explore both the possibilities and limitations
of the theory of modern finance taught at the University of Chicago.
By 1982, when he decided to leave Chase and start his own firm,
"many people in the world knew what I stood for," he says. "The
bank didn’t have the vision I felt was necessary to turn a consulting
practice based on the economic model of the firm into a successful
business." Stern Stewart, founded with partner Bennett Stewart
III, opened in November 1982 with just eight employees. At the
outset, Stern announced the firm would reap $2 million in profits
on revenues of $4 million in its first full year. Defying a challenge
from an early member of the firm’s board, who argued such a debut
was impossible, Stern went out and achieved precisely the financial
goals he’d predicted.
"Today, we’ve gone from eight employees to 230 professional people,
and offices in New York City, Chicago, London, Munich, Johannesburg,
Singapore, and Sydney. We expect to open in Brazil and Paris in
1999," Stern said. "We’ve positioned Stern Stewart ideas in almost
every major business market in the world."
To achieve that growth, the firm has successfully educated investment
bankers, money managers and securities analysts about the merits
of EVA. "They’ve become not only EVA literate but EVA enthusiastic,"
said Stern. "It has facilitated the marketing process by which
prospects are turned into clients around the world."
Stern is executive editor of the Journal of Applied Corporate Finance and an adjunct professor at several leading business schools.
He has been a rotating panelist on PBS’s "Wall Street Week" for
17 years, and occasionally contributes to the Wall Street Journal and Fortune. Yet he may be best known to GSB Chicago readers as a prognosticator
at the GSB’s annual Business Forecasts. His forecasts have been
amazingly accurate. "I studied at the foot of the dean of forecasters,
[the late] Walter ("Bud") Fackler," he reported. "Standing next
to him, it was a pleasure to humble myself, especially in the
early years."
There have been few professional embarassments for Stern, say
those who know him. GSB distinguished service professor emeritus
Sidney Davidson, who taught Stern 35 years ago, recalls him as
"always innovative, brash, willing to put forth new ideas." Asked
to describe Stern today, Davidson deadpans: "Always innovative,
brash, willing to put forth new ideas."
Looking ahead, Stern doesn’t envision slowing down. "The mystery
of life is that we don’t know what’s ahead of us," he observes.
"I only hope that what’s driven me intellectually in the past
will be able to drive me forward, whether in the business world,
philanthropy, or in helping kids."
--Jeffrey Steele