The relationship between profit-sharing/gain-sharing plans, productivity and economic value added

Journal of the Academy of Business and Economics, Jan, 2004 by Elizabeth Krauter, Leonardo Fernando Cruz Basso, Herbert Kimura

Basso (2002) introduced productivity in the EVA[R] formula. Emphasizing a forgotten characteristic of EVA[R], its relation with the statement of added value and productivity (DE LUCCA, 1998; GRAY & MAUDERS, 1986; GRAY & MEEK, 1988), the author rewrote the most well known EVA[R] formula.

Value Added (VA) is the difference between the gross production value (VBP), and the intermediate consumption (CI) (DORNBUSCH & FISCHER, 1994; SIMONSEN & CYSNE, 1998):

VA = VBP - CI

This sum is initially appropriated for the employees (CT - labor costs) and what remains is the gross operating income.

LO = VA - CT

The second appropriation is executed by the Government, which demands a portion of the gross operating income, represented by the tax rate:

LO (1-t) = (VA - CT).(1 -t)

By substituting the operating profit in the EVA[R] definition we obtain:

EVA[R] = (VBP - CI - CT).(1-t) - WACC. (1-t).(AOL)

By substituting the gross production value by its definition, we obtain:

EVA[R] = (P x Q - CI - CT) - t.VA t.CT - WACC.(1-t).(AOL)

The productivity of the work can be defined as the quotient between the produced amount (Q) and the worked hours (HT). By multiplying and dividing the quantities produced by the sum of hours of work needed to produce them, we obtain:

EVA[R] = P x (Q/HT).HT - CI - CT- t.VA - t.CT - WACC.(1-t).(AOL)

EVA[R] = P x PROD x HT - CI - CT.(1-t) - t.VA - WACC.(1-t).(AOL)

By dividing the expression by the net operating assets (AOL), i.e., the assets used to produce the economic value added, we obtain:

(EVA[R]/AOL) = P x PROD x (HT/AOL) - (CI/AOL) - [CT.(1-t)/AOL]- (t.VA/AOL) - WACC.(1-t)

Where: PROD is the productivity of the work; HT/AOL the efficiency of the net operating assets; CI/AOL the participation of the intermediate consumption in the net operating assets; CT.(1-t)/AOL the participation of the work in the net operating assets; t.VA/AOL the participation of taxation on value added in the net operating assets; and WACC = [CCT.(1-t) CCP.(1-t)]/AOL

EVA[R] can be redrafted through the following formula:

EVA[R] = [P x PROD x Efficiency of AOL - Share of Intermediate Consumption in Net Operating Assets - Share of Work in the Net Operating Assets - Share of Taxation on Value Added in the Net Operating Assets - Net Weighted Average Cost of Capital] x AOL

This equation shows all the variables that increase the economic profit, that is: price increase; productivity increase; increase of the efficiency of net operating assets; reduction in the share of intermediate consumption in net operating assets; reduction of the payroll as a proportion of net operating assets; reduction of the tax burden on the value added as a proportion of net operating assets; reduction of the weighted average cost of capital.

The formula makes the relation between the increase in productivity and the increase in economic value added explicit, providing all the other factors remain constant.

2.7 Value Drivers

Value drivers are proactive measures on which companies can act to anticipate results, with the objective of creating value for shareholders (RAPPAPORT, 2001; BLACK et al., 2001; YOUNG & O'BYRNE, 2001).