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Second Thoughts on the Analytical Properties of Earned Economic Income

Research output: Contribution to journalJournal article

Published
<mark>Journal publication date</mark>09/1995
<mark>Journal</mark>British Accounting Review
Issue number3
Volume27
Number of pages11
Pages (from-to)229-239
Publication statusPublished
Original languageEnglish

Abstract

The present paper amends the two propositions in Peasnell (1995) concerning the fitness of J. R. Grinyer’s ‘earned economic income’ (EEI) model for its declared purpose of evaluating managerial performance in the light of comments in Grinyer (1995). Proposition I now includes the requirement that the profitability index is the same for each depreciable asset in the multi-asset firm in order for EEI to yield the same answers as the net present value (NPV) of the firm itself. Proposition II is now adjusted to reflect the possibility that errors in forecasted benefits can be large in magnitude. The new version distinguishes between random forecast errors and ‘earnings management’. The original result concerning the conditions when EEI will be more or less reliable than re-computed NPV holds as far as random forecast errors are concerned. In the case of management manipulations, the results depend on whether the investment is believed by management to be worthwhile and on whether the forecast biases are sufficient to turn a poor performance into a good one. The paper concludes with a brief reply to certain key points raised by Grinyer concerning
my earlier analysis.