Proponents of economic value added (EVA) argue that changes in the metric accurately
measure changes in the performance of a firm or business unit through time and therefore
can represent a reliable measure of managerial effectiveness. However, inflation
distorts EVA through the operating profit, the cost of capital, and the capital base
and these distortions have the potential to result in inefficient investment and
compensation outcomes. Using an inflation-corrected EVA metric, I measure the sensitivity
of EVA to the level of, and changes in, inflation for a large sample of US stocks
and find evidence of significant inflation induced distortions.