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| 86.
RI Is The Superior Predictor Of Long Term Company Value
| The University of Chicago graduate school of business has done extensive research on residual income as a predictor of long-term company value. Their research supports the conclusion that residual income (RI) is the best predictor of long-term company value.
Because residual income reflects management strategies and the ability to execute them in absolute terms, it truly measures management effectiveness. Accordingly, RI is a wonderful tool to be used in executive compensation. Because the CEO's primary job is growth in company value, residual income is the best measure of how well the CEO and his team are performing. Therefore compensating the executive team based on growth in residual income is entirely appropriate.
Residual income, defined as net income after tax minus the annual cost of capital, is easily calculated. Because RI truly captures the results of management strategies and their execution of those strategies, it unflinchingly measures performance.
It is therefore reasonable to conclude that a company with stable management that has shown consistent growth in residual income could be reasonably expected to continue that level of performance as long as that management team and their approach remains in place.
Obviously, this has very interesting implications for succession planning, organization planning, and management development. |
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