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Article Excerpt
Abstract
In this paper, we examine the influence of IT strategic role to extend the findings of Im et al. (2001), Chatterjee et al. (2002) and Dos Santos et al. (1993). Specifically, we demonstrate that IT strategic role can explain hew IT investments in each of the IT strategic roles might affect the firm's competitive position and ultimately firm value. We find positive, abnormal returns to announcements of IT investments by firms making transformative IT investments, and with membership in industries with transform IT strategic roles. The results of previous research are not found to be significant when IT strategic role is included as an explanatory variable. These results provide support for the value of capturing the IT strategic role era firm's I T-related competitive maneuvering in studies striving to understand the conditions under which IT investments are likely to produce out-of-the-ordinary, positive returns.
Keywords: IT investment, event study, IT strategic role, stock market reaction
Introduction
Do investments in information technology (IT) pay off? Increasingly, the evidence suggests the answer is yes, but only when the IT investment scenario is well targeted, well timed, and accompanied with complementary investments and actions (Barua and Mukhopadhyay 2000). The salient question, then, is not "Do investments in IT pay off?" but rather "Under what conditions do investments in IT pay off?" This paper seeks to add to our collective understanding of this rephrased research question. Through the use of event study methodology and careful research design, it is possible to assess the extent to which attributes of IT investments, investing firms, and/or investment contexts influence shareholders' interpretation of the value relevance of such announcements and, as a consequence, produce abnormal movements in the investing firm's stock price.
Previous research examining the value relevance of announcements of IT investments has produced intriguing results (Dos Santos et al. 1993; Im et al. 2001). However, they fail to produce a general understanding of the conditions under which IT investments are likely to produce positive returns. We extend earlier work by proposing an overarching construct, IT strategic role, that accounts for factors previously found to affect the stock market response to IT announcements and provides for a more robust understanding of the conditions that lead investors to positively value an IT investment. First, we briefly review prior studies regarding IT investment announcements, and then we elaborate on the influence of IT strategic role in investors' appraisals of IT investments. We follow that by proposing an empirical model and test the relation between IT strategic role and firm value. We conclude with a discussion of our results.
Previous, Related Event Studies of IT Investment Announcements
Dos Santos et al. (1993) examine the stock price reaction to IT investment announcements in the context of two explanatory variables, industry and innovation. The industry variable (financial firms versus manufacturing firms) is expected to have a significant effect because IT is proposed to have a larger impact on financial firms than non-financial firms due to the information intensity of the financial industry. The innovation variable captures the effect of being the first to use a new technology or to introduce a new technology-enabled product or service. As argued, firms introducing innovative IT initiatives are likely to experience increases in profitability until the initiative becomes routine, i.e., a competitive necessity, within the industry. While Dos Santos et al. did not find any significant effects for financial firms, they did find that innovative IT investments were related to positive, abnormal stock price returns.
Im et al. (2001) examine the stock price reaction to IT investment announcements in the context of three explanatory variables: industry, size, and time period. Consistent with Dos Santos et al., the industry variable (financial versus non-financial) serves as a proxy for industry-level information intensity. Regarding firm size, Im et al. argue that smaller firms are more likely to have certain advantages when information is considered an asset and complete contracting is not possible (Brynjolfsson 1994). We expect firm size to be related to abnormal returns for two additional reasons. First, competitive advantage is likely to be more sustainable for small firms as it is more difficult for other firms to be aware of the actions of small firms vis-a-vis large firms (Feeny and Ives 1991), i.e., the smaller firms are, the less likely they are to undergo scrutiny and be viewed as a threat by larger firms in the industry. Second, firm size proxies for the information set available to investors prior to the IT investment announcement, and the announcements for small firms contain more news than those for large firms (Atiase 1985). Im et al. introduce the third variable, time period, in order to account for the time lag between when IT investments are made and when the benefits show up in financial statements. While this is a relevant argument when using accounting performance measures, it is not relevant when using market measures as investors take into account future performance impacts at the time of an announcement. How ever, other arguments can be raised for the salience of a time effect: a maturing of a firm's understanding of IT, a maturing of a firm's IT infrastructure and IT application portfolio, and a greater likelihood that complementary investments have been made. Subsequent analysis showed that abnormal returns to IT investment announcements were, in fact, related to firm size, time period, and financial/non-financial industry.
Very recently, Chatterjee et al. (2002) undertook a study of 112 IT investment announcements between 1992 and 1995 to assess a proposition that an important condition that underlay investors' appreciation of IT investments is the targeting of a firm's IT infrastructure rather than IT applications. Chatterjee et al. (2002) argue that IT infrastructure investments will induce a positive, abnormal marketplace reaction because of the broader scope of such investments and their option-like characteristics, i.e., they introduce robust technology platforms that can be leveraged by a variety of current and future IT applications. Support for these ideas was confirmed in the ensuing empirical analyses.
Hypotheses Development
It is argued that the primary signals to which investors react regarding IT investment announcements are the expected marketplace impact targeted by the IT investment and the dominant role served by IT across the firms competing in an industry. Both of these conditions evolve from the IT strategic role construct, conceptualized by Schein (1992) and Zuboff (1988) as:
* Automate, i.e., replacing human labor in automating business processes
* Informate-up, i.e., provide information about business activities to senior management
* Informate-down, i.e., provide information about business activities to employees across the firm
* Transform, i.e., fundamentally redefine business and industry processes and relationships
It is important to note that IT strategic role operates at both the firm and industry-level. Prior research has applied the IT strategic role construct both at a firm level, e.g., Armstrong and Sambamurthy (1999), and at an industry-level, e.g., Chatterjee et al. (2001). We examine the reaction to IT investment announcements by accounting for the targeted strategic role of the announced IT investment, the dominant industry IT strategic role for the industry of which the announcing firm is a member, and the interactive effect between these two variables. Note, however, that when a company announces an IT investment, this investment's strategic role may very well be distinct from the firm's overall IT strategic role (which we do not measure). Below, the relationship between these IT strategic roles and firm value is discussed.
Strategic Role of an IT Investment
Companies that use IT to automate human labor generally invest in IT in order to improve the efficiency of existing business processes. There are two reasons why automate IT investments are not expected to produce large increases in profits or value. First, it has proven extremely difficult for firms to sustain competitive advantages gained through IT investments (Clemons and Row 1991). Unless the IT-enabled investment is extremely difficult to duplicate (i.e., involves scarce resources, is dependent on a series of antecedent investments, involves unique qualities of an organization's culture or capabilities, etc.), competitors will quickly implement comparable initiatives and allay any relative competitive advantage. Thus, accruing benefits tend to be very short-lived. Second, when such IT practices come to dominate an industry, these IT investments are best referred to as competitive necessities. Rather than providing a firm with a...
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