Week 01 – Business Value of IT
I am pleased to announce that Dr. Keongtae Kim at Chinese University of Hong Kong, a lead author of the bond-market paper at MISQ that we discussed last week, will join us this Wednesday as a guest speaker via a virtual meeting for 20-30 minutes. You can find his bio here.
He will join us at 9 AM (10 PM at Hong Kong time). Please don’t be late for class. In our meeting with him, we will ask him about his experiences in writing and publishing his MISQ paper. Please prepare for a question that you might want to ask him.
The paper asks the important question of whether IT does create value that is reflected in the market value of firms and in their future profitability. This question has been hard to address and there have been varying viewpoints about this topic. Proponents argue that companies can make innovative use of IT in ways that create value by taking advantage of unique resources of a firm. Critics, on the other hand argue that IT is easily replicable and cannot provide sustained competitive advantage as profits obtained from improved business would be competed away. Further, another line of thinking is that firms may develop specific set of architecture and skills that are not easily replicable and thus IT capabilities may themselves become a strategic resource. The paper wants to resolve this conundrum by utilizing the Y2K bug situation in 2000 that had forced IT firms to think about their existing IT strategies seriously.
The paper hypothesizes that there is a positive association between shareholder value and Y2K spending and this is more pronounced in the transform than the informate than the automate industries respectively in that order. It also hypothesizes that there is a negative association between shareholder value and industry level spending on Y2K and that there is a positive association between earnings in future periods and Y2K spendings that are higher for firms in transformate industries versus the other industries. The authors employ a market valuation framework similar to that applied by Lev and Sougiannis’ (1996). The novelty of the method is the use of earnings in one period as predictors of earnings in the future. The results show that firms that spent more in the Y2K period experienced the benefits of improved earnings and increased firm value. These benefits were more pronounced in transform industries versus the other two. These companies, in the long run, were more flexible and were faster to adopt upcoming trends in e-business etc, thus providing them with more benefits. The authors also carry out bunch of robustness checks and rule out endogeneity concerns (using 3SLS etc) keeping the results consistent.
Ho, J., Tian, F., Wu, A., & Xu, S. X. (2017). Seeking value through deviation? Economic impacts of IT overinvestment and underinvestment. Information Systems Research, 28(4), 850-862.
Information technology (IT) investment decisions are of continuing strategic importance to firm. Under Red Queen competitive pressures, each firm’s performance depends on exceeding the actions of its rivals. This logic is useful but underresearched in the context of IT investment and its economic impacts.
This paper addresses the economic impacts of information technology overinvestment and underinvestment decisions. Hypothesis in this work draws on the view of Red Queen competition in conjunction with institutional theory. It argues that there is an effect of deviation on competitive advantage and an effect of deviation on legitimacy. Combining the two effects, a nonlinear relationship between firm performance and over- or under investment is expected (Hypothesis 1). In addition, drawing on the idea of management control mechanisms, the nonlinear firm performance impacts are conditional on ownership concentration (Hypothesis 2).
The authors use Tobin’s q to indicate firm performance, firm IT investment deviation is the difference between a firm’s IT capital and Industry IT. Sample set covers S&P 500 firms during 2001–2006. Firstly, ordinary least squares regression is applied. Then, to handle the possible endogeneity problem caused by selection bias, this paper uses Garen’s two-stage approach to model it. Another two partial adjustment models are applied to help address the dynamics of IT investment.
From the four models result, this paper finds that, on average, there is a positive relationship between a firm’s overinvestment in IT and Tobin’s q, although the relationship attenuates at higher levels of over-investment. However, on average, there is no relationship between a firm’s underinvestment in IT and its Tobin’s q. In addition, family ownership positively moderates the performance impact of underinvestment. These findings partially support hypotheses proposed.
Kim, K., Mithas, S., & Kimbrough, M. (2017). Information technology investments, and firm risk across industries: Evidence from the bond market.
When firms in U.S. make decision in IT investment, it is necessary for them to evaluate the impact on their bond, because bond markets are the single laregest financial sources for U.S. firms. However, how bondholders view IT investment is little known. This paper tends to investigate the problem from two perspectives : 1. the association between IT investments and two measures, initial bond rating and yield spreads, for newly issued bonds; 2. how these associations vary across industries.
The paper examines research questions through the lens of real option thoery (e.g. Benorach 2002; Fichman et al. 2005) . Decision maker face the trade off betweem the benefits and risks IT may bring. In the context of this paper, bondholders play the role of decision maker, on one hand, IT investment may increase cash flow of a firm, on the onther hand, they also consider several riskiness associated with IT. Furthermore, the paper focuses on three broad industry categories based on the differing strategic roles of IT (Anderson et al. 2006; Banker et al. 2011) : 1. automate, 2. informate, 3. transform. It discusses industry heterogeneity in IT investment risks which are classified into (Benaroch 2002) : 1. firm-specific risks, 2. competition risks, 3. market risks. It points out transform industries are more likely to face higher risk from IT investment than other two thus negatively influence the bond evaluation.
It uses data from financial database and InformationWeek database. Empirical models are established to examine the research questions.
The main findings are bondholders perceive the impact of IT ivestments on bond ratings and yield spreads differently across industries. They view IT investment in automate and infomate industires more favorably than those in transform industries. Becuase bondholders’ aversion to the riskiness and the lack of collateralizability of IT investments.
Anderson, M.C., Banker, R.D., and Ravindran, S. (2006) “Value Implications of Investments in Information Technology,” Management Science (52:9) pp. 1359-1376.
Anderson, Banker, and Ravindran (2006) capitalized on the unique Y2K bug situation to further the debate on the value of IT. Skeptics of IT spending argue that companies overspend on IT (Carr, 2004) based on the false belief that IT can provide a sustainable competitive advantage. Proponents of this belief feel that companies should wait to allow others to absorb the cost of IT and simply mimic successful implementations. On the contrary, IT supporters argue that IT creates value by connecting consumers and suppliers in a value driven way. This debate has been ongoing due to the difficulties that arise when attempting to empirically address IT performance and value; past research has relied on survey information (Bharadwaj et al., 1999; Brynjolfsson et al., 2002) or public announcements (Dos Santos et al., 1993; Im et al., 2001; Chatterjee et al., 2001). However, Anderson et al. (2006) capitalized on the U.S. SEC’s mandate to disclose Y2K preparations in order to gain unique insight into this ongoing debate.
Following a market valuation framework similar to Lev and Sougiannis’ (1996), Anderson et al. (2006) employed empirical models which related the combination of firms’ current book values and earnings, along with other value-relevant variables, to firms’ market values (i.e. prevailing stock prices). Though some critics proposed that organizations were overzealous with their IT spending in light of Y2K (Kong and Seipel, 2000), Anderson et al. (2006) found companies who spent more in the Y2K period experienced the benefits of improved earnings performance and increased value. These benefits were further realized in transformational industries, or those where IT has the potential to alter traditional business processes and relationships. Effectively, companies that embraced IT upgrades in response to the Y2K bug positioned themselves so that they could realize the benefits of emerging e-business applications.
Aral, S., & Weill, P. (2007). IT assets, organizational capabilities, and firm performance: How resource allocations and organizational differences explain performance variation. Organization Science, 18(5), 763-780.
While the positive effect of IT investments on firm performance has been shown from past evidence, the explanation of substantial variation across firms still remains obscure. Our knowledge of the specific factors driving the differences remains quite limited for both industry and academia. This study by Aral and Weill in 2007 tries to address the following two key questions: 1) what types of organizational characteristics explain this variation in firm performance? 2) why two firms with the same amount of IT capital perform differently?
To answer these two questions, the authors dive into the literature on resource-based theory of the firm (Wernerfelt 1984, Barney 1991) and propose a theoretical model of IT resources by 1) categorizing IT investments of firms into a portfolio of four IT assets disaggregated by strategic purpose: infrastructure, transactional, informational, and strategic assets and by 2) grouping the IT capability(ITC) as a mutually reinforcing system of practices(routines) and competencies(skills). Using data from 147 firms over 4 years and qualitative evidence from a case study of 7-Eleven Japan, the authors empirically investigate the impact of IT assets, IT capabilities, and their combination on four dimensions of firm performance: market valuation, profitability, cost, and innovation. They then find that 1) investments in a particular IT asset class deliver higher performance only when the dimension of the asset consistent with the strategic purpose of it and 2) organizational IT capabilities strengthens the performance effects of IT assets and broadens their impact beyond their intended purpose.
Although the empirical parts remain huge potentials for future researchers to explore, this paper is an easy-to-follow benchmark of behavior IS study. The authors integrate past literature and develop a new conceptual model which complements and extends recent resource-based theories of IT value.
Paper: Cheng, Zhuo, and Barrie R. Nault. “Industry level supplier-driven IT spillovers.” Management Science 53, no. 8 (2007): 1199-1216.
This paper is about understanding the impact of upstream IT investment on downstream productivity, to be more specific, the authors examine the spillover effect of supplier-side IT stock capital investment on downstream industry productivity.
The authors list several reasons on the rationales behind the research motivation for this topic. First, supplier’s investment on IT infrastructure could translate into better or new products, service, or more efficient operation for downstream industries. Second, supplier’s improvement on interorganizational systems will provide more accurate demand forecast that benefits downstream companies. Despite the obvious benefits of supplier’s IT investment on inter-firm cooperation and management, little research has been done to scientifically examine the effect due to empirical data scarcity. The authors develop a model for spillover effect of supplier-side IT investment explicitly accounting for the measurement error of the price deflator of the intermediate input, reflecting the mismeasurement of the quality enhancement provided by upstream IT investment. They find that the supplier-driven IT spillovers are both positive and significant. Moreover, they also indicate that because of the failure to account for the quality improvement, the measured price deflator overestimates the true deflator by approximately 30% at the mean level of IT capital stock.
In terms of relevant literatures and contributions of this paper, the authors list two aspects. The first is that the modeling approach proposed by the authors extend the production-function framework to a new field in understanding spillover effect of IT investment. Second, this paper also builds up findings and research in Supplier-driven IT spillovers.
The authors derive the proposed model from the basic Cobb-Douglas production function. They derive a model of supplier-driven IT spillovers by explicitly accounting for the errors in the measurement of intermediate input prices. The model facilitates authors to infer the magnitude of measurement error of the intermediate input price deflators from the estimates of the parameters.
Each week, I will assign one paper to each student, who is required to write a brief up to 300 words for the assigned paper and lead the discussion on the paper in class. Here is the assignment for the first week.
- Anderson et al. (2006) – Sid Bhattacharya, Kennedy Heather
- Aral and Weill (2007) – Zhe Deng
- Cheng and Nault (2007) – Jack Tong
- Ho et al. (2017) – Xi Wu
- Kim et al. (2017) – Leting Zhang
A brief is due by 11:59 PM on the day before the class date (Tuesday, Jan 16). Submit your brief as a new post on this site and do not email it to me. Be advised that you’re required to read all the five papers