The Effects of Investments in Information Technology on Firm Performance: An Investor Perspective

Analyzing the beneficial effects of investments in information technology (IT) is an area of research that interests investors and academics. A number of studies have examined whether investments in IT have a positive effect on some measure of earnings or other form of financial return. Results from these studies have been mixed. This paper extends the literature by adopting an investor’s perspective on firm performance when IT investments are made, using the preservation of capital as a performance measure. The authors examine companies that made public announcements of their investments in technology to see if they were able to mitigate losses to investors by reducing their downside risk to investors. This study further discusses whether different types of IT investments have different impacts on firm risk from an investor’s viewpoint. Findings suggest that IT investments impact a firm’s downside risk, and the authors offer an alternative perspective on the benefits of IT investments, particularly where no positive incremental financial results are evident. DOI: 10.4018/jitr.2011070101 2 Journal of Information Technology Research, 4(3), 1-13, July-September 2011 Copyright © 2011, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited. management (Kohli & Davaraj, 2003). However, results of these studies have been mixed. For example, Brynjolfsson and Hitt (1993), Bharadwaj, Bharadwaj, and Konsynski (1999), and Stratopoulis and Dehning (2000), among others found a positive association between investments in IT and firm performance. On the other hand, researchers such as Loveman (1994) and Roach (1987) found a significantly negative association between investments in IT and resulting firm performance. We contribute to the literature by examining the relationship between investments in IT and a firm’s risk profile using a non-traditional measure of firm performance that is not captured in either productivity gains or increased profitability. Although IT investments may allow firms to achieve superior profits relative to their competitors, we believe that IT investments also serve to reduce a firm’s financial risk profile, or its downside risk. Downside risk has been proposed by economists as the perspective that characterizes investor sentiment towards making investments (Nawrocki, 1999). Economists have posited that the disutility incurred by a loss outweighs the utility of a gain of the same amount. Our research should be of interest to both researchers and investors (Heine, Grover, & Malhotra, 2003; Melville, Kraemer, & Gurbaxani, 2004). Our study provides evidence that there is an association between reductions in downside risk following the announcement of IT investments. We also find evidence that suggests the type of IT investment affects the degree of downside risk following the announcement of the investment, as well as whether the firm is a leader in defining IT strategies for their industry. In the following section, we briefly discuss literature related to IT investments relevant to this study. The next section develops our hypotheses relating firms’ investments in IT to downside risk and discusses the model we use to test these hypotheses. We then focus on methodological issues and discuss the results of our study. We conclude and summarize the paper, comment on limitations of our study, and discuss and directions for future research in the final section. LITERATURE RELATED TO IT INVESTMENTS AND FIRM PERFORMANCE Prior literature relating investments in IT to the effect on firms has focused primarily on positive outcomes such as productivity gains or financial returns. Kohli and Davaraj (2003) and Melville et al. (2004) have noted that the results of studies focusing on the specific organizational performance and productivity improvements have been mixed. Given the mixed results of past studies, our use of the investor’s perspective provides an alternative explanation about how IT investments may have a positive effect on firm performance. We will briefly discuss some of the key studies related to measuring the impact of IT investments on firm performance and then explain why using downside risk as an alternative measure makes sense. Research has documented a positive performance associated with the announcements of certain types of IT investments. Dos Santos, Peffers, and Mauer (1993) investigated the effect of IT investments on the market value of firms. Two particular attributes, industry type and IT investment type, were examined to see if either had an effect on the cumulative abnormal returns (CARs) near the dates of the announcements. Evidence indicates that only announcements of innovative IT investments were (positively) associated with CARs. Im, Dow, and Grover (2001) extended the literature by investigating whether industry size and time lag had an effect on firm market value using a larger sample of IT investment announcements over a longer time period. Small firm size and announcements made from 1991 and after (time lag) were found to be positively associated with market value effects. Additionally, Im et al. (2001) found that IT investment announcements firms in the financial industry were positively associated with market value, but only for announcements made after 1991. Journal of Information Technology Research, 4(3), 1-13, July-September 2011 3 Copyright © 2011, IGI Global. Copying or distributing in print or electronic forms without written permission of IGI Global is prohibited. Dehning, Richardson, and Zmud (2003) built upon this stream of literature by examining the relationship between the industry strategic role of IT investments and firm value. Using the IT strategic role construct conceptualized by Schein (1992), IT investment announcements were classified as those that automate, informate, or transform an organization. Dehning et al. (2003) tested the associations between market value and the classification of IT investment announcement by firms. Findings from this study provide evidence that the industry strategic role of IT investments does influence the market value of a firm. Specifically, firms that announce transformational IT investments, and firms announcing IT investments in industries in which transformational investments dominate the industry experience positive market value reactions from those announcements. Additionally, Dehning et al. (2003) found firms that announce IT investments, and are leaders in their industry, experience positive market value reactions. Recent studies have sought to further refine the circumstances under which firms experience positive returns on IT investments. Stone, Good, and Baker-Eveleth (2007) found that in certain situations, IT can have a positive effect on a firm’s marketing performance, which can in turn, enhance revenue generation. Mittal and Nault (2009) find evidence that IT affects certain firms in different ways. The effects of IT tend to be indirect on IT intensive firms, while direct effects are associated with non-IT intensive firms. Chari, Devaraj, and Parthiban (2008) posit that investments in IT pay off when firms own and operate businesses in multiple industries because IT facilitates control and coordination. While studies prior to ours have focused on measuring the positive impact of IT on performance, our paper extends the literature by employing a measure that captures a different aspect of performance than preceding studies (e.g., Stone et al., 2007; Mittal & Nault, 2009; Chari et al., 2008; Dos Santos et al., 1993; Im et al., 2001; Dehning et al., 2003). The downside risk performance measure focuses on mitigating losses instead of focusing on positive returns, thereby complementing the studies previously discussed. Our study provides a deeper understanding about the influence that IT investments ultimately have on what is important