Effect of IT Investments on Stock Markets

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Relations between performance and IT may be difficult to detect using contemporaneous accounting-based output measures because accounting tracks short-term performance whereas benefits from IT investments may be realized over the long-term (Brynjolfsson 1993). Since stock prices impound investor expectations about future earnings, they may be used to measure the expected influence of IT investments on long-term performance. Many researchers in economics and business have used stock market valuation as an alternative measure of business performance. Bharadwaj, Bharadwaj, and Konsynski (1999) relate information in stock prices to measures of IT intensity. They relate Tobin’s q, the ratio of the market value of firm assets to their accounting value, to the level of IT spending. Brynjolfsson and Yang (1999) derive an economic model that uses the market value of the firm to estimate the intangible costs and benefits of IT capital. They find marginal value impact of IT being far in excess of the marginal cost, which they attributed to intangible assets created by organizational transformations that accompany computer investments. Brynjolfsson, Hitt, and Yang (2000) explicitly linked high market capitalization values for IT to investments in organizational assets, including greater use of teams, broader decision making authority, and increased worker training. They found that firms that are high IT users are more likely to adapt these work practices, that firm value increases with this cluster of organizational characteristics, and that in firms that have these organizational characteristics, computer assets have a disproportionately higher market valuation. Use of event-study as a methodology in studying invents in IT has been rather limited. The strength of the event-study lies in the fact that it captures the overall assessment by a large number of investors of the discounted value of current and future firm performance attributable to individual events which is reflected in the stock price and the market value of the firm (McWilliams and Siegal, 1997). The event study methodology provides management researchers a powerful technique to explore the strength of the link between managerial actions and the creation of value for the firm (McWilliams and Siegal, 1997). Still, the use of event-studies in information systems research is but limited. In the first ever event study of market reactions to IT investment announcements, Dos Santos, Peffers and Mauer (1993) investigated the relationship between IT and market value using the stock market’s reaction to announcements as an assessment of how the announcement impacts stockholders’ valuation of the firm. They identified 97 announcements for publicly traded firms from 1981 to 1988. They found no change in stock prices for the sample of IT investment announcements.  However, a positive stock market reaction was observed for ‘innovative IT investments’. The study suggests that stockholders do, in fact, carefully consider the nature of announced IT investments, the likely impact of this investment on the firm’s net present value, and then buy or sell a stock accordingly. Dos Santos et al (1993) defines an innovative IT investment as one which does something new – a first use of a technology, a new product or service, or a new IT application – within an industry. While ‘first-to-market’ is an often-valued competitive strategy, being first-to-market does not guarantee marketplace success, particularly with the uncertainties surrounding new technologies. Im, Dow and Grover (2001) extended the sample taken by Dos Santos et al (1993) to include IT announcements from 1989 to 1996 and arrive at 238 announcements including those used by Dos Santos et al (1993). In addition to the stock price analysis they included reaction of trading volume to the announcements to identify whether IT investment announcements affect investors’ beliefs about IT value and also analyze potentially confounding factors such as industry, size, and time lag effects. They find positive returns for announcements of IT investments for small size firms but not for larger firms and present evidence that size is an influential factor affecting the returns to (announcements of) IT investments. Further, for the latter time period, they found evidence of increasing returns from IT investment announcements for firms within financial industries but not for firms in non-financial industries. They found that both price and volume reacted more positively to new announcements of IT investments than to old announcements and also industry and size effects got stronger with time. Subramani & Walden (1999) used event-study methodology for validating popular anticipations of significant future benefits to firms entering into e-commerce arrangements, which they call ‘dotcom effect’. They assess the cumulative abnormal returns (CARs) for 305 e-commerce announcements between October and December 1998. They find that firms, which can more easily deploy the relevant intangible assets, produce greater return for their owners. They find that business model or customer asset ownership do not significantly determines return on EC investments. In a sequential study Subramani & Walden (2001) extend their earlier work. Using the event study methodology they test the effect of ease in ability of a firm to create and deploy complementary intangible assets on the return for investors. Their result support that the theory that intangible, IT complementing investments are necessary to successfully create value via EC activities. In a similar study Subramani & Walden (2000) conduct a series of two event studies to examine the effects of name changes on the market valuation of firms. They find that the benefit of a dotcom name change is negligible supporting rationality of markets with respect to dotcom firms. Use of Event-Study Methodology for IT Investments: The value of organizational complements to IT can be found using financial market data. The value of stocks of a firm provides the market perceived value of the firm. The announcement regarding IT investments that we call ‘intensions’ are important cue to the security market regarding firms IT initiatives and if the market values these initiatives it can surely be reflected in excess returns. Value relevance of information technology can be analyzed through event-study methodology.  It allows the measurement of stock market reactions to the release of information about IT investments. If the market responds by revaluing a firm’s stock to reflect the information in the IT investment announcements, it can be concluded that the investment affects the market value of the firm. In our case key event is the announcement in the business press of what a firm believes to be a significant IT investment. Using event-study it is possible to assess the extent to which attributes of IT investments, firms, or investment contexts influence shareholders’ interpretation of such announcements and, accordingly, produce through their trading actions produce abnormal movements in the investing firm’s stock price. If IT initiatives of firms enhance future cash flows, the capital market would respond favorably to IT investment announcements by firms that would be reflected in a positive movement of their stock price. In other words, if rational investors value both tangible and intangible aspects of IT investments, a change in stock price should approximate the true contribution of IT to the firm ’s value not only in cost reductions, but also in increased variety, timeliness, and quality (Brynjolfsson and Yang 1996). A project is valued by the performance of project. It can be measured by following indicators: stock price, net asset value, modified NPV, goodwill, license, patent, etceteras. Investment amount is the present value of investment during the project period. The indicators for investment amount are plant: facilities, equipment, R&D expense, leased lines, and etceteras. Volatility is a measure of how volatile the current value of project is. It is measured by the change of stock, stock index, service (or product) price, subscribers, industry index, etc. Project period is a measure of the time left until the expiration of the project. Indicators for the project period can be technology transition cycle, intent of management, etc. The interest rate used is the risk-free rate, such as U.S. Treasury Bills as following a risk-neutral basis.

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