Stock price responses to information technology changes.

Author:Kang, Eun
 
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  1. INTRODUCTION

    Technology and the effect of its use in companies on their performance have received much attention especially in the management information systems literature. This paper focuses on the financial aspect of information technology (IT), i.e., the effect of IT investment on the stock prices of firms.

    Previously, technology represents production task technology (Blau et al. 1976, Hickson et al. 1969). Information technology is a relatively new concept. The definition of information technology varies according to authors. A broad definition would be "all hardware, software, communications, telephone and facsimile as well as all personnel and resources dedicated to IT (Weill 1992)." In this paper, IT broadly includes all sorts of technology that could be used to process data, to manage orders, to help customers locate needed information, to organize the system, and so on. Studies on the effect of IT investment on firm performance can be grouped by the variables each study focuses. Broadly, one group focuses on managerial variables like user satisfaction, system quality, or impact on individual users (Delone and Mclean 1992), and the other group focuses on financial variables like return on assets, growth rate, market to book value, and pre-tax profits (Cron and Sobol 1983, Weill 1992, Chari et al. 2008). Especially, several studies analyze the effect of IT investment on the stock price (Dos Santos et al. 1993, Brown et al. 1995, Hobijn and Jovanovic 2001, Laitner and Stolyarov 2003).

    This paper presents several empirical findings on the effect of IT investment announcement on the stock price and on the long-run performance of firms. Using event study methodology, we examine stock price responses on the announcements of IT investment in the department store industry where IT has a lot of applicability.

    The IT announcement effect is not significantly different from zero either when we analyze the excess returns adjusted by the beta from a market model or when we analyze unadjusted daily returns. From this result, it seems that the market is not quite enthusiastic about the announcement of IT investment. The main reason should be the uncertainty of the benefit of the costly IT investment, that is, the market is not sure about whether there will be enough cash flow to justify the cost of IT investment. The result is in fact consistent with a lot of previous papers which could not find any positive relationship between IT investment and firm performance.

    The main problem of previous research and our event study approach in finding the relationship between IT investment and firm performance is such that while IT investment is a long-term project, the methodology of measuring firm performance is usually short-term. We need a long-term performance measure to test the long-term effect of IT investment. In that vein, we analyze long-term cumulative returns of firms. We divide the firms into two groups according to whether firms announced IT investment. The average cumulative return of firms which announced IT investment at least once is significantly greater than that of firms which had no announcement. The results are consistent with Hobijn and Jovanovic (2001)'s analysis that IT takes effect in the stock market with a lag, and Bharadwaj et al. (1999)'s finding that IT investments have a positive association with Tobin's q value.

    From the above results, since IT investment has a lot of uncertainty about its benefits and thereby risky, we can understand the market's neutral responses to the announcement of IT investment. As time passes and the effect of IT investment gradually materializes, the firm's cash flow will improve and the market will value the firm accordingly. It seems that the financial market reacts more strongly on the financial information such as earnings (Healy and Palepu 1988, Atiase and Bamber 1994, Landsman and Maydew 2002) or dividend (Asquith and Mullins 1983, Dyl and Weigand 1998, Nissim and Ziv 2001, Graham et al. 2006) announcements than other types of information including IT investment announcements. Therefore, at the time of IT investment announcement, the market's response is lukewarm, but as time passes and the effect of IT investment begins to show in financial terms such as increased sales, higher earnings, or increased dividends, the market reacts with higher stock prices, and in the long run the effect is strong enough to be noticeable.

    The paper is organized as follows. In the next section, the sample selection procedure and the data are described. In section three, the methodology used to measure the stock price response to IT investment announcements are described. The results are presented in section four. Concluding remarks are in section five.

  2. THE DATA

    As is common in the IT literature, we examine a specific industry to analyze the stock price responses on IT investment announcements. Standard Industrial Classification (SIC) codes...

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