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Investigating the Risk-Return Relationship of Information Technology Investment: Firm-Level Empirical Analysis

  • Sanjeev Dewan

    ()

    (The Paul Merage School of Business, University of California at Irvine, Irvine, California 92697)

  • Charles Shi

    ()

    (The Paul Merage School of Business, University of California at Irvine, Irvine, California 92697)

  • Vijay Gurbaxani

    ()

    (The Paul Merage School of Business, University of California at Irvine, Irvine, California 92697)

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    This paper develops empirical proxy measures of information technology (IT) risk and incorporates them into the usual empirical models for analyzing IT returns: production function and market value specifications. The results suggest that IT capital investments make a substantially larger contribution to overall firm risk than non-IT capital investments. Further, firms with higher IT risk have a higher marginal product of IT relative to firms with low IT risk. In the market value specification, the impact of IT risk is positive and significant, and inclusion of the IT risk term substantially reduces the coefficient on IT capital. We estimate that about 30% of the gross return on IT investment corresponds to the risk premium associated with IT risk. Taken together, our results show that IT risk provides part of the explanation for the unusually high valuations of IT capital investment in recent research.

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    File URL: http://dx.doi.org/10.1287/mnsc.1070.0739
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    Article provided by INFORMS in its journal Management Science.

    Volume (Year): 53 (2007)
    Issue (Month): 12 (December)
    Pages: 1829-1842

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    Handle: RePEc:inm:ormnsc:v:53:y:2007:i:12:p:1829-1842
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    1. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-36, May-June.
    2. Sanjeev Dewan & Chung-ki Min, 1997. "The Substitution of Information Technology for Other Factors of Production: A Firm Level Analysis," Management Science, INFORMS, vol. 43(12), pages 1660-1675, December.
    3. Re-Jin Guo & Baruch Lev & Charles Shi, 2006. "Explaining the Short- and Long-Term IPO Anomalies in the US by R&D," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 33(3-4), pages 550-579.
    4. Eduardo S. Schwartz & Carlos Zozaya-Gorostiza, 2003. "Investment Under Uncertainty in Information Technology: Acquisition and Development Projects," Management Science, INFORMS, vol. 49(1), pages 57-70, January.
    5. Robert McDonald & Daniel Siegel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, Oxford University Press, vol. 101(4), pages 707-727.
    6. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-38, May.
    7. Richard B. Carter & Frederick H. Dark & Ajai K. Singh, 1998. "Underwriter Reputation, Initial Returns, and the Long-Run Performance of IPO Stocks," Journal of Finance, American Finance Association, vol. 53(1), pages 285-311, 02.
    8. Anandhi S. Bharadwaj & Sundar G. Bharadwaj & Benn R. Konsynski, 1999. "Information Technology Effects on Firm Performance as Measured by Tobin's q," Management Science, INFORMS, vol. 45(7), pages 1008-1024, July.
    9. Siew Hong Teoh & Ivo Welch & T.J. Wong, 1998. "Earnings Management and the Long-Run Market Performance of Initial Public Offerings," Journal of Finance, American Finance Association, vol. 53(6), pages 1935-1974, December.
    10. Brynjolfsson, Erik. & Hitt, Lorin M., 1995. "Paradox lost? : firm-level evidence on the returns to information systems spending," Working papers 3786-95., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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