Source: web.gsm.uci.edu
Topic: Investment Firm
Sort Desciption: investment makes a substantially larger contribution to overall firm risk ... A firm with an investment opportunity holds a real option in that it has the ...
Content Inside: Dewan, Shi and Gurbaxani: Investigating the Risk-Return Relationship of Information Technology Investment: Firm-Level Empirical Analysis Article submitted to Management Science; manuscript no. MS-00524-2003.R3 1 Investigating the Risk-Return Relationship of Information Technology Investment: Firm-Level Empirical Analysis Sanjeev Dewan, Charles Shi, Vijay Gurbaxani The Paul Merage School of Business, University of California at Irvine, Irvine, CA 92697 {sdewan@uci.edu, cshi@uci.edu, vgurbaxa@uci.edu} This paper develops empirical proxy measures of 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 investment makes a substantially larger contribution to overall firm risk than non-IT capital investments. Fur- ther, 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 invest- ment corresponds to the risk premium associated with IT risk. Taken together, our results show that IT risk pro- vides part of the explanation for the unusually high valuations of IT capital investment in recent research. Key words: IT capital; productivity paradox; IT returns; IT risk; IT investment; IT value; real options __________________________________________ __________________________________________ 1. Introduction There is widespread recognition that investments in IT are inherently risky due to uncertainty about their economic impact, technological complexity, rapid obsolescence, implementation challenges, and so forth. 1 The interplay between risk and return plays a central role in the evaluation of investments in the financial economics literature, and is therefore a key element i ...
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