Empirical Evidence on the Role of IT Innovation Capability on Value Creation

During the Recession of Early 2000s

Changling Chen 

Jee-Hae Lim

Theophanis C. StratopoulosUniversity of Waterloo

UWCISA conference, Oct.1-3, 2009

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Objective• Introduce dynamic IT Innovation capability

(ITIC), defined as a company’s ability to integrate IT with organizational, and managerial processes in order to respond to a rapidly changing competitive environment.

• Our objective is to investigate and contrast the effectiveness of ITIC approaches on earnings persistence during the recession of the early 2000s.

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Motivation• IT spending has been rising; for most

companies IT spending is becoming their largest capital spending item.

• IT-enabled strategies have been recognized as a source of sustainable competitive advantage.

• Analyze and compare effect of IT during the recession. 

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Theoretical Foundation• "The resource-based view provides an

explanation of competitive heterogeneity based on the premise that close competitors differ in their resources and capabilities in important and durable ways.” Helfat and Peterar 2003

• Assumption: “ITIC is heterogeneously distributed across firms in important and durable ways”

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Our Approach: Winning in Terms of ITIC

N (Population of Firms)

C

(Set of ITIC Candidate Firms)

N

(Set of ITIC Leaders)

S

(Set of Systematic ITIC

Leaders)

SC

(Set of Opportunistic ITIC

Leaders)

Nc

(Set of Non-ITIC Leaders)

Cc

(Set of Non-ITIC Candidate

Firms)

Based on 4-year Window

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HypothesesIT innovation strategies and value creation• H1: Systematic ITIC firms are more positively associated with

abnormal ROE than non-ITIC firms.IT innovation strategies and sustainability/agility in value creation• H2a: Systematic ITIC firms are more likely to have more

persistent positive abnormal ROE (good news) than non- ITIC firms.

• H2b: Systematic ITIC firms are more likely to have transitory negative abnormal ROE (bad news) than non- ITIC firms.

IT innovation strategies and sustainable value creation during business cycles

• H3a:Systematic ITIC firms are more likely to have persistent abnormal ROE in recovery period than non- ITIC firms.

• H3b: Systematic ITIC firms are more likely to have less persistent (transitory) abnormal ROE in recession period than non- ITIC firms.

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Measures• IT innovation strategies: systematic, opportunistic, and non-IT

innovative strategy (Stratopoulos and Lim 2008; Lim et al. 2008)• Firm abnormal ROEA: equals residual income scaled by book value

of equity (Net income (#237)t/Book value of equity (#60)t-1 - cost of equity*)

– We derive the industry cost of equity from the 48 industry risk premiums documented by Fama and French (1997).

– The industry cost of equity: the sum of the annualized one-month T-bill yield and the Fama and French (1997) industry equity premium (estimated from the three-factor model).

• Therefore, to distinguish differential firm abnormal ROE beyond industry average abnormal ROE, we compute the industry average abnormal ROE weighted by book value of equity (ROEAIN) and then take the difference between firm abnormal ROE and industry average ROE for firm differential abnormal ROE (ROEFM).

• Control Variables: Size, R&D, Market Share, Industry concentration ratio, and fixed effects for industry and year.

Sensitivity Analyses

• Alternative measure for the industry cost of capital derived from CAPM model.

• Alternative measures of good vs. bad news using positive/negative unexpected returns.– The unexpected return is computed as cumulative 240 days returns

of the one-year period before the fiscal year end (about 240 trading days) minus Fama-French three factor cost of capital.

• Alternative measures of firm performance measure– Using actual firm abnormal ROE

• Further consider whether the effect of systematic IT innovation is different on the profitability persistence of different industries.

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Limitations and Future Research

- The firms in the sample are not randomly The firms in the sample are not randomly selectedselected.

- Other influencing contextual factors (e.g. top executive or board’s strategy capability or management).

+ Types of IT innovation strategy

+ Comprehensive dataset

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Contributions• Develop a framework that explains how

technological innovation strategies link to earnings persistence and, therefore, map into the sustainable competitive advantages.

• Analyze specific measures of IT innovation strategies on earning persistence in reflecting publicly available good news vs. bad news.

• Provide detailed empirical evidence on the relation between IT innovation strategies and earnings persistence during business cycles.

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Any Question or Comment?