Will announcing an IT investment help or hurt your company's stock price? That's among the hardest questions for a CIO to answer. But in a study entitled "The Moderating Effect of Context on the Market Reaction to IT Investments," to be published in the Journal of Information Systems in 2006, three academic researchers provide guidance.
The study looked at 339 IT investment announcements and found that share price increased one day after the announcement when a company had high growth potential (as signaled by a high market-to-book ratio) and investors were uncertain about the company's future (as indicated by a high variation in a stock's average daily return), or the company was making an investment that could transform its business. Strategic investments were more likely to increase the return when the outlook was uncertain, because the investment signaled to Wall Street how the company planned to compete.
"Shareholders are bright," says Professor Vernon Richardson of the University of Arkansas, in Fayetteville, one of the paper's coauthors. "They won't react to an investment in one standard manner."
However, shares were likely to lose value when a company with uncertain prospects announced an IT investment that required highly specialized or customized software or hardware, or a long period of codevelopment by customer and vendor. In those cases, the authors write, the IT investment looked less like a solution than a risky gamble. For example, the share price of Baldor Electric Co., an electric motor manufacturer in Fort Smith, Ark. with $558 million in sales in 1997, dropped 2.2 percent after IQ Software Corp. announced Baldor had selected its reporting tool on April 16, 1998. It appears Wall Street was not impressed with this quote from a Baldor IT manager in IQ Software's press release: "IQ's products were the only ones we looked at that would allow us to work in the highly scalable environment we needed."
Since the study only considered stock valuation for the day after the announcement, it's hard to say what the long-term impact on share price is. But the paper, by Richardson and two Montreal-based researchers, Wonseok Oh, of McGill University, and Joung Kim, of Concordia University, does suggest that IT spending is generally smiled upon by investors. Overall, the average share price of a stock increases .32 percent one day after the news of an IT investment goes public.
This article was originally published on 11-05-2005