Risk and Return Underlying IT Investments

by Sanjeev Dewan

As firms have ramped up their investments in information technology (IT), they are increasingly concerned about the financial returns on their IT investments or lack thereof. The concerns are only amplified by the steady stream of reports in the business press about IT failures and disasters. For example, a survey by the Standish Group of over 8,000 IT projects found that 23% of projects failed outright, while an additional 49% were completed late or over-budget, or with fewer features than promised. IT implementation problems at companies such as Hershey Foods and Foxmeyer Drugs have become the stuff of legends.

Surprisingly, the consideration of risk in the evaluation of IT investments has received limited attention in the management literature. These considerations include: How risky are IT investments relative to other types of capital investments? What is the nature of IT risk, and what are the implications for the justification of new IT initiatives and investments? What “hurdle rate” would be appropriate in the IT capital budgeting process? What risk management processes are appropriate for mitigating the risks underlying IT investments? These are questions that motivate Professor Dewan’s research into the risk and return underlying IT investments by corporations.

Two papers have been recently published in leading academic journals. The first paper, “Investigating the Risk-Return Relationship of Information Technology Investment: Firm-Level Empirical Analysis” (coauthored with Charles Shi and Vijay Gurbaxani) appeared in Management Science. This paper develops empirical measures for IT risk from firm-level accounting data, and employs IT risk to explain variation in IT returns across firms. One key finding is that IT investments are generally much riskier than other types of capital investment. Further, the IT risk premium accounts for some 30% of gross IT returns. This is the first study to empirically measure IT risk, and to systematically analyze the implications of IT risk for the estimation of IT returns.

The second paper, “Risk and Return of Information Technology Initiatives: Evidence from Electronic Commerce Announcements” was published in Information Systems Research. This paper was coauthored with Fei Ren, a recent Ph.D. graduate, now at the Guanghua School of Management, Beijing University. They examine the wealth and risk effects associated with early electronic commerce announcements in the 1996 to 2002 time period. They find that risk effects are generally quite significant. While much of the added risk due to electronic commerce activities is in fact diversifiable, they find some evidence that the use of new online channels and activities might actually reduce intrinsic business risk, perhaps due to reductions in demand uncertainty and cyclicality of sales revenues.

Dewan’s research is supported by a research grant from the National Science Foundation titled “Risk Vs. Return of Information Technology Investment." His results will provide a scientific platform for an informed discussion of IT risk management, which is an increasingly critical concern in the industry and society of the digital age. He is currently working on a survey that will generate additional evidence on the risk and return of IT investment by companies, as well as shed light on IT risk management practices followed in organizations. Dewan hopes this research will impact both industry practice and policy formulation.