While information systems outsourcing has been on the rise in recent years, empirical evidence about whether IS outsourcing is value creating for shareholders is limited. Little is known about what factors influence the relation between information systems outsourcing and firm value. This study examines the effect of information systems outsourcing announcements on firm value by analyzing whether equity market reactions are associated with the management's strategic intent for outsourcing and firm characteristics of the outsourcing firm. After examining 103 IS outsourcing announcements made during the period from 1996 to 2003, results suggest that value is created for firms outsourcing with short-term operational intent rather than for longer term strategic reasons. In addition, the increase in firm value from an IS outsourcing announcement is positively associated with the firm's operating asset efficiency and the firm being in a service industry.
Outsourcing of the information systems (IS) function has become increasingly common since the mid-1980s and has continued to grow in recent years.3 Firms deciding to outsource part or all of their IS operations often cite one or more strategic intents for the IS outsourcing decision. However, recent work chronicling the benefits (e.g., Cross et al., 1997, Lacity and Willcocks, 1998, Loh and Venkatraman, 1992 and Smith et al., 1998) and risks involved in IS outsourcing (Aubert et al., 2004, Earl, 1996 and Oh et al., 2006) suggest that there remains widespread uncertainty about the value-adding benefits of IS outsourcing.
Although conceptually the purported benefits such as cost reductions and improvements in system quality, access to expertise, organizational flexibility, and ability to focus on core competencies are appealing, they must be weighed against risks created by outsourcing arrangements such as vendor over-opportunism, loss of control, increased governance costs, and technological inflexibility (Beasley et al., 2004 and Aubert et al., 1998). Therefore, the decision to outsource IS with the ultimate goal of impacting firm value through increased profits is a strategic decision, which weighs various costs and benefits, made by the managers of a firm. However, limited empirical evidence exists about whether management's strategic intent regarding IS outsourcing actually achieves the intended goal of increasing firm value.
Because many of the benefits of IS outsourcing are both intangible and long-term oriented, but many of the risks such as loss of control due to asset specificity (Lonsdale, 2001) and technological lock-in (Aubert et al., 2004) are near-term, there is a timing mismatch between risks and potential benefits. This study attempts to look at this mismatch by examining management's strategic intent for IS outsourcing in face of the known and unknown risks.
This paper contributes to existing research and literature on IS outsourcing. Examining the market reaction to IS outsourcing announcements is an important and timely subject for researchers, policy makers, and managers. While there have been numerous media reports on the social and economic costs and benefits of outsourcing, much of the attention on the outsourcing decision assumes that outsourcing affects all firms similarly. This study provides some initial insights as to whether the benefits of IS outsourcing are the same across firms with different firm characteristics and whether shareholders value IS outsourcing decisions differently when management makes those decisions for dissimilar reasons.
Specifically, this research focuses on the outsourcing of IS functions by examining the market reaction to firm announcements of the decisions. The overall change in the market value of the firm attributable to the IS outsourcing announcement is not significantly different from zero, providing further support for the suggestion that a broad definitive statement about the costs or benefits of IS outsourcing is not possible. An analysis of the firm characteristics of the outsourcing firms and the strategic intents provided by outsourcing managers provide additional insights. Subsequent examination of the interaction between strategic intent and firm characteristics shows the complexity of this area.
While some prior evidence exists about size and industry (firm-specific characteristics) and CARs surrounding IS outsourcing announcements, little is known about whether other specific firm characteristics provide additional information useful to shareholders when the IS outsourcing decisions are announced. The results show that after controlling for firm size, more efficient firms (as measured by asset turnover) have significantly higher two-day CARs than firms that are less efficient in their deployment of assets. There is no association between a firm's leverage and the CARs associated with the announcement. The findings also show that firms whose management asserts that the IS outsourcing strategy is not driven by cost-savings experience significantly lower CARs.
