The new productivity paradox

Abstract

ECONOMIC studies cx)nduaed in the 1980s and early 1990s failed to find evidence of improved firm productivity corresponding to greater IT investment. Because business firms expeaed performance to improve as a result of IT, the failure to observe higher productivity (more output from resources employed) was dubbed the "productivity paradox" [5]. The alleged implication was that they had overinvested in computers and other IT.If firm productivity did improve with investment in IT, the shareholder value of publicly traded com-High valuation multiples on IT spending suggest that companies are underinvesting in IT.reporting on IT initiatives under current accounting rules. The resulting inability to publicly observe firm spending on IT makes it difficult to measure IT influence on productivity or firm value. On the other hand, the relation between shareholder value and R&D spending (reported separately in accounting statements) has been studied extensively [10].With respect to IT spending, the Y2K situation was exceptional because the U.S. Securities and Exchange Commission (SEC) instructed publicly panies would increase with IT spending. When we traded companies to provide estimates of all IT costs studied the relation between shareholder value and IT spending by Fortune 1000 companies as they prepared for the Y2K date change we found that shareholder value associated with Y2K spending was in fact many times greater than the spending itself We also found this strong positive relation between shareholder value and Y2K spending persisted through the market downturn of 2000-2002. associated with Y2K preparation in quarterly and annual reports beginning in the fall of 1998. Companies had to disclose estimates of all amounts that had been or would be incurred to correct existing IT or to acquire new IT if acquisitions were made or accelerated to achieve Y2K compliance.Simple correction of existing IT would not add economic value because it wotild not improve firm These restdts are surprising in light of conven-productivity. Moreover, because profit-seeking comtional wisdom that companies overspent on Y2K. panies are expected to make value-adding invest-At face value, the relation between shareholder value ments voluntarily, forced investment in IT would and Y2K spending suggests that improved produc-not be expected to increase firm value. These obsertivity due to Y2K initiatives far outweighed their vations about Y2K make the finding of a large poscosts. This could mean that businesses actually itive valuation multiple on Y2K spending underinvested in new IT during this period, thus particularly puzzling. Our objective in writing this presenting a new paradox that is the reverse of the article is therefore to identify and evaluate possible initial productivity paradox. Financial Reporting on IT InvestmentAlthough information management has assumed an increasingly important role in defining the strategic direction of businesses, there is no standard for explanations for the high market valuation of Y2K spending. Shareho...

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