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A comprehensive investigation on the relationship between information technology investments and firm diversification

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Abstract

This paper empirically investigates the role played by information technology in diversified firms by building a demand function for IT investments. First by reviewing the management literature, we briefly examine different types of diversification, including related diversification, unrelated diversification, and geographic diversification. After carefully developing the theoretical arguments we empirically test the relationship between IT investments and different types of diversification. We find that in general diversified firms demand more investments in information technology, but the positive relationship may also depend on the extent to which firms diversify. Our findings show that firms with diversified structures that increase the complexities of coordination and control, e.g. unrelated diversification or extensive geographic diversification, would face a lesser demand for IT investments because of the increased use of financial controls instead of strategic controls by these firms. Overall, we find that information technology can serve as an effective coordination and control mechanism for moderate levels of diversification whereas non-IT mechanisms for coordination and control becomes more suitable in a context of higher levels of diversification. The implications of these findings for research and practice are discussed.

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Notes

  1. We do not include a hypothesis for unrelated diversification because per our argument unrelated diversification already adopts financial controls and hence multinationality will not necessarily change the relationship between unrelated diversification and IT investments.

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Authors and Affiliations

  1. Lally School of Management and Technology, Rensselaer Polytechnic Institute, Troy, NY, 12180, USA

    Yu Liu & T. Ravichandran

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  1. Yu Liu
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Correspondence to Yu Liu.

Appendix: Entropy measures of diversification (Adapted from [35])

Appendix: Entropy measures of diversification (Adapted from [35])

Assume that a firm is operating in N industry segments, where N is the number of unique four-digit SIC codes reported by the firm. Let P i denote the share of ith segment in the total sales of the firm. The entropy measure of total diversification DT is calculated using the equation below:

$$ DT = {\sum\limits_{i = 1}^N {P_{i} {\text{ln}}(1/P_{i} )} } $$

Let the N industry segments of the firm aggregate into M industry groups, determined by the number of unique two-digit SIC codes reported by the firm (N ≥ M). Let DR j be defined as the related diversification arising out of operating in several segments within an industry group j and P j i be defined as the share of segment i of group j in the total sales of the group. Related diversification DR can be calculated by the following equation:

$$ DR = {\sum\limits_{j = 1}^M {P^{j} } }{\sum\limits_{i \in j} {P^{j}_{i} {\text{ln}}(1/P^{j}_{i} )} } $$

where P j is the share of the jth group sales in the total sales of the firm. Finally unrelated diversification DU is defined as:

$$ DU = {\sum\limits_{j = 1}^M {P^{j} \ln (1/P^{j} )} } $$

It is only a straightforward mathematical calculation to obtain that DT = DR + DU.

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Liu, Y., Ravichandran, T. A comprehensive investigation on the relationship between information technology investments and firm diversification. Inf Technol Manage 9, 169–180 (2008). https://doi.org/10.1007/s10799-008-0042-1

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