An empirical assessment of transaction risks of IT outsourcing arrangements: an event study

Abstract

Our paper uses stock market reactions to assess various risks associated with IT outsourcing. Because much of the value and cost of IT outsourcing is intangible, hidden, and long-term oriented, most prior studies have articulated IT outsourcing risks conceptually and paid little attention to an empirical validation of such risks. We employ an event study methodology to assess how investors perceive and evaluate the risks related to IT outsourcing. More precisely, we empirically test the extent to which sources of IT outsourcing transaction risk (including asset-specificity, resource dependency, technological discontinuity, and performance monitoring) influence investors' reactions to IT outsourcing announcements. Our results indicate that investors exhibit two extreme responses: one perceives that benefits from IT outsourcing outweigh the risks associated with it; the other adopts the exact opposite view. Further analyses reveal that asset specificity of the IT resources to be outsourced and the size of the contract are negatively correlated with investors' reactions as measured by stocks' cumulative abnormal returns (CARs). Contrary to our predictions, contract duration and performance monitoring problems were not significantly associated with the market reaction. We discuss these findings and offer implications for both research and practice.