Journal of Information Technology Case and Application Research

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Impact of Information Technology

Investment on Productivity and
Profitability: The Case of a Leading
Jordanian Bank
a
Ahmad Mashal
a
Deanship of Business Studies, Arab Open University - Jordan
Published online: 12 Sep 2014.
To cite this article: Ahmad Mashal (2006) Impact of Information Technology Investment on Productivity
and Profitability: The Case of a Leading Jordanian Bank, Journal of Information Technology Case and
Application Research, 8:4, 25-46, DOI: 10.1080/15228053.2006.10856099
To link to this article: http://dx.doi.org/10.1080/15228053.2006.10856099
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Impact of IT Investment on Productivity and Profitability
Impact of Information Technology Investment on

Productivity and Profitability:
The Case of a Leading Jordanian Bank
Ahmad Mashal
Deanship of Business Studies, Arab Open University - Jordan
ABSTRACT
Downloaded by ["Queen's University Libraries, Kingston"] at 12:40 29 December 2014
Over the past fau years, there has been much debate as to whether or not investment in
Information Technology (IT) improves productivity and business profitability. Studies at both the
industry andfirm levels have provided varying answers to this question and drferent insights into
the causes ofproductivity fluctuation. Recent research into the banking sector has shown that the
substantially high returns achieved by most banks are largely due to an increase in their
investment in Information Systems (IS) labor, while additional investment in IT capital may have
no real benefits. This study examines the efect of IT investment on productivity and profitability
by analyzing data @om the Arab Bank, one of the leading banks in Jordan, during the period
1985 to 2004. The results indicate that there are substantial returns due to an increase in
investment in IT capital, a fact which incentivizes the bank's management to shift its emphasis in
IT investment@om labor to capital.
Keywords: Impact, Information Technology Investment, Productivity, Profitability, Leading

Jordanian Banks
INTRODUCTION
In the recent past, scholars and policy makers have debated whether or not investment in
Information Technology (IT) and Information Systems (IS) improves business productivity and
profitability. Although conclusive evidence was lacking, some researchers claimed that despite
massive investments in IT, the payoff for most companies was minimal, a situation they termed
the "IT productivity paradox."
How to measure the business value of ISIIT investment has been the subject of considerable study
by many academics and practitioners (Van Grembergen and Van Bruggen, 1998). The difficulty
in measuring benefits and costs often creates uncertainty about the expected benefits of ISIIT
investments. As a result, organizations often waste a great deal of energy, time and money in
their efforts to justify such investments. Alternatively, evaluation is often ignored or carried out
inefficiently or ineffectively because of its elusive and complex nature (Serafeimidis and
Smithson, 1996).
Morrison and Berndt (1990) conclude that IT investments contribute negatively to productivity.
They argue that the "estimated marginal benefits of investment in IT are less than the estimated
JITCA, Volume 8, Number 4,2006 25
marginal costs." For example, for each additional dollar spent on IT, the marginal increase in
measured output was only 60 cents. With this background in mind, this paper examines the
effects of IT on productivity and profitability in one of the leading banks in Jordan. Data on IT
spending was collected from the bank's annual reports and fieldwork at the bank.
PREVIOUS RESEARCH
In recent years, several studies have been conducted at both the industry and firm levels to
examine the impact of IT on productivity. Some of these studies have drawn on the statistical
correlation between IT spending and performance measures such as profitability or stock value.
Nicholas Carr (2003) examines the evolution of information technology in business and shows
that it follows a pattern that is strikingly similar to that of earlier technologies like railroads and
electric power. Carr argues that businesses have overestimated the strategic value of IT,
overspending on technology in the quest for business value. Businesses need to manage large
portions of their IT infrastructures more rigorously with a view to reducing capital investment
requirements and operating costs. McFarlan and Nolan (2003) suggest that new technologies will
continue to give companies the chance to differentiate themselves by service, product feature, and
cost structure for some time to come. However, Carr's (2003) views on IT are not shared by most
IT practitioners and academics who argue that IT still has a lot to offer in the future, and that it
can deliver competitive advantages to organizations (Broadbent et a1 (2003), Strassmann (2003),
Vandenbosch and Lyytinen, (2004)).
Recent evidence suggests that many organizations, carried away by the promise of ISIIT benefits,
spent money unwisely in the late 1990s (Farrell, 2003). According to a study done by the
Mckinesy Global Institute, more successful organizations analyzed their economics carefully and
spent only on those ISIIT applications that would deliver productivity gains, thus cautiously
sequencing their investment in a disciplined approach with innovative management practices
(Farrell, 2003).
A survey and an in-depth case study conducted in Australia by Chad Lin, Graham Pervan and
Donald McDermid (2005) investigated the processes and practices of ISIIT investment evaluation
and the management of benefits realization in large Australian organizations. The results show
that many survey respondents and case study participants actually knew very little about the ISIIT
investment evaluation and benefits realization concepts and practices. In most cases, neither
formal ISIIT investment evaluation nor benefits realization methodologies were adopted by these
organizations. Their evaluation tended to be informal and quantitative in nature. If anything, the
study indicates that most organizations are not yet mature and, despite their adoption of a formal
Benefits Realization Methodology (BRM), some problems still exist.
Loveman (1994) holds that at the manufacturing firms included in his study, there is no
significant contribution to output from IT expenditure. Parsons, Gotlieb, and Denny (1993)
conclude from data gathered from five Canadian banks using a translog production function that
while there is a 17-23% increase in productivity with the use of computers, the returns are very
modest compared to the levels of investment in IT. Colwell and Davis (1992) contend that output
and productivity in banking remain theoretically difficult to assess and even harder to measure
JITCA, Volume 8, Number 4, 2006 26
due to the problem of quality change and disagreement over the nature of bank output; their study
suggests alternative approaches that can be pursued to address this issue. On the one hand, Dos
Santos et a1 (1993) and Strassman (1990) point out that there is insignificant correlation between
IT spending and profitability measures. On the other hand, Lichtenberg (1995) and Brynjolfsson
and Hitt (1996) (having worked with fm level data) identified significant contributions from IT
towards productivity. The latest example of this trend in research is the study conducted by
Brynjolfsson and Hitt (2003) who examined the effect of computerization on productivity and
output growth using data from 527 large US firms over the period 1987-1994. They concluded
that computerization's contribution to measured productivity and output growth in the short term
(comparing one year differences) is consistent with normal returns to computer investments.
However, the productivity and output contributions associated with computerization proved to be
up to five times greater over longer periods (comparing five to seven year differences).
Lichtenberg (1995) concludes that there are substantial excess returns due to investment in
computer capital and that one IS employee is equivalent to six non-IS employees in terms of
marginal productivity. Brynjollfsson and Hitt (1996) believe that investments in computer capital
produce an 81 percent marginal increase in output. In contrast, non-IT capital contributes only 6
percent. Nicolas (2001) states that IT capital accounts for 23 to 39 percent of the growth in labor
productivity between 1989 and 1998. There seems to be a general agreement that a large part of
the increase in U.S. labor productivity that occurred in the second half of the 1990s can be
accounted for by IT investment (Bassanini et al, 2000). Bosworth and Triplett (2000), Gordon
(2000), Jorgenson and Stiroh (2000), as well as Oliner and Sichel(2002) c o n f i that investment
in IT, in turn,was driven by the rapid decline in computer prices during the same period (Tevlin
and Whelan, 2002). This fall in computer prices has been mainly due to rapid and accelerating
technical progress in semiconductors (Jorgenson (2000), Jorgenson and Stiroh (2000), Oliner and
Sichel(2000)).
Kwan (2002) compares bank operating costs across seven Asian economies. The results suggest
that systematic differences exist in bank operating efficiency across these countries. Furthermore,
significant differences in labor cost share are detected across these Asian countries, suggesting
that different countries have different bank production functions.
The evaluation of IS/IT investments requires multi-dimensional measures as outcomes are a

complex tangle of financial, organizational, social, procedural and technical threads, many of
which are currently either avoided or addressed ineffectively (Cronk and Fitzgerald (2002)
Mirtidis and Serafeimidis (1994). In summary, comparing the results of many studies indicates
that the relationship between ISIIT investment spending and benefits is still vague and
confounded with methodological problems and the impact of intervening variables (Grover et al.,
1998b).
Most studies relating to the contribution of IT to firm level productivity are restricted to the
manufacturing industry; owing possibly to a lack of data in the service industry at the firm level
and perhaps, more significantly, to the ambiguous definition of the term "output" in relation to
the service industry. The latter problem is particularly persistent in the banking industry, which is
the focus of this study.

The paradox of IT impact on productivity and profitability can be partially interpreted as the
outcome of insufficient and incomplete analysis of the elements of IT spending, namely IT-
capital and IS-labor. In addition, the database analyses, whether on a short or long term basis and
whether on the firm or industry level, have also contributed to the variations in the conclusions of
the studies mentioned above. Yet, none of those typical studies, to the best of my knowledge, was
conducted in developing countries. This gives this study further justification.
One theory of production economics indicates that, in the long run, average total cost will have an
inverse relationship with technological progress. This theory implies a positive relationship
between productivity and technology. However, the impact of technological progress on
productivity is more likely to be more hlly realized in developed countries than in developing
ones. This is due to the fact that optimum utilization of available resources, including technology,
in production processes, is much more likely to take place in developed countries rather than in
developing ones. Nevertheless, this is not necessarily true in all cases.
RESEARCH OBJECTIVES
Due to the impact of IT on the efficiency, security and risks of the financial system, this paper
focuses on the following objectives:
1- Determining the measurements of productivity and profitability for the Arab bank.
2- Exploring the nature of the relationship that exists between IT investment and IS labor
expenses, as well as the level of productivity and profitability in the Arab Bank.
3- Examining the contribution of IT capital and IS-labor expenses towards productivity and
profitability in the Arab Bank.
The Problem
Inefficient and incomplete use of the IS-labor and IT-capital available in the banking sector in
Jordan may have contributed to widening the gap between the interest paid and the interest
received by Jordanian banks. Such a phenomenon justifies exploring the impact of IT-capital and
IS-labor on productivity and profitability in the case under consideration. Furthermore, exploring
this relationship is critical because the financial services industry is traditionally a major user of
IT and IT can dramatically affect the way financial services are delivered.
Arab Bank Profile
The Arab Bank is owned by approximately 3.300 shareholders from all Arab countries. It was
established in 1930 with a paid-up capital equal to USD 75,000. By the end of December 2004,
the Group's equity was more than USD 3250 million, and with total assets of USD 27.3 billion.
Currently, the Arab Bank Group has a worldwide and diversified network of more than 400
branches. The Arab Bank is one of the principal financial institutions in the Arab World and
ranks among the leading international banks in terms of equity, earnings and assets. The Bank
provides a wide variety of financial services to individuals, corporate and institutional customers,

government agencies, and other international financial institutions. These services include.retail
banking, private banking, trade financing, merchant banking, commercial real estate lending, and
international banking. The Arab Bank Group employs a prudent asset management policy which
is centered on selecting a prime loan portfolio while maintaining, at the same time, high liquidity.
On December 3 1,2004, its liquidity ratio (cash and quasi-cash to total assets) amounted to 53%.
By the end of December 2004, the Arab Bank Group's equity amounted to 12% of total assets.
The capital adequacy ratio for the Group, measured according to the Basle Committee Rule, was
around 21%. Moreover, total equity corresponded to more than 28% of the loan portfolio, thus
placing the bank in a very sound financial position.
Most of the Group's external sources of funds are composed of stable customers' deposits which
give the Group ample room to manage its assets efficiently and reflect the customers'
longstanding confidence and loyalty. Total deposits at the end of December 2004 reached USD
19.3 billion.
The Arab Bank's IT System was designed to address business challenges so that the bank can
prosper in an increasingly competitive market. While the challenges of any modem banking are
significant, the design and modularity of the system protect the bank's initial investment by
allowing the system to expand and adapt as requirements change.
The system is an in-built one using component business object techniques that provide support for
common core banking hnctions, such as:
Customer relationship management
Limits and exposures
Collateral management
Marketing notification and response
Deposit processing
Loans processing
Contingent account processing
Cash accounting
Electronic funds transfer (EFT) switch management
Debt collection
Remittance reconciliation
Correspondence management
Capacity expansion can be undertaken quickly without disruption to the system's operation, and
most importantly, without need for software modification. Following are the key benefits the
system provides:
Continuous Operation-Full functionality and data, as well as 24-hour real-time

updates which provide a consistent view of customer's position. This solution eliminates
the possibility of loss by the bank due to the use of separate stand-in databases.
Customer-centric-A 111 picture of a customer's relationship with the bank and other
customers can be gained from a single inquiry, providing the ability to hone in on specific
account details. This enhances the customer's view of the bank, the bank's view of the
customer's relationship, and allows improved customer services and selling of additional
value-added services.
High Performance--The system has been benchmarked at transaction rates well in
excess of the requirements of similar banks. This gives the bank the comfort of knowing
that its increased transaction and growth rates will not be limited by the system choice.
Highly Flexibility Through the Use of Parameter-profiling Tables-The system is a
highly parameterized one. The contents of the front-end delivery channels (the user
interfaces) are defined by these parameters, not by actual code. This parameterization
enables front-end delivery channels to be created and implemented quickly-even

overnight. Parameterization allows new products to be built and new fees and charges to
be implemented without adding any code. This greatly improves the time-to-market in
comparison with traditional time-consuming requirements associated with implementing
new features.
Delivery Channel AdaptableThe system is a message-based system. The business
code is independent of the front-end delivery, channel-such as automated teller
machines (ATMs), electronic h d transfers (EFTS), and point of sale (POS) devices-so
that new channels can be implemented rapidly.
For enhanced functionality, the system delivers application-programming interfaces that enable
integration to the corporate general ledger portions and other banking products. Other related
products can also be integrated easily such as the treasury as well as domestic and international
payments, Internet banking system, and branch automation system. Furthermore, the system has
been primarily developed to support external users (retail and business customers) and internal
users (bank employees, business managers and information suppliers).
The bank has also introduced optics-based electronic filing and signature verification systems, a
global communications network, membership in several international interbank payment systems,
and a globally coordinated money market management system that brings together the bank's
dealing rooms in Amman, London, Singapore, New York, Manama, Paris and Sydney.
RESEARCH MODEL AND HYPOTHESES
The research questions being investigated in this paper are:
1- Is there a significant relationship between IT, on the one hand, and productivity and
profitability on the other?
2- Does IT investment make a positive contribution to the productivity of banks?
3- Does IT investment make a positive contribution to the profitability of banks?
Research Model
The production function framework has been widely used in the study of IT impact on
productivity and profitability (Parsons et al. (1993), Loveman (1994), Lichtenberg (1995),
Brynjolfsson and Hitt (1996), Prasad and Harker (1997)). In the absence of measurements of the
actual benefits associated with IT, it is not possible to perform cost-benefit analyses of IT
investment and thus, production functions which relate IT spending to overall productivity or
output measures are seen as the best alternative (Parsons et al., 1993). Production function
techniques have proved to be valid and quite successful in hundreds of empirical studies. The
chosen form of production function must conform with the conditions required by economic
theory, such as Monotonicity and quasi-concavity. The Cobb-Douglas finction satisfies such
conditions as its efficiency has been proven for almost a century, and as it has been used by most
of the studies mentioned in the previous sections of this paper. Thus, our study models banks as
operating according to the following form:
Log Q = Bo+BIlogC + B2 Log K + B3 Log S+B4 Log L

Where Q = output of the firm

C = IT capital
K = Non - IT capital
S = IS labor expenses
L = non - IS labor expenses
B1,B2,B3and B4are the associated output elasticities. Different issues may be addressed with
production function approaches, such as the impact of IT on productivity and profitability.
Hypotheses:
The following hypotheses address the research questions asked above:
Hla: B1>O,B3>0, versus the null hypotheses that B1 = B3 = 0;
The marginal product of IT capital and IS labor is positive, implying that investment in IT
improves productivity or profitability.
Hlb: BI (output/IT capital)-cost of IT capital >O

B3 (output/IT labor )-cost of IT labor >O
Hlb allows us to verify that the impact of IT investment is not just positive; rather, IT investment
returns are higher than expenditure. As this study aims at estimating whether there are net returns
(net returns = gross returns - cost) associated with IT or not, this particular test is more valid than
Hla which only tests for the gross returns..
RESEARCH METHODOLOGY
The paper employs the Cobb-Douglas production function discussed above for the analysis of IT
impact on productivity and profitability using the hypotheses articulated above.
Output of Banks for a Production Function Analysis
In banking literature, there exists a considerable disagreement with regards to the definition of
output. Measuring output is crucial to estimating productivity. But this measurement is
JZTCA, Volume 8, Number 4, 2006 31
problematic in all industries, due to the problems associated with aggregation and quality. In
addition, bank output presents its own particular set of difficulties. As Kinsella points out (1980),
each bank is a multi-product firm (posing a problem of aggregation of outputs) where many of its
services are joint or interdependent.
The various approaches researchers have chosen to evaluate the output of banks may be classified
into three broad categories: (a) the assets approach (b) the user-cost approach, and (c) the value-
added approach (Berger and Humphrey 1992). The assets approach considers banks to be
"financial intermediaries" between depositors (or those who provide money to the bank) and
borrowers (or those who receive money from the bank). Thus, loans and other assets become
bank outputs, and deposits and other liabilities, that provide the finance which permits banks to
"sell" finance, become bank inputs. The assets approach to determining a bank's output is best
exemplified by Mester (1987), who argues that "output is best measured by the dollar value of
earning assets of the firm, with inputs being labor, capital, and deposits."
However, the drawback in such an approach is that it groups input and output arbitrarily,
choosing what constitutes a bank's output thus laying itself open to debate and questioning by
others. A more significant problem with such an approach is that it is reductionist in its view of a
bank's function, and fails to recognize the services a bank provides to depositors in return for the
finance with which they provide it (Triplett 1992).
The user-cost approach studies the net contribution of each of the financial products to the bank's
revenue. Depending on whether the product adds or detracts from the revenues of the firm, it
becomes an output or an input. If an asset's financial returns are more than its opportunity costs,
it becomes an output, as does a liability whose financial costs are less than its opportunity cost.
Those assets and liabilities that do not satisfy the conditions to become outputs become inputs.
Hancock (1991), for example, employed the user-cost approach in determining that loans are
categorically bank outputs, whereas deposits present an ambiguous picture: time deposits are
inputs, but demand deposits are outputs. As Berger and Humphrey (1992) discuss, there are
several problems with user-cost methods of determining bank outputs. Most significantly, it is
difficult, if not virtually impossible, to measure and unambiguously apportion financial returns
and opportunity costs among the various financial products of a bank.
The value-added approach (or the activity approach as it is sometimes called) studies all assets
and liabilities as having some output characteristics without grouping them into exclusive input or
output categories. Benston, Hanweck and Humphrey (1982) posit that " output should be
measured in terms of what banks do that cause operating expenses to be incurred." Following
this line of thought, Berger and Humphrey (1992) argue that the value-added for each financial
measure of the bank should be determined on the basis of operating costs, and those that have
"significant" value-added should be considered the outputs of the bank.
This paper adopts output for productivity based on total loans and deposits as well as net income
taking as a model several studies which have used the same approach; in such studies deposits
and loans are considered outputs. The researcher also uses two measures of output for
productivity and two others for profitability. For the productivity analysis, the researcher first
uses the sum of total loans and total deposits to measure output. The analysis is then repeated
with the net income of the bank as the output measure. Thus, it is clear that a hybrid approach is
used in the analysis, not only to overcome the problems associated with the abovementioned
approaches, but also to coincide with the nature and type of available data.
Productivity of Banks
A bank's productivity is largely dependent on efficient scales as well as its ability to focus mainly
on efficiency in the use of inputs-allocative and technical efficiency. An essential background for
the study of productivity is the assessment of conceptual issues relating to banking output. The
following methodological issue is predominant in the analysis of productivity: Should partial or

total productivity be measured? If the latter is to be measured, should this be done by parametric
or non-parametric methods?
Partial productivity ratios which relate output to one type of input only, such as output per man-
hour, are often used as proxies for total productivity. In this respect, a number of studies have
argued that u s e l l insight into bank productivity can be gained by considering accounting ratios
such as asset size and operating revenue per employee. Fanning (1981) found that although on
such measures the productivity of the U.K. clearing banks in the early 1980s improved, it
nevertheless remained inferior to international competition, suggesting that over-manning existed
in U.K. banking. Other partial studies have focused on the relative productivity of the banking
industry in relation to other sections of the economy.
Total Factor Productivity (TFP) is a generalization of the partial factor productivity (PFP) ratio.
It extends the concept of PFP by embracing multiple outputs and multiple inputs in a single
productivity ratio. The central issue in (TFP) measurement relates to the methodology adopted to
estimate the weights used to combine inputs and outputs. The advantage of (TFP) over (PFP) is
that it enables consistent productivity comparisons to be made across the range of the banks'
outputs and inputs.
Profitability of Banks
Profitability studies attempt to ascertain whether the deployment of IT provides any competitive
advantages for the firm. Therefore, profitability-oriented studies are concerned with determining
the contribution of IT investments to firm profits or stock market value.
Several researchers of competitive strategy have shown how the competitive environment in
which the firm operates has a significant effect on its returns from IT investment. Porter (1980)
for example, posits that in a free entry competitive market, firms cannot gain sustainable
competitive advantages from technologies that are available to every firm. It is only when a
technology creates significant barriers to entry that it becomes profitable for investors. From this
point of view, IT freely available to all firms does not really provide any sustainable competitive
advantage to the firm, and in such an environment, IT investment becomes more of a "strategic
necessity" rather than a provider of competitive advantage (Clemons 1991). Thus, the firm's
investment in IT should by no means be associated with supra normal profit.
For profitability analysis, the researcher employs two measures that banks commonly use as
indicators of profitability: Return on Assets (ROA) and Return on Equity (ROE).
Source of Data
The data for this study were obtained from the Arab Bank annual reports spanning the period
(1985-2004) and from fieldwork conducted as part of a major study of the bank. This project aims
at collecting extensive data relating to operations management, human resources management,
work practices, and a detailed survey of technology. The researcher has designed questionnaires
for the "most informed respondent" (Huber and Power, 1985) in the bank covering a number of
areas as mentioned above.

RESULTS
In this study, the researcher tests the hypotheses mentioned previously by using two measures of
output for productivity (Loans and Deposits, and Net Income) and two others for profitability
(ROA & ROE).
Productivity Contribution of IT
The summary of statistics in Table 1 shows that the bank in our case has an average of
($14499.979) million in terms of loans and deposits and ($101.5466) million in terms of
generated revenues. Table 1 also shows the average investment in IT and non-IT capital and
labor, as they are illustrated in the bar charts in Appendix(2). These charts indicate that the rate
of change in IS-expenses is greater than that of IT-expenses, and that there is a pronounced and
positive change in productivity measures (Loans & Deposit and net profit) relative to that of
profitability measures (ROA & ROE).
Table 1: Summarv Statistics
I Dependent Variable: Output Measures I

Avg.-Loans & Avg.
Avg. Revenues (Net Income) Avg. ROA
Deposits ROE
I Independent Variables (Inputs)

I Avg.
Avg. IT capital Avg. IS labor Avg. Non-IT capital Non-IS
labor
$
$ 14.985 $87.15143 M. $ 68.46 M. 15.0914
M.
Test of Hwotheses When Output=Loans and Deposits
Table 2 shows the statistical estimates of loans and deposits production function to be as follows:
Hla: B1>O, Bz>O
Table 2: Output = (Total Loans + Total Deposits)

t-statistic: Ratio to Marginal
Parameter Coefficient t-statistics
Significance Output Product
B, IT capital 6022 0.915 62% 0.001033 401.868
B3 Non-IT capital 1531.884 0.603 54% 0.0047 22.3766

B2 IS-Labor expenses 4004.695 1.027 68% 0.006 1 45.949
I I
B4
Non-IS labor
expenses
1 -5504.586 1 -1.77 1 74% 1 0.00104 ( -364.749 1
It also shows that the coefficients associated with IT capital and IS - labor are positive. However,
a fairly good significance level associated with both coefficients (B1,B2) implies that there are
fairly low probabilities of 38% and 32% respectively, and that both coefficients are zero. Thus,
we are able to establish evidence to support Hypothesis Hla for IT capital and IS - labor. That is
to say IT capital and IS labor produce positive returns in productivities. However, it is
interesting to note that the coefficient of non-IS labor is definitely negative. This implies that IS
labor has relatively better returns than non-IS labor. At the same time, the results show that we
cannot reject Hla for IT capital and IS labor. Since the marginal product of IT capital ($401.868)
is greater than that of IS labor ($45.949), we can safely conclude that IT capital is associated with
a higher increase in the output of the bank than that of IS labor.
Hlb: From Table 2 it is evident that the marginal product for IT capital is very high ($401.868).
Since every dollar of IT capital costs a dollar, the excess returns from IT capital can be computed
as ($ 401.686-I), or $400.868. Thus Hlb cannot be rejected for IT capital. We restrict our
discussion on IT capital because IS labor is associated with negative marginal product as is
demonstrated in Table 3.
Table 3: Output = Net Income of the Bank

t-statistic: Ratio to
Parameter Coefficient t-statistics Marginal Product
Si nificance Ou
B1 IT capital 108.595 1.755 90% 0.14756 7.25
B3 Non-IT capital 4.97 0.208 18% 0.6747 0.073

B2 IS-Labor expenses - 1.492 -0.04 4% 0.858 -0.0 172
Non-IS labor 0.1486 -4.3285
B4 -65.324 -1.486 84%
expenses
R' = 0.90
35
Test of Hvpotheses When Output=Net Income
Hla: It is clear that the coefficients associated with both types of labor expenses (IS and non IS-
labor) are negative, while those associated with IT capital variables are positive. This is perhaps
reflective of the banking industry where the emphasis on computers implies that IT-Capital is a
more worthwhile investment than that of labor. Given that the results imply negative productivity
with the investment in labor, we have no alternative but to reject Hla and conclude that IS labor
investment influences productivity negatively. Hla cannot be rejected for IT-capital since the
marginal product of IT-capital is $7.25. Thus, IT capital when analyzed with the net income of
the bank as the output measure, is associated with increase in the output of the bank.
Hlb: The rejection of hypothesis Hla for IS-labor means that we can reject the stronger
hypotheses Hlb for IS-labor. There can be no "excess benefits" as there are no benefits derived
from IS-labor investment. For IT-capital, the marginal product is $7.25, that is, with every dollar
invested in IT-capital, there is an increase in the output 'net income' of $7.25. The excess returns
fiom IT-capital is $17.25 - 1 or $6.25. Thus, Hlb, cannot be rejected for IT-capital.
Issue of Multicollinearitv
In the estimation of a Cobb-Douglas production hnction, it is usual to expect a relatively high

correlation between independent variables. In our case, there is the likelihood of high correlation
between IT capital and IS labor investments. As Kennedy (1985) notes, "the existence of
multicollinearity in a data set does not necessarily mean that the coefficient estimates in which
the researcher is interested have unacceptably high variances. The classical example of this is the
estimation. It is due to the Cobb-Douglas production function: The input of capital and labor are
highly collinear, but none the less, good estimates are obtained." The t-statistics we obtained for
IS-labor imply that IS-labor is not a significant variable in the regression, with its estimated
coefficient tending to zero. This result is not due to collinearity problems, but rather is a result of
the estimation brought about by the low correlation between IT capital and IS labor investments
throughout the period covering the data of this research (r = 0.273).
Profitability contribution of IT - Capital and IS Labor
In this analysis, the researcher employs two measures that banks commonly use as indicators of
profitability: Return on Assets (ROA) and Return on Equity (ROE). To use the definition
provided in the annual reports of the bank, ROA is the "net income as a percentage of total assets
..... indicating how well the bank has used its assets," while ROE is the net income as a
percentage of total share holders' equity.... measuring how well a bank's equity has been
employed." The key fmdings from the estimation are reported in Tables 4 and 5. Generally
speaking, the t-statistics and marginal product from the analysis of the profitability measures are
very low. The easy availability of IT to all banks implies that IT investments do not provide any
competitive advantage.
Table 4: Outout = Return on Assets (ROAI

t-statistic: Marginal
Significance Product
B, IT capital 0.743 3.075 99% 0.04958
B3 Non-IT capital -0.071 85 -0.77 55% -0.001 049

Bz IS-Labor expenses -0.321 -2.242 94% -0.003683

B4 Non-IS labor expenses 0.158 0.922 43% 0.010469
R' = 0.65
Table 5: Output = Return on Equity (ROE)

t-statistic:
Significance
B* I IT capital 1 -14.422 1 -0.987 ( 66%
B3 I Non-IT capital 1 3.640 1 0.645 ( 47%
BZ IS-Labor expenses 6.248 0.722 52%

. .
..
B4 Non-IS labor expenses " " 0.446 0.043 4%
R' = 0.40
In other words, since there is no '%anier to entry" in terms of IT in the retail banking industry, a
bank's investment in IT does not stand to gain additional market share as a result of this
investment. In fact, by not investing in IT and by foregoing the gains provided by it, a bank may,
on the other hand, lose market share (Clemons 1991). Thus, in this competitive environment of
retail banking, neither IT capital nor IS labor investments should make any significant impact on
the bank's profitability. In brief, one may conclude: IT investments has insignificant effect on
bank profitability.
DISCUSSION OF ECONOMETRIC RESULTS
It is remarkable that IS labor makes zero and even perhaps slightly negative contribution to
I
productivity. This result is in conformity with conclusions reached by previous studies in the
manufacturing sector (Lichtenberg 1995, Brynjolfsson and Hitt 1996), and seems significantly
different fiom those obtained in Parsons (1993) and Baba Prasad et a1 (1997). IT capital presents
37
a different picture. With total loans and deposits and with net income as output measures, IT
capital proves to be a significant contributor to output. Its marginal product is at least 10 times
those of non-IT capital in cases of loans and deposits as well as net income. It is interesting to
compare the marginal product of IT capital as opposed to IS labor. At the same time, it is worth
noting that while IT capital contributes significantly to productivity increases, IS labor does not.
Thus, these results attest to the fact that while the bank in our study may have over-invested in IS
labor (over staffed) with unqualified employees, there is significant benefit in rational hiring and
increasing investment in IT capital.
A graphical representation has also been done; appendix (1): (figures A, B, C and D) ensures not
only the nonlinearity of these relations, but also its nature (change in the dependent variable due
to the change in the independent variables). If anything, those coincided, more or less, with the
above explanations.
Further investigation has been done on the above mentioned relations via the re-conduction of the
analysis using the lagged model, due to the fact that implicit and explicit knowledge and IT
capital and IS labor respectively, have an accumulated effect which can be expressed into a
lagged form, as is shown in Tables 6&7. No major differences are revealed that can be
compared to the previously used Model (un lagged), specifically, in terms of the insignificance of
IS-labor impact on the productivity and profitability of the bank. Moreover, the analysis, using
lagged model, highlights the negative signs of IS labor in the dependent variables which implies
that IS labor has been overly used.
Table 6: Summary of Results Lagged Model
Y,:Output: Loans & Deposits Y2:Output: Net income

t-statistic:
Independent t-statistic:
Coefficient 4 significanc Coefficient
Variable significance
e
IT-capital 406.275 2.37 93% 5.07 2.29 92%
Non- IT capital 30.288 *1.65 71% -0.068 -0.284 19%
IS-labor -29.503 -0.4 13 38% -0.185 -0.20 1 17%

Non IS -labor 111.543 * 1.73 88% 0.617 0.589 45%
R2: 0.996 z2 :0.987
* significant at level of 0.05.

However, this analysis reveals some contradictions with unlagged models, especially in relation
to the fact that IT investment has a significant impact on bank profitability which explains the
accumulated effect of knowledge and experience acquired throughout time.
Table 7:
Yj: Output: ROA Y4: Output: ROE

Independent Coefficient t t-statistic: coefficient t t-statistic:
Variable significance significanc
e
IT-capital 0.075 2.4 94% 0.008 *1.8 92%
Non- IT capital 0.004 * 1.29 82% 0.001 2.09 90%

IS-labor -0.049 -3.8 99% -0.008 -4.88 99%

Non IS -labor 0.038 2.64 95% 0.006 3.388 99%
R2: 0.971 E2:0.969
* significant at level of 0.05
CONCLUSION AND RECOMMENDATIONS

This paper sheds light on the importance of IT capital in the overall productivity and profitability
of the case under consideration, the Arab Bank. Also, it shows the insignificant impact of IS labor
on the productivity and profitability of the bank. This can be explained by the ratio of investment
in IS labor to IT capital 15.8% (Table I), which implies that the bank has over-invested in IS
labor and greatly under-invested in IT capital. These findings stand in contrast with those of
Prasad and Harker (1997), but coincides with some other previously mentioned studies. The
paper also proves that IT investment has an insignificant effect on bank profitability; however,
the Lagged Model shows the opposite in this respect.
Despite these conclusions, it will be a long time before economists can make an objective
assessment of IT impact on both the stability and efficiency of the financial system. It is
necessary to explore the above conclusion by looking at the bank's management practices in IS
and IT capital in order to be able to answer the question of whether or not the increase in IT
capital would contribute positively to the productivity and profitability of the bank.-In brief, it
would be too early to confirm any of those results, as further investigation on a large number of
cases should be done and results thereof should be taken into consideration.
Typically, in the Cobb-Douglas model, there is a substitution between inputs. However, in the
case of IS-labor and IT-capital, one would expect a complementary relation at the early stage of
production (operation), followed by the emergence of a substitution between inputs as is shown
in the statistical parameters. The evolutionary system (invention & innovation) in the IT industry
may change the typical shape of the production hnction which depends on the nature, state of the
art and the objectives of the production process undertaken by the firm, especially when
environmental and welfare issues are emerging.
IS labor will continue to be the leading element in any production system, no matter how high the
substitutability of IT-capital for IS-labor. A great deal of craft can be provided, but the vision of
human beings cannot be given. IT-capita1 is a means in itseIf but IS-labor is the architect.
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Dr. Ahmad Mashal is an Assistant Professor of Business Administration at the Arab Open
UniversityIJordan Branch. Dr. Mashal obtained his Doctoral Degree in Economics from the
University of IllinoisNSA in 1988, his Master's Degree in Economics from DePaul
UniversityNSA in 1984. His field of concentration is Economic Analysis. Before joining the
Arab Open University in 2002, Dr. Mashal served as Assistant Professor of Economics and
Administrative Sciences at Al-Zaytoonah UniversityIJordan from 2000 -2002. Duirng 1989 -
2000, he held several posts at the Arab Bank Plc including Acting Manager: Research and
Financial Planning Department; Deputy Manager: Reengineering Team; Deputy Manager: Credit
Facilities Division; and Editor of the "Analytical Bulletin." At the University of IllinoisIChicago,
he was Lecturer in its Department of Economics from 1988-1989. He taught several courses in
Management and Economics and has more than (40) Research papers published in the Arab Bank
Quarterly Economic and Financial Publication "Analytical Bulletin". He has recently published a
book entitled, "Econometrics and Analytical Economy: Theory and Application."
Appendix (1)
Figures, A, B, C and D, show the relation of each of productivity measures (YI:
LoanstkDeposits) (Yz: Net Income) and profitability measures (Y3: ROA, Y4: ROE) with
XI, X2, XI and a; IT capital, non IT capital, IS-labor, and non IS-labor respectively.
fl
r2
-B-

-D-
.
l
,
a m U
, I ~
,
am,
,
m m
,
Imm
Appendix (2)
Deposits+ Credits Net Frofit
250
200
150
100
50
0
Net RofitlEquity
Net RofitlAssets
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0

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This article was downloaded by: ["Queen's University Libraries, Kingston"]

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Journal of Information Technology Case

Impact of Information Technology

To link to this article: http://dx.doi.org/10.1080/15228053.2006.10856099

PLEASE SCROLL DOWN FOR ARTICLE

Impact of Information Technology Investment on

Keywords: Impact, Information Technology Investment, Productivity, Profitability, Leading

The evaluation of IS/IT investments requires multi-dimensional measures as outcomes are a

JITCA, Volume 8, Number 4, 2006 27

JITCA, Volume 8, Number 4, 2006 28

Continuous Operation-Full functionality and data, as well as 24-hour real-time

enables front-end delivery channels to be created and implemented quickly-even

The research questions being investigated in this paper are:

Log Q = Bo+BIlogC + B2 Log K + B3 Log S+B4 Log L

Where Q = output of the firm

The following hypotheses address the research questions asked above:

Hla: B1>O,B3>0, versus the null hypotheses that B1 = B3 = 0;

Hlb: BI (output/IT capital)-cost of IT capital >O

Output of Banks for a Production Function Analysis

following methodological issue is predominant in the analysis of productivity: Should partial or

areas as mentioned above.

Table 1: Summarv Statistics

I Dependent Variable: Output Measures I

I Independent Variables (Inputs)

Table 2: Output = (Total Loans + Total Deposits)

B3 Non-IT capital 1531.884 0.603 54% 0.0047 22.3766

Table 3: Output = Net Income of the Bank

B3 Non-IT capital 4.97 0.208 18% 0.6747 0.073

Test of Hvpotheses When Output=Net Income

In the estimation of a Cobb-Douglas production hnction, it is usual to expect a relatively high

Table 4: Outout = Return on Assets (ROAI

B3 Non-IT capital -0.071 85 -0.77 55% -0.001 049

Bz IS-Labor expenses -0.321 -2.242 94% -0.003683

Table 5: Output = Return on Equity (ROE)

B3 I Non-IT capital 1 3.640 1 0.645 ( 47%

BZ IS-Labor expenses 6.248 0.722 52%

Table 6: Summary of Results Lagged Model

Y,:Output: Loans & Deposits Y2:Output: Net income

Non- IT capital 30.288 *1.65 71% -0.068 -0.284 19%

IS-labor -29.503 -0.4 13 38% -0.185 -0.20 1 17%

* significant at level of 0.05.

Yj: Output: ROA Y4: Output: ROE

Non- IT capital 0.004 * 1.29 82% 0.001 2.09 90%

IS-labor -0.049 -3.8 99% -0.008 -4.88 99%

* significant at level of 0.05

CONCLUSION AND RECOMMENDATIONS

Impact of IT Investment on Productivity and Profitability

Deposits+ Credits Net Frofit

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