Information & Management 42 (2005) 781–787
www.elsevier.com/locate/dsw
Does information technology provide banks with profit?
Wesley Shu a,*, Paul A. Strassmann b
a
Department of Information and Decision Systems, San Diego State University, San Diego, CA 92182-8234, USA
b
Strassmann Inc., New Canaan, CT, USA
Accepted 13 June 2003
Available online 19 February 2005
Abstract
While many studies have affirmed the contributions of information technology (IT) to business value, people are not
convinced. So far IT in the service industry has not yet been seen to be more productive. The data in most previous studies either
focus on specific industries or exclude financial industry data. As such, the need to do an analysis on IT productivity in the
service industry is imminent. We chose 12 banks covering 9 years for our analysis. To eliminate possible estimation errors, we
applied an analysis for panel data—a random effect model. We found IT investment demonstrated the highest marginal product
among the input factors we chose.
# 2005 Elsevier B.V. All rights reserved.
Keywords: Productivity; Panel data; Information technology; Banking
1. Introduction
Information systems (IS) or information technology (IT) productivity has always been a concern in
academia and industry. The Bureau of Labor Statistics
and National Income and Product Account have
shown that IT investment has increased to 25 times
what it was 30 years ago. During the same period,
labor productivity did not increase. The labor
productivity growth rate declined from its high of
2.68%/year in 1960s to a low of 1.03% in the early
1990s. This phenomenon has been labeled the ‘‘IT
* Corresponding author. Tel.: +1 619 594 0207;
fax: +1 619 594 3675.
E-mail address: wesley.shu@sdsu.edu (W. Shu).
productivity paradox.’’ Nobel Laureate Solow’s
famous saying succinctly pictured this paradox:
‘‘you can see the computer age everywhere but not
in the productivity statistics.’’ [24] Some studies
[4,5,19–21] also reported non-significant or negative
IT contributions to business value. The absence of any
positive correlation between profitability of firms and
IT spending has been demonstrated by Strassmann,
based on his consulting practice for 40 corporate cases
[25], as well as for 292 corporate cases [26] and again
for 486 corporate cases [27].
On the other hand, some research [6–8,18,23,29]
found very positive IT contributions. After observing
many studies showing positive IT contributions to
business value, Bakos raised another question, ‘‘how
can computers be so productive?’’ [1] However, by
0378-7206/$ – see front matter # 2005 Elsevier B.V. All rights reserved.
doi:10.1016/j.im.2003.06.007
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W. Shu, P.A. Strassmann / Information & Management 42 (2005) 781–787
using the same data set as the above five studies, Lee
and Shu could not find significant IT contributions
either. They also showed that difference in methodology could lead to a significant difference in research
outcome [30] and also reported mixed results for
newly industrialized economies.
While much research has been performed in the
firm or at the macroeconomic levels, we have not
seen many scholarly articles that analyze a specific
industry. While some previous studies analyzed IT
productivity in the manufacturing industry using data
from the 1980s, this paper is focused on the banking
industry using more recent data. In addition, our data
came from a pooled data set, which contains both
cross-section and time series data. Traditional
ordinary least square (OLS) analysis suffers from a
variety of statistical problems and does not produce
satisfactory results; therefore some analysis tools for
panel data, which can avoid these statistical problems,
were used.
We have seen some studies of the productivity of
capital, but little has been done to communicate the
productivity of corporate information-creating and consuming resources in ways that is useful to business
executives in assessing, planning and budgeting. Thus,
we resorted to IT budget information from CIOs to
calculate IT capital.
reliability of such a data set is still questionable
because it used mail-in questionnaires or telephone
surveys which are either incomplete or from interpretations that deal more with the views of the
respondents than the facts. The respondents are
usually administrators at the non-supervisory level.
We chose the banking industry because it is part of
the service industry that has been suspected of having
one of the lowest IT productivity. When Hitt and
Brynjolfsson claimed that the IT productivity paradox
was gone in their 1993 paper [12], many still believed
that the service industry did not truly escape from this
paradox. Ives [16] describes the argument as, ‘‘much
of the hoopla surrounding the productivity paradox
has centered on the high growth service industry.’’ Hitt
and Bryjolfsson estimated IT had 81% gross marginal
product (increase in dollar output per dollar of capital
stock while the relative importance of computer
capital assets was declining as a share of IT budgets)
for their 1987–1991 data. The service industry still had
only 0.7% productivity growth on average, far lower
than the manufacturing industry average. Such a
difference stirs our interest in knowing the cause. We
are also interested to learn if such a suspicion is
supported by empirical evidence and if recent data still
demonstrate this paradox. Thus, the objective of this
paper was to critically analyze the banking industry
with more recent data and employ a model that fits
better into the panel data that will be used.
2. IT and banking industry
Even though IT has become an omnipresent term in
today’s business world, its definition is not clear. The
U.S. Department of Commerce’s Bureau of Economic
Analysis (BEA) has a category called ‘‘ producers’
durable equipment—information processing equipment.’’ It includes office, computing and accounting
machinery, computers and peripheral equipment,
instruments, photocopy, and related equipment. However, the BEA does not include corporate operating
expenses associated with IT budgets, such as the costs
of administrators, systems planners, consultants, and
equipment operators in a broader category.
Using government data, such discrepancies make
IT productivity analysis unreliable. Thus, researchers
have used other sets of IT spending data, for example,
the data came from the International Data Group
(IGD) survey on about 300 companies. But, the
3. Description of the data
Knowing the data source is necessary when
assessing the reliability of the data used in IT
productivity or profitability analysis. In our study,
we use a proprietary data set obtained from 12 U.S.
banks. The general financial data are taken from the
Worldscope Global Researcher Database [9], which
summarizes data filed with the Security Exchange
Commission in a standardized format.
The IT data were obtained directly from the
banking CIOs in connection with consulting services
that analyzed their IT productivity. As IT spending, we
employed the IT budgets of a bank’s central
organizations as a reasonable approximation, because
such data are not made public. Our data have higher
reliability than that simply obtained from telephone or
W. Shu, P.A. Strassmann / Information & Management 42 (2005) 781–787
mail-in surveys. Since the banks provided IT budget
data for the practical purpose of understanding their
productivity, this information must be a good proxy to
IT spending from the banks’ own point of view. It is
important, however, to note that this approach is not
likely to suit most U.S. industrial corporations, where
an increasing share of IT spending is absorbed as
operating overhead expenses. In the banking industry,
the concentration of IT spending under corporate
management assures that there is a full accounting for
all IT costs. In our case, we used the reported IT
budget data and filled missing time series with
imputed values. The imputation is based on a
relationship between each bank’s IT budget and its
non-interest expenses that represent the informationhandling overhead’s costs.
Our data cover most of the largest banks in the U.S.,
including Bank One, Bank of America, Bank of
Boston, Bankers Trust, Chase Manhattan, First
Chicago, First Union, Fleet Financial, Keycorp,
Morgan (J.P.) PNC, and Wells Fargo. The data
spanned from 1989 to 1997 for each bank—a typical
panel data set. Compared to previous studies, this data
set is more up-to-date, reflecting recent conditions.
Furthermore, since the data cover the 1990s, the
statistical result provides an interesting comparison to
the results from data of the 1980s.
Our input vector contains the IT budget, noninterest expenses, interest expenses, staff costs, and
other operating expenses. Except for interest
expenses, our input variables are IT and information
management related. The reliance on non-interest
expenses and other operating expenses is an indication
of information management costs (e.g., overhead),
which warrants particular attention in connection with
our findings. It was noted by [28], that assessments of
IT effectiveness must always start with an examination
of the information productivity of industrial corporations. IT costs represent only 3–8% of the costs that a
firm incurs for managing its information resources,
which are represented mostly by the payrolls for
administrative staffs and for purchases of information
services. Before one can evaluate the effectiveness of
IT one must first consider the productivity of the
people who are using the IT. In this view of
productivity, only people (with or without IT) can
be productive because computers, by themselves, are
only inert metal, glass, and plastics.
783
For industrial corporations, the cost of information
resources is conservatively represented by Sales,
General, Administrative and Research & Development expenses (SG&A plus R&D), as reported
according to generally accepted accounting principles.
In the case of banking enterprises, all expenses other
than the costs of interest are, in fact, information
resource costs, because a bank is essentially an
information handling enterprise. Accordingly, we
classify ‘‘interest expense’’ as the equivalent of the
industrial firm’s accounting definition as ‘‘cost of
goods sold’’ and ‘‘non-interest plus other operating
expense’’ as equivalent of SG&A plus R&D.
4. The model and analysis for panel data
Our data set contains both cross-sectional and time
series data ranging from the time period 1989 to 1997.
Such data sets are called panel or longitudinal data. A
simple OLS regression suffers from inefficiency,
multicollinearity, and correlation between the explanatory variables and the error terms1 with the
estimation being biased [14].
In Fig. 1, the oval represents observation points for
a company over time. The dotted line is the regression
of variable I on Y for each company. The straight line
is the OLS regression. The data of each company
shows that variable I has little relation with Y. It is also
evident that the OLS regression overestimates its
relation. It is the companies’ differences (maybe the
size of the companies) represented by the different
height of the three companies, related to Y. Ben-Porath
gave another example [3]. Suppose that a crosssectional sample of married women is found to have
an average yearly labor force participation rate of
50%; at one extreme this might be interpreted as ‘‘each
woman has a 50% chance of being in the labor force in
any given year,’’ while at the other extreme it might
1
Multicollinearity is the relation between two explanatory variables. In mathematical term, it means jxx0 j 6¼ 0. Panel data contain
time series data and multicollinearity becomes possible. Efficiency
is measured by the p-value. Increasing the degrees of freedom
increases the efficiency and panel data has more observations than
pure time series or pure cross-section data and therefore can increase
the degrees of freedom. OLS also assumes the explanatory variables
do not correlate with the error terms. When the relation occurs, the
estimation is biased. Panel data analysis provides means to eliminate
or reduce such a bias.
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W. Shu, P.A. Strassmann / Information & Management 42 (2005) 781–787
Fig. 1. OLS shows biased estimation.
imply that ‘‘50% of the women always work and 50%
never work’’ (Fig. 2).
From this, it is clear that we need to isolate the
company’s specific effect to analyze panel data. To
this end, our model in Cobb–Douglas production
function becomes:
ln Y it ¼ ln a0 þ aI ln I it þ aN ln N it þ aIN ln INit
þ aL ln Lit þ aOE ln OEit þ mi þ nit ;
(1)
A traditional Cobb–Douglas function is
ln Y it ¼ ln a0 þ aI ln I it þ aN ln N it þ aIN ln INit
þ aL ln Lit þ aOE ln OE þ yit :
(2)
Here, the subscript i denotes the banks, and t the time. yit
is the disturbance. I, N, IN, L, and OE represent IT
budget, non-interest expense, interest expense, staff
(labor) cost, and operating expense. The output Y is
defined as the net sales or revenue in the income statement and, therefore, the parameters can give us the
Fig. 2. IT spending as % of compensation shows dependency on
computerization.
estimation of the impact from each input variable on the
sales. We do not use profit because it is the net of
revenue from all investments. The relationship between
a particular input and the profit therefore contains impact
from other inputs. As such, it is difficult to explain the
meaning of the parameters. However, we will see the
marginal product, MPi, derived from the parameters
can still give us the return on investment from input i.
The disturbance in Eq. (1) is separated into two
kinds. nit is the random error. It shows the disturbance
due to the unobservable difference between banks, for
example, company size. This model therefore,
acknowledges and controls the heterogeneity of banks.
There are several methodologies to analyze panel
data. The ‘within’ model assumes that there are
common slopes but that each cross section unit (i.e.,
each bank) has its own intercept (e.g., company size
varies.) The ‘between’ model regresses only the
independent variable-specific difference (e.g., bank
size) on the dependent variable. The random effects
model assumes that the intercepts are drawn from a
common distribution with mean m and variance. The
estimator in the ‘random effects’ model is computed by
estimating the relative importance of between and
within variation of the disturbance mi nit and using
this estimated ratio to combine the within and between
estimators optimally [11]. We use the random effect
model, to measure the output elasticity and marginal
product of input variables of a Cobb–Douglas function.
The Cobb–Douglas production function satisfies some
economic rules. One important rule is the law of
diminishing marginal productivity. It means, for
example, that the first 100 units of I can produce,
say 80 units of Y, but the second 100 units of I can
produce only 70 units of Y. It is clear that a Cobb–
Douglas function can satisfy this property when ai < 1.
Because a production function has to satisfy this basic
economic property, we cannot simply use a linear
regression. This Cobb–Douglas function also satisfies
some other economic properties; for example, the law
of diminishing marginal rate of technical substitution.
However, it is not the purpose of this paper to prove that
it can satisfy most economic properties. We are
concerned with the use of an appropriate analysis for
panel data to the extent that the results will be
statistically unbiased and consistent.
From Eq. (1), we can calculate the output elasticity.
This is used to measure the percentage change of the
W. Shu, P.A. Strassmann / Information & Management 42 (2005) 781–787
output due to one percentage change of an input.
@X i
Therefore, it is defined as ln Y/ln Xi or @Y
Y = X i . We also
know that the parameters aI, aN, aIN, aL, and aOE in
this logarithmic transformed Cobb–Douglas function
are actually the measurements for ln Y/ln Xi, and are
therefore the output elasticity for each input variable.
From the output elasticity, we can calculate the
marginal product from this equation as: MPi = aiY/Xi,
since the marginal product is @Y/@X. The marginal
product is important because it measures how many
units of an output will be increased by increasing one
unit of an input. In our case, if MPi is greater than one,
it is clear that input i on the margin generates positive
profit, and if it is less than one, an additional dollar of
input i does not provide more value than US$ 1.
5. Finding
First, let us compare the estimation between OLS
and random effect model for panel data Table 1. Panel
data analysis shows positive IT productivity illustrates
the results from random effect model while Table 2 is
from OLS.
Although some estimators are significant in Table 2,
the estimation for IT and labor are not satisfactory.
Neither is significant under a 1% confidence interval.
The p-value for labor from OLS is extremely large—
0.784, compared with 0.159 from the random effect
Table 1
Panel data analysis shows positive IT productivity
Variable
Estimate
t-Statistic
Constant*
IT*
Non-interest expense*
Interest expense*
Labor
1.284
0.075
0.249
0.145
0.032
4.069
3.808
5.153
3.326
1.409
Estimate
t-Statistic
1.255
0.048
0.319
0.199
0.007
3.911
2.379
5.826
4.012
0.275
*
p-value 0.01.
Table 2
OLS shows inefficient estimation
Variable
*
Constant
IT*
Non-interest expense*
Interest expense*
Labor
*
p-value 0.01.
785
Table 3
Marginal product shows strong IT contribution
Variable
MP
Average
I
N
IN
L
OE
1.39
0.70
0.33
0.18
0.59
438,848
2,867,017
3,610,242
1,451,163
6,855,850
model. Therefore, a random effect model is super both
in theory and in empirical results when using panel data.
We can calculate the marginal product for each
parameter by the formula MPi = ai(Y/Xi), where ai is
the output elasticity of variable i. The result is found in
Table 3.
It shows that information spending has the highest
marginal product among all the input variables.
Among them, labor stands as the lowest productive
input. Since these two variables are mostly substitutable, the difference between their marginal
products may justify a banks’ decisions to substitute
labor for IT products. Since MP means how much the
dollar value increases in output for an additional
US$ 1 input, we can see that IT is the only variable that
provides more than a dollar return for a dollar expense
on the margin. This would suggest increasing IT
investment. We also see that for each additional dollar
of labor expense, the output value can increase by only
18 cents, so we would suggest cutting labor expenses.
This suggestion is strengthened by the fact that the
average spending on IT is far less than other inputs
(see column Average of Table 3).
This shows a sharp difference from previous IT
productivity reports based on the data of the 1980s.
Even though many studies have shown strong IT
productivity, the paradox cannot be cleared without a
positive result in the service industry. The 1980 data
may not reveal strong IT productivity in the banking
industry but this research, using recent data, shows
that IT is the only variable with positive marginal gain
and its productivity is far better than labor.
6. Conclusion
The purpose of this paper was to try to enhance our
understanding of the IT productivity paradox in the
banking industry. This issue became more important
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W. Shu, P.A. Strassmann / Information & Management 42 (2005) 781–787
in the 1990s when journalists and economists alike
observed a consequence of the so-called ‘New
Economy’ [22]. Articles from Business Week have
provided evidence that the nature of our economy now
is different from before and one of the fundamental
drives is IT. Shepard stated, ‘‘. . . information
technology accounts for a quarter to a third of
economic growth . . .It boosts productivity, reduces
costs, cuts inventories, and facilitates electronic
commerce. It is, in short, a transcendent technology—like railroads in the 19th century and automobiles in the 20th.’’ He continued by stating, ‘‘to the
believers in the New Economy, we have here the
magic bullet—a way to return to the high-growth, lowinflation conditions of the 1950s and 1960s.’’ Statistics
have shown that productivity was weak from the 1960s
to the early 1990s, but there are signs of a revival; e.g.,
the U.S. Department of Labor data showed that the
average productivity growth rate dropped from 2.68%
in the 1960s to 1.26% in 1980s but it bounced back to
1.46% in the 1990s up to 1998.
Yet, there has been no evidence showing that the
recent productivity growth reversal is due to IT. The
only way to prove that it is playing a significant role in
improving productivity is to provide an accurate
methodology of measuring IT productivity. Here, we
have used bank data from 1989 to 1997. The data
covers section sectional and time series data, so we
have applied the random effect model—the model
control individual (bank) heterogeneity. IT productivity, precisely speaking, IT contributions to corporate
profit was measured. Our production function shows
that IT is the only input variable that provides more
dollar value than the input cost on the margin when it
is compared with interest expense, non-interest
expense, staff cost, and operating expense. For those
New Economy advocates and those who claimed the
IT productivity paradox has been solved, this paper is
encouraging, because it suggests that IT maybe one of
the positive drivers for recent productivity gains by
large U.S. companies.
One must caution against making generalized
conclusions about productivity from a limited sample
of banking data. Financial institutions are unique in
their extraordinary dependency on IT spending as
compared with staff compensation costs.
The median compensation of banking employees in
our sample is US$ 51,500 which is well above the
median for industrial firms. The information-intensive
banking operations are also more amenable to routine
standardization to an extent that is rarely found in
other sectors of the economy. For these reasons, our
favorable findings about the benefits of substituting
expensive labor costs with IT are not surprising.
The contribution of this paper is not only its
discovery achieved by using more recent data, but also
the methodology proposed. The data set can be biased
if it contains both time series and cross-section data
and when an OLS regression is applied. We have
carefully chosen the appropriate methodology so that
the results can be more accurate and convincing. One
important aspect is the endogeneity of the input
variables. This argues that the input variables are not
independent. A firm’s objective is to maximize profit
or minimize cost and it will adjust the output and input
volumes to achieve this goal. The change of the inputs
arises in large part because of intentional actions taken
by firms who respond to market incentives and as
Varian and Intriligator suggested, a model incorporating this assumption is better than one without [15,31]
both in an economics and in econometric sense. One
important criterion for firms to adjust the input
quantity is price. When IT prices drop and other input
prices are unchanged, companies would buy more IT
and reduce their buying on other input factors.
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