The debate around the value of Information Technology (IT) has raged for a long time and the analysis suggests that IT does in fact create business value. Value from IT arises not only directly but also indirectly through several channels. IT interacts with the organizational processes, strategies and incentives within an organization and alters the relationship of the firm with the external world by altering the competitive conditions. Because the benefits of IT are diffuse and arise through many mechanisms, the benefits have been measured at various levels (process, firm and economy) using different measures (market valuation, subjective and objective performance). But most studies have adopted a black-box approach in measuring the value of IT by focusing on the question of how much value is added rather than on the mechanisms that drive the value.; The fact that IT interacts with other parts of the organization has only recently started to receive attention. In the first part of the study, we argue that IT affects other factors inputs such as non-IT capital and labor. In the process IT increases value by making other factor inputs more productive than they would be without the use of IT. We incorporate the efficiency enhancing effects of IT capital on non-IT capital and labor by extending the traditional production function approach. We show that in presence of such indirect effects, not accounting for these effects would lead to under-investment in IT and over estimation of the output elasticity of IT. Further, we empirically estimate these efficiency-enhancing effects of IT capital. The empirical results show that indirect effects are significant and positive. The results show that IT primarily adds value through other factor inputs in the IT intensive sector while in the non-IT intensive sector the value addition is primarily driven by IT itself. Similarly, in the durable sector the effects of IT are through other factor inputs while in the non-durable sector the action is directly through IT.; The second part of our study highlights the problems associated with the use of dollar data (data on factor inputs and outputs is measured in dollars at the macro level), as opposed to quantity data (for example, number of widgets), in the traditional production function approach. We show that the parameters such as output elasticity of IT capital, recovered from the production function approach using dollar data for outputs and inputs are actually driven by an underlying accounting identity. Therefore, we cannot recover the underlying technology parameters using this approach. We then extend the accounting identity formulation to incorporate the returns from IT capital and empirically estimate the returns to IT capital. The returns to IT capital are positive from this methodology. The IT intensive sector shows positive and significant returns to IT capital while the non-IT intensive sector does not show any significant returns to IT capital. The durable sector does not show any return to IT factor while the non-durable sector shows positive and significant returns to IT.; In summary; this study contributes to the understanding about value of IT in two distinct ways. Conceptually, it incorporates the indirect effects of IT capital thus providing insight into the mechanisms of accrual of value from IT. Methodologically, it uses a new approach using the accounting identity to triangulate the value of IT.
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