Robert J. Kauffman and Xiaotong Li INFORMS CIST 2003 Atlanta, 10/19/2003

1. PAYOFF EXTERNALITIES, INFORMATIONAL CASCADES AND MANAGERIAL INCENTIVES: A THEORETICAL FRAMEWORK FOR IT ADOPTION HERDING Robert J. Kauffman and Xiaotong Li INFORMS CIST 2003 Atlanta, 10/19/2003 INFORMS CIST 2003

2. Herd Behavior in Decisionmaking INFORMS CIST 2003

3. Herd Behavior in IT Adoption • We have recently observed “herd behavior” in many instances of information technology (IT) adoption. • In these instances, most IT managers quickly converge to the same adoption decision independent of their private information. • Irrational Exuberance or Rational Herding? • A theoretical framework of rational IT adoption herding INFORMS CIST 2003

4. Why Rational Herding? Positive Payoff Externalities (Brynjolfsson and Kemerer, 1996 Gallaugher and Wang, 2002 Kauffman, McAndrews and Wang, 2000) Rational IT Adoption Herding Informational Cascades (Banerjee, 1992; Bikhchandani, Hirshleifer and Welch, 1992 and 1998; Li 2003) Managers’ Career Concerns (Scharfstein and Stein, 1990; Zwiebel, 1995) INFORMS CIST 2003

5. Potential Problems of IT Adoption Herding INFORMS CIST 2003

6. Network Externalities • Network externalities tend to reward herding decisions by increasing the payoffs to IT adopters who associate themselves with the majority. • Herding in the presence of network externalities also decreases IT adopters’ risks of being stranded in technologies with too small installed user bases. • The extrinsic (indirect) network effects created by complementary products and services can in some cases further increase the benefits of herding INFORMS CIST 2003

7. Information Loss in Observational Learning? • Observational learning can sometimes results in an informational cascade in which most people adopt the same technology independent of their own private information • Information revealed through others’ adoption actions may have accumulated enough to overwhelm a decisionmaker’s imprecise private information. • Later decisionmakers may rationally disregard their own information and imitate the prevailing decision • Informational cascades and network externalities can be mutually reinforcing INFORMS CIST 2003

8. Informational Cascades INFORMS CIST 2003

9. Herd for Managerial Reputation? • Holmström (1999) shows that reputation-concerned managers are very likely to make inefficient investment decisions in the absence of effective mechanisms to align their own interests with those of their companies • Scharfstein and Stein (1990) develop a theory suggesting that managers may tend to intentionally imitate others’ investment decisions for their reputations that is instrumental in determining their human capital returns • We believe that strategic IT adoption decisions—are more susceptible to reputational herding INFORMS CIST 2003

10. Managerial Reputational Herding INFORMS CIST 2003

11. A Framework for Assessing Adoption Herding Theories Identify important stakeholders in IT adoption Identify important stakeholders in IT adoption Some Questions to ask: 1. What can a decisionmaker gain or lose by engaging in adoption herding? 2. How will my strategy affect other stakeholders and how will their strategies affect me? 3. What potential loss can adoption herding cause? 4. Are there any ways to deal with inefficient herding? understand their strategic concerns in IT adoption decisionmaking Determine which theoretical perspective is the most appropriate one Multiple stakeholders? more than one theoretical perspective? INFORMS CIST 2003

12. Model Managerial Incentive Driven IT Adoption Herding • Long time horizon with possible contract renegotiation (generally not one shot games) • IT Payoff Unobservability (repeated games with imperfect monitoring Fudenburg, Levine and Maskin 1994, Folk Theorem holds? Under what conditions?) • Dynamic interactions between IT investment and non-IT investment decisionmaking in a decentralized setting; Internal or external capital market, two-tier agency problems. (Bernardo, Cai and Luo 2003; Stein 2001) INFORMS CIST 2003