ABSTRACT: Drawing on the resource-based theory of the firm and using Ohlson’s (1995) residual income valuation framework, this paper investigates the relationships between IT capability and IT spending, and market value. We also assess whether these relationships differ based on the industry type (i.e., high-tech). Using publicly available ratings, and after controlling for firm-specific determinants as well as industry fixed-effects, we find that IT capability is value relevant (i.e., the stock market values of firms with superior IT capability are both economically and statistically higher than the values of a control sample), whereas the level of IT spending did not explain variation in market values. The results are shown to hold using two unique archival data sets representing the immediate pre-Internet (1992–1994) and the post-Internet commercialization (1999–2006) eras and are remarkably robust to variations in the control sample, sampling method, and model specifications. Consistent with these results, we also find that IT capability is associated with actual future earnings. Additionally, we find that IT capability is more value relevant for firms in high-tech industries in the post-Internet period. Overall, our analysis suggests that, on average, investors reward firms with superior IT capabilities through higher market values, consistent with the notion that IT capability contributes to the firm’s future prospects (the size and risk associated with the firm’s future income stream), and that market performance differential from IT rests less on IT spending, per se, and more on the firm’s IT capability. The implications of these findings for practice and research are discussed.

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