The Business Value of IT in Light of Prospect Theory

Abstract

A key problem with IT decision-making is that the real value contributions of IT projects are unknown ex-ante to their executions. Thus, an organization has to rely on the expectations and perceptions of its decision makers. Moreover, these perceptions are prone to biases and display only a transfigured or irrational image of reality. This paper examines how these biases are related to the business value of IT (BVIT) and how IT decision-making can be rationalized. To this aim, a model is set up based on prospect theory, which is a frequently cited theory from behavioral economics used to descriptively analyze human value perception under risk. Applying the results found via prospect theory to IT decisions, the “perceived” BVIT is quantified and analyzed. Based on the model, the paper shows that the irrationalities rooted in human value perception provide explanations for two central paradoxes of IT. First, it reveals that they cause a disparity between the anticipated value-adding effects of IT and the actual measured outcomes, reflecting a famous observation within BVIT research known as the “productivity paradox of IT.” Second, recent studies show that IT increases the operational efficiency and competitiveness of organizations. However, only the operational effects are perceived in practice. In the paper, this one-sided perception is referred to as the “perception paradox of IT”. It is ultimately concluded that a rethinking of the position of IT within modern organizations and the establishment of suitable corporate governance mechanisms can resolve these issues, avoid irrationalities, and positively influence the performance impacts of IT.