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The impact of perceived risk on the capital market’s reaction to outsourcing announcements

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Abstract

Outsourcing is a widely accepted option in strategic management, which, like every business venture, bears opportunities and risks. Supplementing the popular area of research on the merits of outsourcing, this paper examines how stockholders rate corporate sourcing decisions with regard to the risk they associate with this transaction. Using event study methodology and multivariate cross-sectional OLS-regression, we analyze a sample of 182 outsourcing transactions in the global financial services industry between 1998 and 2004 in order to investigate the risk-specific drivers of excess returns to shareholders. The analysis studies the impact of risk-specific independent variables, including transaction size, length, outsourced business functionality, and experience with outsourcing. Our findings indicate that risk-mitigating strategies have significant explanatory power, indicating that the capital market’s reaction to an outsourcing announcement might at least partly be forecast. Results show a positive correlation between market reaction and business process outsourcing by financial services companies. We also find strong evidence indicating that capital markets react positively to relatively large transactions compared to the market capitalization of the outsourcing firm. For service providers our results show that traditional IT-related sourcing projects or the insourcing of administrative processes have a significant positive correlation with market reaction.

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Author information

Authors and Affiliations

  1. E-Finance Lab, Johann Wolfgang Goethe-University, Mertonstraße 17, 60054, Frankfurt am Main, Germany

    Heiko Gewald & Tom Gellrich

Authors
  1. Heiko Gewald
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  2. Tom Gellrich
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Corresponding author

Correspondence to Heiko Gewald.

Appendix

Appendix

Table 3 Number and value of deals according to relevant business functionality and industry classification (N = 170; 12 transactions have been omitted in this table since relevant data could not be extracted). The industry classification of the outsourcing company has been taken according to the classification in Bloomberg
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Table 4 Number and value of deals according to relevant region and industry classification (N = 170; 12 transactions have been omitted in this table since relevant data could not be extracted). The industry classification of the outsourcing company has been taken according to the classification in Bloomberg
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Table 5 Independent variables. Data for performance figures has been extracted from Datastream and Bankscope. Data for RoE (Return on Equity) has been taken at the year-end of the year prior to the announcement date. Data for MtB (Market to Book Ratio) has been taken on t = −21 (i.e., 21 days prior to the announcement). Variables have been winsorized at the 10 and 90% level
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Table 6 Results of the event study analyzing outsourcing transactions in the global financial services industry covering the timeframe from 1998 to March 2004. Abnormal returns have been calculated using OLS-regression. OLS-parameters have been estimated for a period of 252 trading days (1 trading year) prior to the event window [−20;20]. As market returns we have used the relevant industry indices S&P 500, MSCI World Banks, MSCI World Insurance and MSCI World Financial Services as provided by DataStream and Bloomberg. Cumulated abnormal returns (CARs) have been winsorized at the 10 and 90% level ***/**/* indicate significance at the 1/5/10 per cent level
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Table 7 Results of the multivariate cross-sectional OLS-regression for the cumulated abnormal returns of outsourcers, insourcers and combined entity. Dependent variable is cumulated abnormal return for the event window [−3;3]. For the separate analysis of outsourcers and insourcers a fixed-effects model has been employed. The number of observations (N) is lower than the total number of observations due to missing data. Missing data for independent variables has been estimated using OLS-regression. Variables have been winsorized at the 10 and 90 per cent level. Logarithms (ln) have been used for the variables size, market capitalization of outsourcer and insourcer, relative size of the parties and relative deal size compared to the market capitalization. Robustness checks for the other event windows have been performed and results are robust. Relevant data regarding the independent variables has been extracted from Bankscope, Datastream or the original deal announcement. ***/**/* indicate significance at the 1/5/10 per cent level
Full size table

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Gewald, H., Gellrich, T. The impact of perceived risk on the capital market’s reaction to outsourcing announcements. Inf Technol Manage 8, 279–296 (2007). https://doi.org/10.1007/s10799-006-0008-0

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