Capability-Enhancing Foreign Investments and Evolution of Corporate Scope in Software Services: Market Reactions and Implications for Competitive Advantage

Joydeep Chatterjee, University of Washington, Bothell, and Harbir Singh, Management, The Wharton School

Abstract: How does the stock market react to competitive actions by firms and their rivals? In this study we empirically explore capability-seeking investments by firms from different strategic groups within an industry and examine their impact on rival firms in the competitive context of global software services. We argue that when firms make foreign investments to access high-value added capabilities (i.e., software architectural skills – requiring high levels of tacit, socially complex knowledge), they face greater challenges compared to firms making investments to access low-value added capabilities (i.e., software implementation skills – requiring only operational and cost efficiency). This is primarily because it is difficult to incorporate tacit, socially complex knowledge into routines and to build trusted relationships with key client stakeholders. We find that firms’ already possessing high-value-added capabilities have an advantage over firms that do not, and that the market differentially penalizes rival firms based on whether they have high- or low-value-added capabilities. Analysis of cumulative abnormal returns in response to capability-seeking investment announcements made by a sample of leading U.S. and Indian firms in the global IT services industry provides support for these arguments.