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THE IMPACT OF OUTSOURCING ON SHAREHOLDER VALUE

To examine the impact of offshore-outsourcing announcements on firm value, we utilize the event-study methodology to estimate the shareholder wealth effects of outsourcing announcements. This methodology estimates the stock market's reaction to events, while adjusting for industry and market-wide influences.26 Event studies have been widely used to evaluate the impact of operational events on the firm value of publicly traded firms.27 The method determines the impact of an event on firm value by calculating the adjusted stock market return (commonly referred to as an abnormal return), which reflects the portion of change in a firm's stock price due to the firm specific event. In an efficient market, stock prices will adjust immediately to new information contained in an event.28 The effects of an event on shareholder value can thus be estimated by observing stock price behavior over a short time period. The market model is used to estimate the abnormal returns in this study. This model predicts the relationship between the return of a stock and the return of the market portfolio while adjusting for the systematic risk of a stock.

The event-study methodology can be used to determine the abnormal return over a variety of time periods (i.e., daily, monthly, yearly). However, the one-day period is commonly used because it reduces the chances that the observed abnormal return can be influenced by other factors. The use of a one-day time period requires the precise determination of the day and time of each announcement in the sample. The event day of interest in this study is the first trading day during which the stock market can respond to an announcement; this day is designated as day 0. The calendar day of an announcement was converted into the event day according to the following guidelines. If the announcement was made in the Wall Street Journal (WSJ), the announcement calendar day is day 0 in event time and the previous trading day is day -1. If the announcement was made in the Dow Jones News Service (DJNS), PR Newswire (PR), or Business Week (BW) before the stock market closed (4 p.m. Eastern Standard time), the announcement calendar day is day 0 in event time, and the previous trading day is day -1. If the announcement was made in the DJNS, PR, or BW after 4 p.m., the next trading day is day 0 in event time. If an announcement was released in any news service on a nontrading day (on which the market is closed), the next trading day is designated day 0 in event time.

Our analysis focuses on the impact of outsourcing on firms based within the United States. A search of the WSJ, DJNS, PR, and BW identified 152 relevant announcements between 1998 and 2010. Of these, 75 announcements indicated the movement of business activities from the United States to an offshore location, and 77 announcements reflected that activities were being transferred to a third party that conducted business in the United States. A total of 70 of the 75 offshore announcements involved the movement of activities to locations in the Asia-Pacific region and five announced movement to locations in Central America. It should be noted that there appears to be a large shift toward offshore announcements after 2001. The annual sales of the firms in the sample ranged from $12 million to $180 billion, with a mean of $20 billion. Examples of an offshore and onshore announcement are provided in Table 6.1.

The Impact of Offshore Outsourcing on Shareholder Value

The share price of firms in our study experienced an average increase of 0.64 percent (above the expected return) on the day that an offshore-outsourcing decision was announced. Moreover, nearly two-thirds of the firms experienced an increase in share price. These results provide strong evidence that the market reacts positively to offshore-outsourcing announcements. They are not unexpected considering the large number of firms that have outsourced services to offshore locations to take advantage of the cost savings. The findings suggest that the stock market believes that the potential benefits of offshore outsourcing outweigh the

Table 6.1. Sample Outsourcing/Offshoring Announcements

Sample Outsourcing/Offshoring Announcements

associated risks, and that outsourcing will improve a firm's financial performance. Though the observed abnormal returns may seem miniscule to the casual observer they can be substantial when put in perspective. For example, a hypothetical firm with a market capitalization of $5 billion that experiences an increase in share price increase of 0.64 percent would realize a $32 million increase in shareholder value.

 
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