Capital market reaction to defective IT products: The case of computer viruses

Studies in various industries indicate that market reaction to recall announcements is used as a catalyst to control the creation of substandard products. In the IT industry, flawed software is being blamed for the increasing numbers of computer viruses that plague information systems and the escalating costs to repair these viruses. This paper examines whether the market penalizes firms that produce substandard IT products. We use the event study methodology to assess the impact of public virus announcements on the stock prices of responsible IT vendors between 1988 and 2002. The results show that the market reacts negatively to the production of flawed Information Technology in approximately 50% of the cases. However, this negative market reaction is not statistically significant over extended periods and is limited to announcements involving certain types of defects (i.e., IT products that contain computer viruses). There was no statistically significant negative market reaction for announcements involving IT products that are susceptible to computer viruses. Our analysis implies that unlike in other industries, market forces atone cannot be used as an effective control mechanism for the production of substandard IT products. The study concludes that under these present conditions, IT vendors have little economic incentives to invest in defect-free computing. (C) 2005 Elsevier Ltd. All rights reserved.