Information technology, coordination costs, and firm size

The primary objective of our study is to investigate the nature of the relationship between IT and one important organizational change: declines in firm size. To accomplish this goal, our study comprehensively extends and complements Brynjolfsson et al.'s (1994) study. Based on transaction cost economics and organizational theories, we formulate four cross-sectional models. Among the four models, the size effect model and the coordination model are based on organizational theories, which reflect the organizational imperative perspective. The other two models, the substitution effect model and the outsourcing effect model, are based on production theory and transaction cost economics, respectively. These models are aligned with the view of the technological imperative. By integrating the two perspectives, we also formulate a longitudinal model: the bi-directional and time-lagged model.;These five models are tested using a 12-year panel data on IT spending, coordination costs, firm size, and relevant control variables for 277 manufacturing firms. In cross-sectional analysis, we find that firm size is significantly associated with subsequent increases in IT spending (i.e., size effect). However, when coordination costs are incorporated, the size effect is found to vanish and it is transmitted only via coordination costs (i.e., coordination effect). We also find that the increased use of IT is only indirectly associated with decreases in firm size via coordination costs (i.e., outsourcing effect). In longitudinal analysis, we further find a sequential interaction between IT and firm size over time. Thus, it is found that as firms grow in size, coordination costs also increase; firms use then more IT to facilitate the increased activities of coordination; the increased use of IT in turn decreases coordination costs; and eventually the size of firms declines.;We believe that our study provides many insights into the nature of the linkage between IT and firm size. In particular, our results suggest that coordination costs should be considered a complete mediator on the linkage. We also suggest that our models could be applied to the research on the impacts of IT on organizational performance or other organizational changes.