Firm Volatility and IT

The past few decades have seen an increase in volatility at the firm level, be it financial or sales growth. The existing explanations in the literature focus on financial innovation or increased product competition to explain this change. In this paper I argue that IT usage, which enhances firms’ information processing capability, is an important variable which affects firm level volatility. I build a general equilibrium model with heterogeneous firm productivity levels and show that increase in information processing capability has made the firms more volatile at all levels. But the general equilibrium effect acting through the aggregate price index decreases volatility for a given size. When volatility is conditional on firm size these two effects lead to decrease in volatility of small sized firms which did not adopt IT and increase in volatility of big firms which adopted IT. I further show that these results hold empirically for the dataset with French firms where I use ERP as a measure of information processing capability of firms. The information processing channel suggested in this paper also proposes another way to explain the power law relationship between standard deviation of revenue growth and firm revenue as seen in the cross-sectional data.