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The Determinants of Technology Adoption: The Case of the Banking Firm

Author(s): Timothy H. Hannan and John M. McDowell

Source: The RAND Journal of Economics, Vol. 15, No. 3 (Autumn, 1984), pp. 328-335
Published by: Wiley on behalf of RAND Corporation
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Rand Journal of Economics

Vol. 15, No. 3, Autumn 1984

The determinantsof technology adoption:

the case of the banking firm
Timothy H. Hannan*
John M. McDowell**

Using data on the adoption of automatic teller machines by firms in the banking industry,
this study examines the relationship between the decision to adopt new technology and its
determinants. Since bankingfirms differ considerably in terms of the competitive environments in which they operate, focusing on this one innovation in this industry allows a
stronger test of the relationship between market structure and the adoption of new
technology than has been previously conducted. Using a failure time estimation procedure,
wefind that larger banks and banks operating in more concentrated local banking markets
register a higher conditional probability of adopting this new technology, all else equal.
We also find that other results are consistent with the underlying model and that the
bank's regulatory environment shapes its adoption decision in plausible ways.
1. Introduction
* The rate at which innovations are adopted by firms constitutes an important part of
the process of technological change. Thus, investigation of the firm-specific and marketspecific characteristics which influence decisions to adopt innovations has long been
recognized as an important area of study. In this article we seek to shed further light on
this question by choosing as our object of study the decision by banks to adopt automatic
teller machines (ATMs).' This choice allows us to avoid a number of the problems
encountered by earlier studies of the influence of market characteristics on the adoption
of technology because markets in which commercial banks operate are limited geographically. Thus it is possible to compare the adoption decisions by firms in the same industry
that operate under widely varying market conditions. By definition we avoid the
potentially serious problem frequently faced by previous researchers of accounting for the
affect of interindustry differences on the adoption of an innovation. In addition, because
* Federal Reserve Board.
** Arizona State University.
The views expressed herein are the authors' and do not necessarily reflect those of the Federal Reserve
Board or its staff. We wish to thank David Walker and Keith Quince for making the data employed in this
study available. We also owe a special debt to Robert Avery, without whose skill and advice in using the
estimation procedure, this article would not have been possible.
' Past studies of the adoption decision and its determinants include Mansfield (1968), Romeo (1975), and
Oster (1982).

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of the large number of banks and local banking markets in existence, we are able to
avoid the problem of few observations and few degrees of freedom encountered in
previous studies of the relationship between market characteristics and the adoption
Another advance over the previous literature involves the estimation procedure that
we employ. Our study uses data indicating the point in time that each of a large number
of banks introduced an ATM system. The principal task is to assess the dependence of
adoption decisions on explanatory variables which may take on different values at
different points in time during the period that the innovation could have been adopted.
To account for possible changes in the value of explanatory variables over this time
period (and thus to avoid the usual assumption of unchanging values), we employ a
"failure time" estimation procedure used recently by Lancaster (1979) and Flinn and
Heckman (1983) to investigate unemployment duration.
The plan of the article is as follows. Section 2 introduces the explanatory variables
to be employed in the analysis and discusses their expected role in the adoption decision.
Section 3 describes the data and the estimation procedure, and Section 4 presents the
econometric results. The final section concludes with a summary and a discussion of

2. The determinants of ATM adoption

* In examining those characteristics of banks and banking markets which are likely to
influence the decision to adopt ATM systems, we use as a guide the presumption that an
innovation will appear more attractive to a potential adopter, the greater is the positive
differential between profits obtainable with and without the innovation.3 This suggests
the role of a number of firm and market characteristics in the adoption decision.
Consider first the prevailing wage rate (WAGE) in the market in which the bank
operates. Since ATMs are labor-saving, an increase in the wages which must be paid
employees should reduce the profitability of ATM operations by less than it effects the
profitability of operations involving human tellers. Thus, adoption of ATM systems
should appear more attractive to banks operating in higher wage areas, all else equal.4
Market growth (GROWTH) is another characteristic which may influence the
profitability of an ATM system relative to its alternatives. To the extent that it allows
establishment of ATM operations without having to replace undepreciated capital
associated with human teller operations, ATMs should appear more attractive to banks
operating in markets experiencing faster growth.
We also include a measure of firm size in the analysis. Most researchershave focused
on its role as a proxy for the profitability of an innovation as a result of scale economies.
2 In focusing on the adoption of a given innovation by several different industries, past researchers have
been able to use only as many observations as there are adopting industries, and this in practice has turned out
to be a rather small number. Thus, Romeo's (1975) investigations of the adoption of numerically controlled
machine tools could muster only ten different industry observations and reported estimations with as few as four
degrees of freedom. Mansfield (1968) speculates on the relationship between the adoption decision and market
structure from the standpoint of even fewer observations.
3 While this simple presumption is sufficient for our purposes, the relationship between the adoption
decision and profits that may be obtained with and without the innovation and with and without rival adoption
of the innovation is more complex than the presumption may suggest. See Kamien and Schwartz (1982, Chs. 4
and 5) and an earlier version of our article (Hannan and McDowell, 1983) for a fuller discussion.
The precise sense in which "greaterattractiveness" translates into an adoption decision is developed fully
below. Note further that higher wage levels may make ATM adoption more attractive for other reasons as well.
Areas with higher wage rates have a higher proportion of people who value their time relatively highly, thus
registeringgreater demand for ATMs. Also, to the extent it proxies average educational levels, higher wage rates
may indicate a population more adaptable to the use of a new technology.

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Other routes of causation, however, include the possibility of differences in managerial

attitudes between large and small firms and differences in relative risk exposure for firms
of different size. Thus, the effect of firm size cannot be predicted. Also included in some
estimations is a term representing size squared ((SIZE)2) to allow for more flexibility in
the relationship and to investigate the existence of a bank size most conducive to
technology adoption.
Of central concern in our study is the much debated relationship between market
structure and the tendency of firms to adopt new technology. We examine this question
by including in the analysis the three-firm concentration ratio as a measure of market
concentration.5 While several economists have undertaken the task of deriving from
theory the relationship between market structure and various aspects of firm "innovativeness," these relationships appear to be at best complex ones, contingent on circumstances
about which there may be little information in any empirical application.6 Thus, the
impact of market concentration in this study is not suggested a priori.
We also include a variable designed to control for differences in bank product mix.
According to Walker (1976, p. 13), cash withdrawals from checking accounts represent
the most common transaction performed with ATMs. We therefore include a measure
defined as the proportion of the bank's total deposits accounted for by demand deposits
(denoted PROMIX), with the expectation that banks specializing more in demand
deposits will find ATM adoption more attractive.
Included also is a measure of firm profitability. At issue here is the question of
whether a liquidity constraint in funding the adoption of the innovation exists. If the
availability of internally generated funds constrains investment in this new technology,
then the more profitable firm should evidence a greater tendency to adopt it. Since the
validity of such a constraint is open to question, the impact of profits is not suggested
a priori.
The data employed also allow us to examine the impact of regulatory restrictions on
this aspect of innovative activity, since states differ in terms of the restrictions imposed
on banks and their usage of ATMs. One such difference involves state branching
restrictions, which are controlled for in our estimation through the use of two dummy
variables. UNITBR denotes operation in a state in which no branches (only unit banks)
are allowed, while LIMBR denotes operation in a state where branching is allowed only
within limited geographic areas. Remaining banks operate in states which allow statewide
branching. Some authors have suggested that banks for which branching is restricted tend
to substitute other competitive devices for the prohibited branches.7 This in and of itself
might suggest that the existence of branching restrictions promotes the adoption of ATMs.
Other considerations may also be relevant, however. If, for example, the lack of branching
restrictions makes entry into new banking markets less costly, established banks operating
in such an environment may face a greater threat of entry. Since we cannot predict the
impact of these possible differences in potential competition, the role played by branching
restrictions is not suggested a priori.
State regulatory restrictions on the usage of ATMs themselves differ in at least one
important respect. While some states allow banks to locate ATMs away from the premises
of an established banking office, others do not. This distinction should prove important
in states which prohibit or restrict branching activity, since offpremise ATMs may enable
banks partially to circumvent these restrictions. To account for this, we use a dummy
5 This is the most commonly used measure of market concentration in studies of banking market structure
and bank performance. See Rhoades (1982) for a summary.
6 See, for example, the extensive work of Kamien and Schwartz as summarized in their book (1982, Chs.
4 and 5).
' See, for example, Flannery (1982, p. 1).

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variable (OFFPRM) to indicate operation in a state which prohibits or restricts branching

activity but which allows offpremise ATMs. Thus, the case in which OFFPREM = 1
should signify a situation in which ATMs appear more attractive to potential adopters.
We also account for two additional considerations. To control for differences between
urban and rural environments, we include a dummy variable (URBAN) which indicates
operation in an SMSA. We also introduce a dummy variable (BHCDUM) which indicates
ownership by a bank holding company. In neither case is the impact of these two
variables suggested a priori.

3. The test
* While we have thus far discussed determinants of the "attractiveness" of ATM
adoption to potential adopters, an empirical analysis clearly requires a more concrete
specification of the relationship between firm adoption behavior and explanatory variables.
As noted above, this should also be done in a way which accounts for changing values in
the explanatory variables during the time period in which the innovation could have
been adopted. We accomplish this by using the econometric specifications employed in
"failure time" estimation procedures.8 Allowing F(T) to denote the probability that a
bank will not have introduced an ATM system by period T (sometimes referred to as the
survivor function), it can be shown that




where h(t), called the "hazard rate," is defined as the conditional probability that the firm
will adopt the innovation at time t, given that it has not done so by that time. The link
between observed behavior and firm or market characteristics in the model is obtained
by specifying the conditional probabilities (the h(t)'s) as functions of firm or market
characteristics. In view of the nonnegativity of h(t), the most natural and commonly used
form is the exponential,
h(t) = exp(X43),
where X1 is a vector of firm and market characteristics prevailing at time t and : is a
vector of coefficients. Note that substitution of (2) into (1) yields F(T) as functions of the
firm and market characteristics prevailing in each period up to period T. The estimation
procedure employed maximizes a likelihood function composed of these probabilities.9
Estimated coefficients may be interpreted in terms of the relationship between explanatory
variables and the conditional probability of adoption, as expressed in (2).
The data set that we employ is extensive. It consists of annual observations of ATM
adoptions and bank and market characteristics for the period 1971-1979 and covers

See Kalbfleisch and Prentice (1980) and Lancaster (1979) for a full discussion.
9Because of problems with our adoption data for the years 1977 and 1978, we exclude adoption
information for these two years and use as our likelihood function

J [Fi(Ti -

i= I



1) - Fi(Ti)] fJ [Fk(T'976)

- Fk(T'979)]


where N', N2, and N3 denote the number of banks that introduced ATMs by 1976, between 1977 and 1979, or
did not adopt by 1979, respectively. The first bracketed expression refers to the first six years of information and
notes that the probability of adoption during any of these years is the probability of not having the innovation
by the end of the previous year, minus the probability of not having it by the end of the year in question. The
second bracketed expression denotes the probability of adoption sometime during 1977 through 1979 (since we
do not use 1977 and 1978 adoption information). The last expression denotes the probability of not adopting
by the end of the last year, 1979. Because of the omission of two years of adoption information, this likelihood
function can be shown to be superior to the alternative of using probability densities.

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3,841 banking firms operating in 392 different SMSAs or counties which have been
judged to approximate local banking markets.'0 Of these banks, 740 had introduced
ATM systems by 1979, the last year for which data are available.

4. The results
* Table 1 defines the variables used in the estimations reported below. We report
maximum likelihood estimations obtained for this sample of 3,841 banks in Table 2.
Columns (1) and (2) report coefficient estimates obtained with and without the size
squared term, (SIZE)2. Note first the positive and highly significant coefficients of market
concentration (CR3) in both estimations. All else equal, banks operating in more
concentrated markets are found to have a higher probability of introducing this new
technology, given that they have not yet done so. These results are important in that they
suggest the possibility of a Schumpeterian-like tradeoff in efforts designed to deconcentrate
local banking markets. While such efforts are generally undertaken to produce static
efficiency gains associated with lower profit rates and lower prices, our results suggest that
they may come at the price of slower introduction of new technology.
The coefficients of SIZE are positive and significant, while the coefficient of (SIZE)2
is negative and insignificant. Thus, larger banks are found to exhibit a higher conditional
probability of adoption, all else equal. " This finding is consistent with several different
explanations, including the existence of economies of scale in the use of ATMs, less
relative risk exposure on the part of larger banks, and different attitudes toward new
technology on the part of managers of larger banks.
Consistent with a priori expectations, the coefficients of WAGE are positive and
highly significant. Since ATMs are labor-saving, this positive impact of the area wage rate
on the conditional probability of adoption suggests that cost savings may be at least part
of the reason for the adoption of ATMs.
GROWTH fails to register a statistically significant impact in these estimations, while
the coefficients of PROMIX, defined as the proportion of the bank's deposits accounted
for by demand deposits, are positive and significant. This positive impact is consistent
with the expectation that, because cash withdrawals from demand deposits are the most
common type of transaction performed with ATMs, banks with greater proportions of
demand deposits find ATMs more suitable to their operations.
The impact of PROFITS on the conditional probability of adoption is negative but
statistically insignificant. We therefore fail to find statistical support for the notion that
profits, because of a binding constraint placed upon technology adoption by the supply
of internally generated funds, have a positive impact on the conditional probability of
adoption. This is consistent with the results of other studies which, focusing on other
aspects of technological progressiveness, also fail to find an important role for firm
The coefficients of BHCDUM are positive and highly significant, suggesting that all
else equal, banks that are members of bank holding company organizations have a higher

'0 This sample was obtained from Stephen Rhoades, who has used these market definitions in a number
of recent contributions. See Rhoades (1980). Data sources are the FDIC's Summary of Deposits, bank call
reports, bank income and dividend reports, the FDIC population surveys of bank ATM usage, the Bureau of
the Census, City and County Data Book, and state statutes pertaining to electronic funds transfer systems as
summarized by Penny and Baker (1980).
" Accepting the point estimates of the coefficients of SIZE and (SIZE)2, we find that the size of firm
consistent with the highest conditional probability of ATM adoption is several times larger than the largest bank
in the sample.
12 See Kamien and Schwartz (1982, p. 98) for a brief review of this literature.

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Variable Definitions

CR3 = Market three-firm concentration ratio, measured as the proportion of total market deposits

accounted for by the largest three firms (expressed as a percentage).

SIZE = Bank size, measured in total assets (in millions).
WAGE = Wage rate (manufacturing) prevailing in the market.
GROWTH = Yearly growth in market deposits.
PROMIX = Product mix, defined as the ratio of each bank's demand deposits to its total deposits.
PROFIT = Bank profit rate, measured by net income divided by total assets.
UNITBR = Dummy variable indicating operation in a unit-banking state.
LIMBR = Dummy variable indicating operation in a state in which branching is restricted to limited

geographic areas.

= Dummy variable indicating operation in a state where branching is either prohibited or restricted

and offpremise ATMs are allowed.

URBAN = Dummy variable indicating operation in an SMSA.
BHCDUM = Dummy variable indicating ownership by a bank holding company.


Determinants of the Conditional Probability of ATM Adoption

Coefficient Estimates





Derivatives of the 9-Year

Adoption Probability














-. 17E-8





.37E- 1



.13E- 1


















.27E- 1










-2 ln k






Note: *, * and *** represent significance at the .01, .05, and .10 level, respectively.
Numbers in parentheses are coefficients divided by asymptotic standard errors.

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conditional probability of adoption. Less relative risk exposure on the part of large, more
diversified bank holding company organizations is a possible explanation.
We introduce the variables UNITBR, LIMBR, and OFFPRM to account for
potentially important differences in the regulatory environments in which banks operate.
The positive coefficients of UNITBR and LIMBR are consistent with the notion that
banks are more likely to adopt ATMs as a means of attracting customers when the
alternative of providing convenience through branching is restricted. Only the coefficients
of UNITBR reach significance at even marginal levels, however. The coefficients of
OFFPRM are positive and highly significant, thereby suggesting that banks are more
likely to introduce ATM systems in a regulatory environment in which offpremise ATMs
may be used as a vehicle to circumvent restrictive branching laws.
The coefficients of URBAN suggest that urban banks have a higher conditional
probability of ATM adoption, although statistical significance is at best marginal. This
result is roughly consistent with observations by Walker (1979, p. 12), who notes a higher
proportion of banks in SMSAs having ATMs than banks operating outside SMSAs.13
Finally, to illustrate the implications of coefficient magnitudes in terms of the
adoption probabilities over time, columns (la) and (2a) in Table 2 report the implied
derivatives of the probability of adoption by 1979 associated with a once-and-for-all
change (lasting throughout the nine-year study period) of each explanatory variable, as
derived from estimations (1) and (2), respectively. Derivatives are evaluated at the average
values of explanatory variables.'4 Note that the derivative estimate of the three-firm
concentration ratio implies that an increase of ten percentage points in CR3 would result
in an increase in the probability of adoption by the end of the study period of
approximately .02. This change may be viewed in the context of an actual proportion of
adoptions by 1979 of .19. Other derivatives may be interpreted similarly.

5. Conclusion
* Using data on ATM adoptions by firms in the banking industry, we have examined
the relationship between the firm's adoption decision and various regulatory, market, and
firm characteristics in a manner that avoids the problems of interindustry differences and
few degrees of freedom faced by previous studies. We also use an estimation procedure
that allows us to account specifically for changes in the values of explanatory variables
over time. Our results are decidedly Schumpeterian. Larger banks, banks operating in
more concentrated local banking markets, and banks that are part of bank holding
company organizations evidence a higher conditional probability of adoption of this new
technology, all else equal. This raises the classic conflict between policies designed to
13 Assuming that the values of explanatory variables are stationary over time, Lancaster (1979) shows that
(1) and (2) imply
E(T) = exp(-X'O),

where X' denotes a vector of time-invariant explanatory variables and T denotes the number of periods until
adoption. Consistent with this, we estimated this relation using the actual time until adoption, as expressed as
ln(T) =-X':,

with Tobit maximum-likelihood with the 1972 values of the explanatory variables. All coefficients were opposite
in sign (with the exception of PROFITS) to those reported in Table 2, as this derivation suggests (since a
positive change in the conditional probability of adoption for each period of time implies a negative change in
the expected time until adoption) and all variables but PROMIX and PROFITS were significant. See Hannan
and McDowell (1983) for a fuller discussion.

Since the probability of adoption by the end of nine years may be expressed as 1 - exp(- z exp(Xf)),

its derivative with respect to any given Xi, affecting all nine periods and evaluated at average values, X, may be
expressed as [9 exp(-9 exp(Xfo))exp(Xfo)]*fi, where fi is the coefficient of Xi.

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promote static efficiency and those that promote technological progressiveness. Our
findings make more critical the question of whether possible static efficiency gains
associated with less concentrated markets outweigh the resulting losses in technological
progressiveness. The other results we report are consistent with theoretical predictions,
thus tending to validate our underlying model. We also find evidence that the regulatory
environment in which banking firms operate shapes their decisions regardingthe adoption
of new technology in plausible ways.
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