Abstract
We examine whether the contribution of firm-level accounting earnings to the informativeness of the aggregate is tilted towards earnings with specific financial reporting characteristics. Specifically, we investigate whether considering the volatility of earnings relative to the volatility of cash flows at the firm level (smoothness) increases the informativeness of aggregate earnings for future real GDP, and if so, whether macroeconomic forecasters use this information efficiently. This study innovates on recently developed mixed data sampling methods in the construction of an aggregate earnings growth measure by allowing each firm’s contribution to the aggregate to vary as a function of earnings smoothness. We find that the aggregate is tilted towards firms with smoother earnings and that this composition of aggregate earnings outperforms traditional weighting schemes in the association with future GDP growth. Further, this tilted aggregate has a stronger positive association with forecast revisions; in fact, analysts who utilize earnings the most in their forecasts appear to fully impound the informativeness of earnings smoothness. Our results synthesize and span parallel yet distinct streams of research on the role of accounting earnings in firm-level and macroeconomic outcomes and suggest an important role for financial reporting characteristics in the aggregate.
1. Introduction
We examine whether considering financial reporting attributes enhances the overall informativeness of aggregate earnings for future real GDP growth and whether professional forecasters incorporate this information. Recent studies provide evidence that aggregate earnings contain information about future realizations of common macroeconomic indicators, such as GDP growth (Konchitchki and Patatoukas 2014a,b), inflation (Shivakumar and Urcan 2017), and the federal funds rate (Gallo et al. 2016). While the equal- and value-weighted aggregate earnings measures employed in these studies provide evidence about the average informativeness of earnings, they implicitly neglect differences in firm-level financial reporting attributes, even though firm-level evidence suggests that such attributes affect earnings informativeness (Kothari 2001; Dechow et al. 2010).
6. Conclusions
Prior literature examines the information content of earnings at the aggregate level for macroeconomic outcomes such as market returns, real and nominal GDP growth, inflation, unemployment and interest rates (e.g., Kothari et al. 2006; Konchitchki and Patatoukas 2014a,b; Shivakumar and Urcan 2017; Nallareddy and Ogneva 2016; Gallo et al. 2016). While these studies are an important first step in understanding the role of aggregate earnings as a leading economic indicator, they are limited in their ability to incorporate firm-level attributes in the measurement of aggregate earnings. In this paper, we attempt to bridge the gap between firm-level findings and these aggregate earnings studies by considering the role of a firm-level attribute, earnings smoothness, in generating a more informative aggregate measure.
