Decomposing the Market, Industry, and Firm Components of Profitability: Implications for Forecasts of Profitability

40 Pages Posted: 27 Nov 2017

See all articles by Andrew B. Jackson

Andrew B. Jackson

UNSW Australia Business School, School of Accounting

Marlene Plumlee

University of Utah - School of Accounting

Brian Rountree

Rice University - Jesse H. Jones Graduate School of Business

Date Written: November 20, 2017

Abstract

Academics and practitioners frequently highlight that overall market and industry performance is an important aspect of a firm’s profitability. However, few studies allow for the decomposition of a firm’s profitability into market, industry, and idiosyncratic components, and those that do often assume that the market and industry components are cross-sectional constants. In this study, we allow for variation in firm-specific sensitivities to market, industry, and idiosyncratic economic shocks, and then assess whether and when this decomposition results in improved forecasts of profitability. For the overall sample, we find significant improvements in terms of the magnitude of forecast errors and the frequency with which forecasts based on the decomposed values are superior versus forecasts using only total profitability. Across the sample as a whole, decomposing profitability in the forecasting process results in more accurate forecasts greater than two-thirds of the time (increasing to almost 80 percent within certain subsamples). Our results provide strong support for the role that firm-specific measures of market and industry profitability play in predicting a firm’s future performance, as well as highlighting settings where the decomposition provides the greatest benefit in terms of predicting future changes in profitability.

Keywords: Macroeconomy, Market, Industry, Profitability, Forecasting, firm-specific estimates

JEL Classification: M41

Suggested Citation

Jackson, Andrew B. and Plumlee, Marlene A. and Rountree, Brian Robert, Decomposing the Market, Industry, and Firm Components of Profitability: Implications for Forecasts of Profitability (November 20, 2017). Review of Accounting Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3074777

Andrew B. Jackson (Contact Author)

UNSW Australia Business School, School of Accounting ( email )

Sydney, NSW 2052
Australia

Marlene A. Plumlee

University of Utah - School of Accounting ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States

Brian Robert Rountree

Rice University - Jesse H. Jones Graduate School of Business ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005-1892
United States

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