Tilting the Evidence: The Role of Firm-Level Earnings Attributes in the Relation between Aggregated Earnings and Gross Domestic Product

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.