Industry Effects on Firm and Segment Profitability Forecasting: Do Aggregation and Diversity Matter?

Yim, Andrew and Schröder, David (2012): Industry Effects on Firm and Segment Profitability Forecasting: Do Aggregation and Diversity Matter?

Abstract

Abstract. A recent study shows that industry-specific analysis has no incremental advantage over economy-wide analysis in forecasting firm profitability. This result seems puzzling because some earlier studies have documented the importance of industry effects in explaining firm profitability. We reconcile the apparent inconsistency by showing that industry effects on profitability forecasting exist at the more refined business segment level, but are obscured by aggregated reporting at the firm level. Using segment-level analysis as well as firm-level analysis that also utilizes segment-level information, we provide consistent evidence supporting that industry-specific analysis is more accurate than economy-wide analysis in predicting the profitability of business segments and the profitability of single-segment firms.

• Item Type: MPRA Paper
• Language: English
• Keywords: Segment profitability, Earnings predictability, Earnings persistence, Aggregation, Diversity, Industry membership
• Subjects: L - Industrial Organization > L2 - Firm Objectives, Organization, and Behavior > L25 - Firm Performance: Size, Diversification, and Scope; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M4 - Accounting and Auditing > M41 - Accounting; G - Financial Economics > G0 - General > G00 - General; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M2 - Business Economics > M21 - Business Economics

References

Albrecht, W. Steve, Larry L. Lookabill, and James C. McKeown. 1977. ‘The Time-Series Properties of Annual Earnings’. Journal of Accounting Research 15 (2) (October 1): 226–244. doi:10.2307/2490350.

Ali, Ashiq, April Klein, and James Rosenfeld. 1992. ‘Analysts’ Use of Information About Permanent and Transitory Earnings Components in Forecasting Annual EPS’. The Accounting Review 67 (1) (January 1): 183–198.

Baginski, Stephen P., Kenneth S. Lorek, G. Lee Willinger, and Bruce C. Branson. 1999. ‘The Relationship Between Economic Characteristics and Alternative Annual Earnings Persistence Measures’. The Accounting Review 74 (1) (January 1): 105–120.

Baldwin, Bruce A. 1984. ‘Segment Earnings Disclosure and the Ability of Security Analysts to Forecast Earnings Per Share’. The Accounting Review 59 (3) (July 1): 376–389.

Bar-Yosef, Sasson, Jeffrey L. Callen, and Joshua Livnat. 1987. ‘Autoregressive Modeling of Earnings-Investment Causality’. The Journal of Finance 42 (1) (March 1): 11–28. doi:10.2307/2328416.

Berger, Philip G., and Rebecca Hann. 2003. ‘The Impact of SFAS No. 131 on Information and Monitoring’. Journal of Accounting Research 41 (May): 163–223. doi:10.1111/1475-679X.00100.

Berger, Philip G., and Rebecca N. Hann. 2007. ‘Segment Profitability and the Proprietary and Agency Costs of Disclosure’. The Accounting Review 82 (July): 869–906. doi:10.2308/accr.2007.82.4.869.

Berger, Philip G., and Eli Ofek. 1995. ‘Diversification’s Effect on Firm Value’. Journal of Financial Economics 37 (1) (January): 39–65. doi:10.1016/0304-405X(94)00798-6.

Botosan, Christine A., and Mary Stanford. 2005. ‘Managers’ Motives to Withhold Segment Disclosures and the Effect of SFAS No. 131 on Analysts’ Information Environment’. The Accounting Review 80 (July): 751–772. doi:10.2308/accr.2005.80.3.751.

Bou, Juan Carlos, and Albert Satorra. 2007. ‘The Persistence of Abnormal Returns at Industry and Firm Levels: Evidence from Spain’. Strategic Management Journal 28 (7) (July 1): 707–722.

Brandon, Charles H., Jeffrey E. Jarrett, and Saleha B. Khumawala. 1983. ‘Revising Forecasts of Accounting Earnings: A Comparison with the Box-Jenkins Method’. Management Science 29 (2) (February 1): 256–263.

Campa, Jose Manuel, and Simi Kedia. 2002. ‘Explaining the Diversification Discount’. The Journal of Finance 57 (August): 1731–1762. doi:10.1111/1540-6261.00476.

Chant, Peter D. 1980. ‘On The Predictability of Corporate Earnings Per Share Behavior’. The Journal of Finance 35 (1) (March 1): 13–21. doi:10.2307/2327177.

Collins, Daniel W. 1976. ‘Predicting Earnings with Sub-Entity Data: Some Further Evidence’. Journal of Accounting Research 14 (1) (April 1): 163–177. doi:10.2307/2490463.

Conroy, Robert, and Robert Harris. 1987. ‘Consensus Forecasts of Corporate Earnings: Analysts’ Forecasts and Time Series Methods’. Management Science 33 (6) (June 1): 725–738.

Cubbin, J., and P. Geroski. 1987. ‘The Convergence of Profits in the Long Run: Inter-Firm and Inter-Industry Comparisons’. The Journal of Industrial Economics 35 (4) (June 1): 427–442. doi:10.2307/2098581.

Dechow, Patricia, Weili Ge, and Catherine Schrand. 2010. ‘Understanding Earnings Quality: A Review of the Proxies, Their Determinants and Their Consequences’. Journal of Accounting and Economics 50 (2-3) (December): 344–401. doi:10.1016/j.jacceco.2010.09.001.

Dichev, Ilia D., and Vicki Wei Tang. 2009. ‘Earnings Volatility and Earnings Predictability’. Journal of Accounting and Economics 47 (1-2) (March): 160–181. doi:10.1016/j.jacceco.2008.09.005.

Ettredge, Michael L., Soo Young Kwon, David B. Smith, and Paul A. Zarowin. 2005. ‘The Impact of SFAS No. 131 Business Segment Data on the Market’s Ability to Anticipate Future Earnings’. The Accounting Review 80 (July): 773–804. doi:10.2308/accr.2005.80.3.773.

Fairfield, Patricia M., Sundaresh Ramnath, and Teri Lombardi Yohn. 2009. ‘Do Industry-Level Analyses Improve Forecasts of Financial Performance?’ Journal of Accounting Research 47 (1) (March 1): 147–178.

Fama, Eugene F, and Kenneth R French. 2000. ‘Forecasting Profitability and Earnings’. The Journal of Business 73 (2): 161–75.

Fama, Eugene F., and James D. MacBeth. 1973. ‘Risk, Return, and Equilibrium: Empirical Tests’. Journal of Political Economy 81 (3) (May 1): 607–636.

Frankel, Richard, and Lubomir Litov. 2009. ‘Earnings Persistence’. Journal of Accounting and Economics 47 (1-2) (March): 182–190. doi:10.1016/j.jacceco.2008.11.008.

Glen, Jack, Kevin Lee, and Ajit Singh. 2003. ‘Corporate Profitability and the Dynamics of Competition in Emerging Markets: A Time Series Analysis’. The Economic Journal 113 (491) (November 1): F465–F484.

Goddard, John, Hong Liu, Philip Molyneux, and John O.S. Wilson. 2011. ‘The Persistence of Bank Profit’. Journal of Banking & Finance 35 (11) (November): 2881–2890. doi:10.1016/j.jbankfin.2011.03.015.

Hund, John, Donald Monk, and Sheri Tice. 2010. ‘Uncertainty About Average Profitability and the Diversification Discount’. Journal of Financial Economics 96 (3) (June): 463–484. doi:10.1016/j.jfineco.2010.02.006.

McGahan, Anita M., and Michael E. Porter. 1997. ‘How Much Does Industry Matter, Really?’ Strategic Management Journal 18 (July 1): 15–30.

———. 1999. ‘The Persistence of Shocks to Profitability’. The Review of Economics and Statistics 81 (1) (February 1): 143–153.

———. 2002. ‘What Do We Know About Variance in Accounting Profitability?’ Management Science 48 (7) (July 1): 834–851.

Mueller, Dennis C. 1977. ‘The Persistence of Profits Above the Norm’. Economica 44 (176). New Series (November 1): 369–380. doi:10.2307/2553570.

Penman, Stephen H. 1983. ‘The Predictive Content of Earnings Forecasts and Dividends’. The Journal of Finance 38 (4): 1181–1199. doi:10.2307/2328019.

Penman, Stephen H., and Xiao-Jun Zhang. 2002. ‘Modeling Sustainable Earnings and P/E Ratios with Financial Statement Analysis’. SSRN eLibrary (June 1). http://papers.ssrn.com/sol3/papers.cfm?abstract_id=318967.

Rogers, W. H. 1993. ‘Regression Standard Errors in Clustered Samples’. Stata Technical Bulletin 13: 19–23.

Ruefli, Timothy W., and Robert R. Wiggins. 2003. ‘Industry, Corporate, and Segment Effects and Business Performance: A Non-Parametric Approach’. Strategic Management Journal 24 (9): 861–879.

Waring, Geoffrey F. 1996. ‘Industry Differences in the Persistence of Firm-Specific Returns’. The American Economic Review 86 (5) (December 1): 1253–1265.

Watts, Ross L., and Richard W. Leftwich. 1977. ‘The Time Series of Annual Accounting Earnings’. Journal of Accounting Research 15 (2) (October 1): 253–271. doi:10.2307/2490352.