The Usefulness of Negative Aggregate Earnings Changes in Predicting Future Gross Domestic Product Growth

• In Event: Accounting information and Economic Forecasting

Abstract

Prior research shows that aggregate accounting earnings growth predicts future nominal gross domestic product (GDP) growth and that professional macro forecasters do not fully incorporate the information contained in aggregate accounting earnings. Due to accounting conservatism, accounting earnings reflects bad economic news in a timelier manner than good news. Therefore, we argue that a model conditioning earnings changes on the direction of the change should be better able to predict future GDP growth rates. We find that only negative changes in aggregate accounting earnings predict future GDP. Furthermore, we show that professional macro forecasters underreact to negative changes in aggregate accounting earnings in particular. In additional tests we find that our results are driven by the accrual component of aggregate earnings. We also find that our results are strongest in the cross section of firms that are more conservative (top 50th percentile of C-Score). Overall, our results suggest that accounting conservatism results in negative earnings being more helpful in predicting macro-economic data than positive earnings.

Authors

• Fabio Bredariol Gaertner, University of Wisconsin-Madison

• Logan B Steele, University of Wisconsin-Madison

• Asad Kausar, Nanyang Technological University