What GAAP Earnings Reveal About the Future Job Market

Analysts have long looked to aggregate earnings news to predict future economic growth, inflation, and even monetary policy. But can those GAAP earnings also predict the future path of the labor market?

In new research, Maryland Smith’s Rebecca Hann, working with co-authors (Maria Ogneva from the University of Southern California and Congcong Li from Duquesne University), seek to answer this question by tying aggregate earnings and their components to aggregate job creation and destruction – essentially forecasting future hiring and future layoffs.

Forecasting labor market growth is taking on particular significance today.

“Even in normal times, many people closely watch the job numbers from the BLS, which are released on the first Friday of each month. These numbers tell us about companies’ hiring and firing decisions, which are key indicators for the outlook of the economy. With the current pandemic, the numbers from the job reports are even more revealing. When job gains were slower than expected in September, we feared that there would be more layoffs. When the October report came out last week showing that job growth is stronger than expected and the jobless rate is lower, many viewed that as a sign of a slow recovery.” Hann says. While the future direction of the labor market may be difficult to forecast in current times, Hann’s research shows that information in a firms’ financial statements can act as a key predictor.

The study, to be published in The Accounting Review, adds to a growing body of research that explores what corporate earnings in aggregate can tell us about future macroeconomic outcomes.

“In prior research, we often focus on the information content of earnings at the firm level. But earnings have a firm-specific, an industry, and a market component. When you aggregate firm-level earnings together, the firm-specific news is mostly diversified away,” says Hann. “And hence shocks in earnings at the aggregate level can tell us where the economy is going.”

“The link between aggregate earnings and job flow is quite intuitive,” says Hann. “We know from prior work that job flows are 'lumpy' – that means firms don’t often make big hiring and firing decisions because it is costly to adjust the size of their workforce, but when they do, they tend to make bigger moves in either direction. Put differently, firms tend to adjust their workforce only when they have to, that is, when they face relatively large shocks.” Hann continues to explain why "core” earnings are particularly relevant in this context. “The 'core' component of earnings – the part of earnings that is persistent – is more likely to trigger labor market changes. Think of a positive earnings shock that affects the company’s profit not just for one period, but for the foreseeable future – these are shocks that can trigger companies to rethink their hiring decisions.”

The fact that accounting information has thematic components, that it can predict future job flows, is perhaps not surprising, Hann says. “But what is surprising is that it has information over and above other well-known macroeconomic indicators – that bottom-up earnings can tell us something about the economy that is not already reflected in GDP growth, inflation, or other leading indicators.”

Read the full research, “Another Look at the Macroeconomic Information Content of Aggregate Earnings: Evidence from the Labor Market,” in The Accounting Review.