Roberto

Summary of the Paper

The paper investigates a specific trait of the time-series characteristics of earnings and, in
particular, the relative persistence of their macroeconomic and of their firm-specific
components. The authors develop a system of equations in which they i) first, construct
estimates of the firm-specific and the macroeconomic components of income (equations (5)
and (6)), and then ii) use these estimates to compute the persistence of each of the
components (equation (4)). The primary results indicate that the macroeconomic component
of earnings is more persistent than the firm-specific one and that the well-documented low
persistence of losses is driven by the firm-specific component. The paper also shows that the
different persistence of macro and firm-specific earnings has capital market and real effects.
In particular, the macro component of earnings is more strongly associated with analyst
forecasts, equity market returns and future firm investments.

Comments

The idea that a firm’s earnings are the compound of different components with different
degrees of persistence has been widely addressed in the past. The sample used in the analysis
is fairly standard. As a consequence, the primary interest and the primary contribution of the
paper potentially lie in its ability to properly identify the components of earnings, which is
mainly an econometric exercise. I have some concerns regarding this dimension:

 The authors estimate the firm-specific and macroeconomic components of income

developing the empirical specification of equation 5), Yt = A + ΓXt + et. In the
subsequent persistence equation, the macroeconomic component M is computed as
𝛤̅ 𝑋 and the firm-specific component F equals 𝑒̅. This seems to suggest that the two
estimated components of earnings are entered into the persistence equation
asymmetrically. While the macro component is considered in its level, the firm-specific
component is considered in its innovation factor, since the constant 𝐴̅ (capturing the
time-invariant portion of the firm-specific component) is not included in the
persistence equation. As a consequence, the observed lower persistence of the firm-
specific component might be due to the different forms in which the two components
are respectively considered
 ̅ represents an innovation factor while M (𝛤̅𝑋) represents a level, F also
Not only F (𝑒)
includes non-firm-specific components of earnings. In particular, the macro
component of earnings which is not properly captured by 𝛤̅𝑋 will be part of the error
term of equation 5) and, therefore, reflected in F. As a consequence, the persistence
of the firm-specific component is also a function of the quality of the econometric
specification used to describe the macro dimension of earnings
  The capital market and the real effect implications of earnings persistence are an
interesting part of the analysis, with potentially practical implications. However,
similarly to above, the interpretation of these results significantly lies in the quality of
the econometric analysis developed in the initial part of the paper

In general, the authors do not provide many institutional insights on the real-world
mechanism that may drive the different persistence of the macro and the firm-specific
portions of a firm’s earnings. As a consequence, their paper primarily relies on the quality of
their econometric approach. My knowledge of time-series econometrics is only limited, but I
still believe that the observed different degrees of persistence might be driven by the
empirical choices of the authors. I suggest the authors consider the richness and the variation
of the institutional setting (such as, of different industries) to investigate their research
question and recommend the rejection of the current version of the paper.