Quality Earnings: Insights from Comparing GAAP to NIPA Earnings

The U.S. Bureau of Economic Analysis produces a measure of aggregate corporate profits (NIPA earnings), which is an integral component of the accounting for GDP. The key advantage of NIPA earnings is rigorous determination with no earnings management and no political meddling; other advantages include double-checks from independent sources and consistent rules over time. Thus, NIPA earnings provide a useful counterpoint to GAAP measures of corporate profits. Using a sample of aggregate GAAP and NIPA earnings over 1950-2010, the main findings are as follows. GAAP and NIPA earnings are in remarkable sync in the early years, with similar means and standard deviations, and with earnings changes correlating at 0.89 during 1950-1980. This close relation greatly deteriorates, however, during the second half of the sample, 1981-2010. While the behavior of NIPA earnings remains roughly the same over these two periods, the volatility of GAAP earnings increases ten-fold, and the correlation between GAAP and NIPA earnings changes falls to 0.35. Additional tests reveal that the increase in the volatility of GAAP earnings is mostly due to rapid earnings reversals, and especially the effect of large transient items during economic downturns. Overall, the evidence points to little change in economic fundamentals over time, while there is substantially increased noise in the GAAP measurement of corporate profitability.