Firm performance and macro-economic variables

The purpose of this research is to predict the fundamental performance of a firm as measured by the rate of return on assets (ROA). The paper presents a model relating ROA to prior year ROA and to the level of activity in the economy. A principal components' analysis of thirty-three economic indicators was used. The variables used were drawn from the main theories/perspectives on macro economic behaviour. These were the Leading and Coincident Indicators perspective, Supply or Cost-Push Theories, Monetary Economics, and Savings-Investment theories. Three factors emerged and were labelled as an Output Factor, Interest Factor, and a Corporate Activity Factor. A four variable model incorporating a lead-lag relationship of ROA, percentage change in Gross Domestic Product (the output factor), prior year interest rate on Treasury Notes (the interest rate factor), corporate profits (the corporate activity factor) was significant. R2 values in excess of .65 indicates considerable aggregate explanatory power. We conclude that firm performance is a function of the prior year ROA, and macro-economic variables. The lead lag model suggests that earnings forecasts may be made based on the model presented in this study.