Industry Effects on Firm and Segment Profitability Forecasting: Do Aggregation and Diversity Matter?

This paper analyzes the incremental advantage of industry-specific models of profitability forecasting, over economy-wide models, for business segments and firms. Some prior research suggests that industry-specific analysis has no advantage over economy-wide analysis in forecasting firm profitability. This seems puzzling because many studies in economics and strategic management have documented the importance of industry effects in explaining firm profitability. We reconcile this apparent inconsistency by showing that industry effects on profitability forecasting exist at the more refined business segment level, but can be obscured by aggregated reporting at the firm level. Industry-specific forecasts are significantly more accurate in predicting profitability for segments and undiversified firms. The limited usefulness of industry-specific forecasting models at the firm level can be explained by the existence of multiple business segments in firms