Are profits procyclical?

Question

This is somewhat related, but distinct from Cyclicality of Markups

Basically, I'm looking for papers on whether firms profits are (on average) procyclical or not, and I appreciate theoretical, but look mainly for empirical papers.

Answer 1

My reading is yes, it is procyclical in levels and margins.

This paper uses industry and firm data to look at price cost mark-ups and firm profit margins in U.K. manufacturing and services. In particular it examines how they behave over the business cycle. It has two main findings. First, the estimated average mark-ups and the profit margin results both suggest that there is imperfect competition in manufacturing and services. Second, mark-ups are pro-cyclical, as are profit margins even after allowing for movements in their standard determinants. This suggests that price pressures may increase during recovery periods and decrease during recessions. One possible explanation for this is Kreps and Scheinkman's argument that the pro-cyclicality of capacity constraints means that firms move between Cournot and Bertrand competition over the cycle. The finding that mark-ups are pro-cyclical also raises doubts about macroeconomic models that assume that demand shocks may affect employment via counter-cyclical mark-ups.

The Cyclicality of Mark-Ups and Profit Margins: Some Evidence for Manufacturing and Services

In this paper, we assess the cyclicality of mark-ups and profit margins within the United Kingdom, at both the aggregate and industry level. We find that the private sector labour share moves countercyclically, suggesting that the aggregate mark-up moves procyclically. This result survives when we consider more sophisticated measures of the mark-up. And this result is also supported by industry-level data. We find that the aggregate market sector profit share moves procyclically and that the cyclical behaviour of profit margins is largely homogenous across industries. Nevertheless, there is some evidence that margins moved against the cycle in the late 1990s, starting to fall in 1997, whereas GDP growth did not peak until 2000. In tandem with these cyclical movements, we also find that the market sector profit share has trended upwards since 1970, in contrast to the aggregate mark-up, which fell over the same period.

The Cyclicality of Mark-Ups and Profit Margins for the United Kingdom: Some New Evidence

Modeling cash flows separately from aggregate consumption is crucial since corporate cash flows have historically been far more volatile and sensitive to economic shocks than has aggregate consumption. For example, corporate earnings have been more than ten times as volatile as consumption growth during the post-war period. Similarly, while aggregate consumption declined nearly 10 percent during the early stages of the Great Depression, aggregate corporate earnings were completely obliterated as they fell more than 103 percent. In addition to being more volatile, corporate cash flows are also highly correlated with aggregate consumption because of their strong procyclical behavior. To provide specifics, during the 1929 to 2001 period the volatility of earnings growth was 29.5 percent, while the correlation between per capita real consumption and earning growth was 68.7 percent.

Intuitively, the reason for the extreme volatility and procyclicality of corporate earnings is that stockholders are residual claimants to corporate cash flows. Thus, the compensation of workers is a senior claim to cash flows. In other words, labor contracts provide workers with some degree of insurance against business cycle risk. These contracts make the fraction of labor income in output (or consumption) countercyclical, while the fraction of earnings in output is procyclical. Gomme and Greenwood (1995) document that these business-cycle-related changes in labor income and earnings can be found in many countries. CORPORATE EARNINGS AND THE EQUITY PREMIUM

Finally, On the cyclical allocation of risk P.117 shows that Labor’s share of income (in Australia, Austria, Britain, Canada, France, Germany, Japan, and the USA) is negatively contemporaneously correlated with the seasonal component of aggregate income, suggesting that when aggregate income is high profit margins are high.