In this paper we use information external to the firm to condition forecasts of future firm performance. Starting with the well-known negative relation between inventory growth and future firm performance, we find that the strength of this relation is attenuated when related firms are also engaging in contemporaneous investment activity.
Based on a sample of 555,696 U.S. firm-months from 1988 through 2010, we find that knowledge of investment decisions in related firms helps to condition the negative relation between inventory growth and future firm performance. We use the Bureau of Economic Analysis's industry-level "make" and "use" tables — standard data about how raw materials are distributed among different sectors of the economy — to construct an industry-level input-output linkage table. When firms in related industries as identified by this input-output table experience contemporaneous relative growth (contraction) in their respective asset base, the negative relation between inventory growth and future firm performance for the firm is much weaker (stronger).
By using information external to the firm it is possible to identify potentially exogenous determinants of accounting quality choices that can then be linked to other outcome variables such as cost of capital.