The search for profits by entrepreneurs and corporate leaders is one of the key incentives to technology development, efficient organization and the hiring of best talent. Yet, while profits are core to economic performance they are also known to vary significantly with the business cycle. This paper seeks to characterize the behavior of profits over the economic cycle. First, does the average growth in profits over time exhibit a mean-reverting behavior?  That is, does the growth in profits exhibit a tendency to return to some average value? Second, how volatile are profits and does this volatility obscure the message of profit growth? Third, does the volatility of profits limit our ability to draw inferences about the trend growth rates of profits? Finally, are growth rates subject to structural change?

In this paper we first divide the corporate profit growth rate series into decades to test if all data share the same characteristics—average growth rate and standard deviation -- and whether there is any change in the characteristic of the trend in profits over time. In addition, we test whether fluctuations around the mean are constant or not, through ARCH/GARCH methods.

Our key findings are that the American corporate world was poorly prepared for the volatility of energy prices and the rapidly rising inflation of the 1970s. As a result the volatility of profit growth was significant and highest, as measured by the standard deviation of 14.67, during this period relative to all other periods. For the subsequent three decades we see that the average growth rate of profit declined as did the volatility (standard deviation) of that growth rate. This pattern suggests that the structure of the corporate sector was changing to a slower growth, less volatile marketplace. Our analysis suggests that 1990-1999 is the most stable period as 1990s had the smallest standard deviation. In addition, we calculated a stability ratio (standard deviation as percent of mean) for each decade and concluded that 1990s was most stable while 1980s was most volatile.

The present study presents three conclusions on the behavior of profits often neglected by traditional approaches to profit modeling. First, one very important issue is non-stationarity of corporate profits. Second, we exploit modern time series modeling techniques, i.e., unit root and ARCH, to examine the linear/non-linear character of the profit model as well as the stability of its variance. We found a strong ARCH effect which tells us profits growth fluctuates around a mean but these fluctuations are larger for some periods than others.

Third, during each decade the rate of growth of profits had a different mean and standard deviation. In each case the standard deviation was greater than the mean and we found an ARCH effect for each decade. Therefore, we will extend our research to test whether corporate profits exhibit a structural change and the possibility of outliers. We will employ the Maddala and Kim (1998) approach and will test unit root under structural change conditions.