Does the firm-analyst relationship explain analysts' forecast errors?

Summary The paper tests to what extent the intensity of the relationship between a firm and a financial analyst improves or degrades the accuracy of the forecasts produced by this analyst on this firm. Using a sample of earnings per share (EPS) forecasts for 208 French firms, we regress the analysts' forecast error on a set of observable variables. We then decompose the fixed effect of the regression and use the firm-analyst pair effect as a measure of the intensity of the relationship. We show that a small (large) pair effect is associated with a small (large) forecast error, suggesting that a close relationship between a firm and an analyst tends to bias the analyst's forecast. Experienced analysts who specialize in tracking large-cap firms, however, seem less prone to this bias.