The Effects of True and Perceived Ability on Analysts' Forecasting Behavior

We model the existence of an equilibrium in which analysts adopt a threshold reporting strategy to convey their forecasting ability. Under this strategy, an analyst issues a forecast only if the realized value of her private signal exceeds a threshold value. Higher-ability analysts choose higher threshold levels than lower-ability analysts, and the market correctly interprets all analysts' forecasts. Our model produces implications for using sample mean squared forecast error to measure analysts' ability, offers alternative explanation for the observed bias in analysts' forecasts, and produces testable predictions concerning analysts' decisions to follow a firm and to issue forecasts for firms they follow