Price Models and Earnings Response Coefficients

We extend the Kothari-Zimmerman (1993) study of price- earnings models to a more general accounting based valuation model. In this more general setting earnings response coefficients are not usually equal to the reciprocal of the firm's cost of equity capital. Moreover the price-earnings models considered by Kothari and Zimmerman (1993) can lead to upward biased estimates of the true earnings response coefficient. Using data for UK companies we first replicate the findings of Kothari and Zimmerman and then present new evidence that rejects the simple price earnings model in favour of the general model