The Pricing of Bank Stocks in Europe

In this study we examine the validity of the earnings - book value capitalization (EBVC) model in the European banking sector. We perform cross section tests using a sample of credit institutions from 21 European Union countries. Moreover, we split our sample into code law and common law countries to check for the influence of the accounting regulatory regime upon the earnings response coefficients. Our empirical findings suggest that disaggregating total reported clean surplus income into income from banking activities and other income increases the explanatory power of the EBVC model. Income from banking activities is priced higher than income from non-banking activities, irrespective of whether the financial sector is classified as a code law or a common law system, probably because the market considers the former as a more stable source of income. Earnings reported under a common law accounting system are priced differently from those reported under a code law accounting system. We also provide evidence that comprehensive income and dirty surplus income are two value relevant variables for banks reporting under a code law system, although dirty surplus income is priced lower than clean surplus income