The accounting valuation of bank stocks in Europe

In this study we examine the validity of the earnings-book value capitalization model in the pricing of bank stocks in Europe. We perform cross-sectional tests using a sample of banks operating in 21 European Union countries. We split our sample into code and common law countries to control for the influence of the financial reporting system upon the pricing of earnings and book value. Our empirical findings suggest that disaggregating total reported clean surplus income into reported gains and losses from securities and other income increases the explanatory power of the accounting valuation model. Indeed, reported gains and losses from securities are priced lower than other income, irrespective of whether the financial reporting system is classified as a code or a common law system, probably because the market considers the former as a less stable source of income. Additionally, we observe that the pricing of both earnings and book value is influenced by the financial reporting system. We conclude that earnings announced under a common law financial reporting system are priced differently from those reported under the respective code law system. Finally, we provide evidence that comprehensive and dirty surplus income are two value relevant variables for banks reporting earnings under the code law system, although dirty surplus income is priced lower than clean surplus income.