The Determinants of the Cost of Capital by Industry within an Emerging Economy: Evidence from Egypt
Year: 2004
Type: preprint
Abstract: ABSTRACT Although many studies have been undertaken on the cost of capital, insufficient attention has been paid to the factors that drive the cost of capital in the emerging markets, in particular the Middle East region. Here, an analysis is undertaken of the cost of capital in Egypt, based on a sample of 119 companies. A number of models are used to measure the cost of equity and in turn the overall cost of capital, which is calculated on the basis of both book and market values. Broadly speaking the cost of equity is around 12.5 per cent and the overall cost of capital roughly around 12 per cent. Step-wise multiple regressions are used to find the underlying determinants. Generally, growth and size are particularly important. Also, for actively traded companies and for heavy industries, in particular, financial and business risks are significant factors. For the contracting and real estate sector, which has a higher cost of capital, fixed asset backing is another key variable. In the food sector, liquidity is one of the important determinants. Finally, a satisfactory model was not found to explain the cost of capital in the service sector. JEL: G35, N25 Keywords: Cost of capital; Equity; Debt; Leverage; Stock market; Egypt I. INTRODUCTION The cost of capital has been a popular issue in corporate finance, yet little is known about the cost of capital on a broader menu of emerging markets (Barry et al, 1998). Since most of the emerging markets were established recently, i.e. in the past couple of decades, the data series of companies listed in these markets seem to be short and this might explain the scarcity of such studies in emerging markets. However, emerging markets in the Asian and Latin American regions have enjoyed a long history compared with other places, in turn some work on the cost of capital has already been performed. At the other extreme, the Middle East region has not attracted comprehensive work on the stock markets because most of these countries embarked on economic reform programmes only in the recent decades, which have enabled them to establish or resurrect their stock markets (Omran, 1999). This paper empirically investigates the cost of capital in Egypt, as Egypt can be considered as one of the most promising financial centres in this region. Using a sample size of 119 Egyptian companies, the results indicate that the cost of equity is around 12.5 per cent and the overall cost of capital roughly around 12 per cent. As for the determinants, growth and size are found to be particularly important. Financial and business risks are significant factors for actively traded companies and for heavy industries. For the contracting and real estate sector, which has a higher cost of capital, fixed asset backing is another key variable. In the food sector, liquidity is one of the important determinants. Finally, a satisfactory model was not found to explain the cost of capital in the service sector. The rest of the paper is organised as follows: Section II deals with the background concerning Egypt's stock market, followed by Section III which highlights some empirical studies concerning the variables that have been found to affect the cost of capital for companies. The methodology and data are given in Section IV, covering specifications of the empirical models. The empirical findings in Section V constitute the main thrust of the paper, utilising ANOVA and step-wise multiple regressions. Finally, the summary and concluding remarks are contained in Section VI. II. BACKGROUND The stock market activity in Egypt goes back as far as 1881. Alexandria stock exchange was the fifth established in the world after those of Inverness (1536), Amsterdam (1608), London (1666), and Paris (1808). Cairo stock exchange was later established in 1903 (Capital Market Authority, 1996a). However, a significant change affected the stock market in Egypt in the late 1950s, as this period witnessed the start of massive and successive waves of nationalization that had radically changed the structure of the economy and this in turn had a devastating effect upon the stock market. …
Source: SSRN Electronic Journal
Authors: Mohammed Omran, John Pointon, Drake Circus
Institution: University of Plymouth
Language: English
Subfield: Strategy and Management
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W3125326853