Variations in Valuation Methodologies and the Cost of Capital: Evidence from MENA Countries

ABSTRACT

Does the capital asset pricing model (CAPM) reflects the real risks perceived in doing business in countries in the Middle East and North Africa (MENA)? To explore this question, first, we examine whether the CAPM yields consistent results in calculating the weighted average cost of capital (WACC) as applied by different academic databases, by comparing three different academic databases for 736 listed companies on stock exchanges in the MENA region. Second, we examine whether practitioners use the WACC inputs and calculations consistent with academic databases, through an analysis of 83 companies and in-depth interviews with 8 financial institutions. We also explore adjustments made by practitioners to reflect the real risk they perceive in MENA countries.

KEY WORDS:

• beta
• capital asset pricing model (CAPM)
• cost of equity
• equity risk premium (ERP)
• Middle East and North Africa (MENA)
• valuation methodologies
• weighted average cost of capital (WACC)

Notes

1. The study used five categories as proxies for external governance at the country level: (1) the investor protection index, which is the principal component of indices of disclosure requirements, liabilities standards, and anti-director rights, from La Porta, Lopez-de-Silanes, and Shleifer (2006), (2) the private enforcement index from La Porta, Lopez-de-Silanes, and Shleifer (2006), (3) the public enforcement index from La Porta, Lopez-de-Silanes, and Shleifer (2006), (4) the law enforcement index, which is the average of rule of law, judicial efficiency, corruption, risk of expropriation, and the contract repudiation index, from La Porta et al. (1998), and (5) the anti-self-dealing index from Djankov et al. (2008). All the regressions include the country-fixed effect, the year-fixed effect, and the industry-fixed effect.

2. The IQI is measured using six variables: (1) voice and accountability, (2) political stability and absence of violence, (3) government effectiveness, (4) regulatory quality, which measures the ability of the government to formulate and implement policies that promote private investment, (5) rule of law, and (6) control of corruption.