Diversification and cash dynamics

Why do diversified firms hold significantly less cash than focused firms? We study this question using a dynamic model of corporate investment, saving, and diversification decisions. We find that investment dynamics are more important in explaining the cash differences than financing frictions. More...

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Bibliographic Details
Published in:Journal of financial economics 2017-03, Vol.123 (3), p.580-601
Main Authors: Bakke, Tor-Erik, Gu, Tiantian
Format: Article
Language:English
Subjects:
Capital market
Capital markets
Cash management
Conglomerates
Corporate saving
Diversification
Internal capital markets
Investment
Organizational structure
Studies
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Summary:Why do diversified firms hold significantly less cash than focused firms? We study this question using a dynamic model of corporate investment, saving, and diversification decisions. We find that investment dynamics are more important in explaining the cash differences than financing frictions. More efficient internal capital markets increase cash differences and are especially valuable when a firm diversifies or refocuses. Contrary to static models, more diverse conglomerates have lower cash differences. Endogenous selection (diversifying firms are larger and have better growth opportunities) accounts for 68% of the cash difference, and the diversification event itself reduces cash holdings by 32%.
ISSN:0304-405X
1879-2774
DOI:10.1016/j.jfineco.2016.12.008