Cash Holdings and Corporate Diversification
70 Pages Posted: 6 Sep 2008 Last revised: 26 Oct 2009
Date Written: September 6, 2008
Abstract
This paper studies the relation between corporate liquidity and diversification. The key finding is that multi-division firms hold significantly less cash than standalone firms because they are diversified in their investment opportunities. Lower cross-divisional correlations in investment opportunity and higher correlations between investment opportunity and cash flow correspond to lower cash holdings, even after controlling for cash-flow volatility. The effects are strongest in financially constrained firms and in well-governed firms, and correspond to efficient fund transfers from low- to high-productivity divisions. Taken together, these results bring forth an efficient link between diversification in investment opportunity and corporate liquidity.
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