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Diversification and Cash Dynamics

59 Pages Posted: 21 Jan 2016  

Tor-Erik Bakke

University of Oklahoma - Division of Finance

Tiantian Gu

D’Amore-McKim School of Business, Northeastern University

Date Written: January 19, 2016

Abstract

Why do diversified firms hold significantly less cash than focused firms? We study this 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 while the diversification event itself reduces cash holdings by 32%.

Keywords: Diversification, organizational structure, corporate saving, cash, investment

JEL Classification: G30, G32, G34

Suggested Citation

Bakke, Tor-Erik and Gu, Tiantian, Diversification and Cash Dynamics (January 19, 2016). Journal of Financial Economics (JFE), Forthcoming; Northeastern U. D’Amore-McKim School of Business Research Paper No. 2718359. Available at SSRN: https://ssrn.com/abstract=2718359

Tor-Erik Bakke

University of Oklahoma - Division of Finance ( email )

Norman, OK 73019
United States

Tiantian Gu (Contact Author)

D’Amore-McKim School of Business, Northeastern University ( email )

360 Huntington Ave
Hayden Hall, Room 413
Boston, MA 02115
United States

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