Diversification and Cash Dynamics
59 Pages Posted: 21 Jan 2016
Date Written: January 19, 2016
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
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