firm diversification and the value of corporate cash holdings.pdf

Firm Diversification and the Value of Corporate Cash Holdings Zhenxu Tong University of Exeter* Paper Number: 08/03 First Draft: June 2007 This Draft: February 2008 Abstract This paper studies how firm diversification affects the value of corporate cash holdings. We develop four hypotheses based on efficient internal capital market, agency problems, coinsurance effect, and shareholder-bondholder conflicts. We find that the value of cash holdings is lower in diversified firms than single-segment firms. We find that firm diversification is associated with a lower value of cash in both financially unconstrained and constrained firms, and that the value of cash is even lower for the diversified firms with more restrictions on shareholder rights. The findings are most consistent with the interpretation that firm diversification reduces the value of corporate cash holdings through agency problems. JEL Classification : G32; G34 Keywords : Firm diversification; Corporate cash holdings ___________________ * Address: Xfi Centre for Finance Investment, School of Business and Economics, University of Exeter, Rennes Drive, Exeter EX4 4ST, United Kingdom. Telephone: +44 1392 263155. E-mail address: z.tong@exeter.ac.uk. I would like to thank Paolo Volpin, Gregory Connor, Chris Veld, and the seminar participants at University of Exeter for their comments and suggestions. 1. Introduction There is a large empirical literature that studies the impact of firm diversification on shareholder value. Lang and Stulz (1994), and Berger and Ofek (1995)