Does corporate diversification affect cash holdings and the value of cash? European evidence

Abstract

PURPOSE OF THE STUDY

The purpose of this thesis is to examine the relation between corporate diversification and corporate cash from two perspectives. First, the thesis focuses on the effect of diversification on cross-sectional cash holdings, and second, it tests for the effect of diversification on the value of the corporate cash holdings. This thesis contributes to the existing literature in two ways. The relation between corporate diversification and cash has been so far studied only in the US, and by focusing on European companies the thesis is able to provide new evidence on the field. Moreover, the thesis fills in a gap by testing the effect of the imperfect correlation of investment opportunities and cash flows of the business segments of diversified firms on the value of corporate cash holdings.

DATA

The data of this study consists of observations from public UK-based, French and German companies in the 12-year period from 1997 to 2008. The thesis has two different empirical parts for which only the methodology of measuring corporate diversification is common. The sample sizes for the cash holdings and value of cash tests amount to 13,597 and 10,395 firm- year observations, respectively.

RESULTS

The main finding of this thesis is that corporate diversification reduces corporate demand for cash in European companies. Similarly as in the US, diversification affects cash holdings mostly through the reduction of investment risk. Evidence on financially constrained companies being more sensitive to diversification in their cash holdings than unconstrained firms is inconclusive. Contrary to the US evidence, in Europe investors are indifferent to corporate diversification when valuing corporate cash holdings. Thus, investors do not expect agency problems in diversified companies, however, they do not discount the value of corporate cash holdings according to the risk reduction achieved through diversification either.