The impact of international and industrial diversification strategies on the cash flow sensitivity of cash

Abstract

PurposeThe purpose of this paper is to examine the impact of the two diversification strategies on firms' propensity to save cash out of cash flow.Design/methodology/approachThe author examines the quarterly data of Compustat's active and research firms from the first quarter of 1999 to the last quarter of 2005, with a sample size of more than 79,000 firm quarters. A two‐step GMM Instrumental Variable regression of change in cash holdings, on variables that measure the degree of industrial as well as international diversification strategies, is employed to investigate whether each diversification strategy alleviates or exacerbates firm's propensity to save cash out of its cash flows.FindingsEvidence is found that industrial diversification mitigates the propensity of firms to save cash out of their cash flows. When the sample is partitioned into financially constrained and financially non‐constrained firms, industrial diversification reduces propensity of firms to save cash out of cash flows for financially constrained firms but not for financially non‐constrained firms. On the other hand, the results do not indicate any impact of international diversification on the sensitivity of cash to cash flows.Originality/valueThe paper tests, empirically, whether international and industrial diversification strategies affect the propensity of firms to save cash out of their cash flow.