National Chiao Tung University,National Taipei University;Financial Holding Co, Taiwan
The existing literatures claim the diversified firms have “diversification discount”. Rajan et al.(2000) argue” diversification discount” is due to cross subsidization. Therefore, more cash holdings could induce more cross subsidization. Duchin (2010) claim that diversification allows firms to hold less cash is the assumption that the reduction in cash holdings is optimal because firms save on the costs of holding cash. The above literatures argue that the diversified firms with more cash holdings will have a reduction of firm value. However, Faulkender and Wang (2006) find that the market perceives the presence of market frictions that make raising outside capital costly. The market rewards firms that retain liquidity with higher valuations, consistent with such firms being able to create more value than an otherwise equivalent firm with less internal cash. Therefore, we think that cash holdings could also reduce diversification discount. In this paper, we would like to examine how corporate cash holdings affect the diversification discount. Our empirical results find that higher level of corporate liquidity (cash holdings) mitigates diversification discount effect on firm value.