The impact of corporate diversification on liquidity management: Evidence from lines of credit

Abstract

We examine the impact of organizational structure on corporate liquidity, specifically focusing on how business diversification influences firms’ choice between bank lines of credit and cash holdings. Using a large sample of publicly traded companies from both developed and emerging markets, we observe that diversified firms operating across multiple industries (segments) tend to rely more heavily on bank lines of credit than their more focused counterparts. We find that lower correlations in the investment opportunities across business segments and higher correlations between investment opportunities and cash flows are associated with a greater reliance on bank lines of credit as a source of corporate liquidity. Moreover, for Emerging Market firms that face binding financial constraints, the effect of diversification on liquidity management is stronger. Our findings do not support the notion that this behavior is driven by diversified firms with lower aggregate risk or better corporate governance. Instead, the results are consistent with the monitored insurance hypothesis, where diversified firms with lower liquidity risk and hedging requirements use bank lines of credit more extensively.