The sample is a panel of non-financial firms publicly traded from 2001 to 2010, with the main sample including 24,000 firm-year observations, of which approximately 45% are diversified firms. To account for industrial heterogeneity in corporate finance, we adjust the debt-to-asset and cash-to-asset ratios for industry effects by matching a firm’s industrial segments to representative focused firms in the same industry, following the excess value approach proposed by Berge and Ofeck (1995) in their seminal study of firm value.
Regressions provide robust evidence for the more-money and less-cash effects of diversification. That is, diversified firms are more leveraged while holding less cash than focused firms in the same industries, even after controlling for the standard determinants of capital structure, omitted variables, and the endogeneity of firm scope. These results are consistent with the notion that the coinsurance generated by a wide industrial scope enables firms to be aggressively financed. A novel finding is that the aggressiveness of corporate finance is increased by both the bright and dark sides of diversification; given firm scope, leverage increases and cash holdings decrease with allocative efficiency (inefficiency) when firms have an efficient (inefficient) internal capital market. This finding suggests that although coinsurance is important in generating the observed effects of firm scope on finance, it is not the sole mechanism underlying them.