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Agency costs of free cash flow, internal capital markets and unrelated diversification

Raffaele Staglianò, Maurizio La Rocca () and Tiziana La Rocca
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Raffaele Staglianò: MRM - Montpellier Research in Management - UPVM - Université Paul-Valéry - Montpellier 3 - UM2 - Université Montpellier 2 - Sciences et Techniques - UPVD - Université de Perpignan Via Domitia - UM1 - Université Montpellier 1 - Groupe Sup de Co Montpellier (GSCM) - Montpellier Business School - UM - Université de Montpellier
Tiziana La Rocca: University of Messina

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Abstract: This paper investigates whether free cash flow arguments or the internal capital market perspective better explains diversification decisions. Based on a unique panel of hand-collected data from listed and unlisted Italian firms for the 1980–2010 time period, the results of this study generally reveal the predominant role of the internal capital market arguments. The benefits of unrelated diversification, which include the avoidance of costly external financing, outweigh its costs, which involve opportunistic problems. Although the literature suggests two distinct forces concurrently affect diversification decisions, in the Italian context, financial benefits appear to be the prevailing motivation for unrelated diversification decisions. Furthermore, the internal capital market argument has a strong effect on decisions to engage in unrelated diversification, particularly with respect to firms that are sensitive to financial constraints.

Date: 2014-03
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Published in Review of Managerial Science, Springer Verlag, 2014, 8 (2), pp.145-174. ⟨10.1007/s11846-013-0098-0⟩

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DOI: 10.1007/s11846-013-0098-0

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