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Asia Pacific Journal of Management

Erschienen in:

27.05.2020

Business group affiliation, corporate diversification, and cash holdings

verfasst von: Kan Nakajima, Takafumi Sasaki

Erschienen in: Asia Pacific Journal of Management | Ausgabe 1/2022

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Abstract

This paper investigates how horizontal business group affiliation affects cash holdings of member firms. Although firm-bank lending and equity ties have weakened since the 1990s, Japanese horizontal keiretsu may still have some financial benefits. We focus on the impact of horizontal business group affiliation on unprofitable cash holdings, which has been one of the most important managerial issue in the past two decades. Using the samples of Japanese firms from 2004 to 2014, we find that horizontal business group affiliation reduces cash holdings even after controlling for firm-bank equity and lending ties. We argue that stable business ties among group firms reduce uncertainty for future cash flows and thus mitigate precautionary demands for cash. Our results also suggest that horizontal business affiliation plays a similar role with corporate diversification in reducing cash holdings.

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Bates et al. (2009) show that the cash-to-assets ratios of US firms more than doubled from 1980 to 2006. They argue that this can be mainly attributed to increasing precautionary demands for cash prepared for research and development (R&D) investment. Relatedly, Brown and Petersen (2011) show that companies with financing frictions use cash to smooth R&D investment.

Rajan and Zingales (1995) report that Japanese companies held larger amounts of cash than other G7 countries. Iskandar-Datta and Jia (2012) also show that cash balances of Japanese firms are the highest among seven industrialized countries, although the difference between Japan and other countries in this regard shrunk significantly in the 1990s. Pinkowitz and Williamson (2001) present evidence consistent with the argument that high cash holdings in Japan can be attributed to the power of banks.

Relatedly, Yan et al. (2010) show that diversified firms are well-positioned to circumvent financing shocks. They document that investment declines in focused firms when external capital becomes costly but remains unchanged in diversified firms. This result suggests a weaker financing constraint for diversified firms.

In fact, member firms have decreased borrowing from their main banks and resolved cross-shareholdings with main banks.

Extant research argued three benefits of Japanese horizontal keiretsu; 1)ready access to bank loans, 2)monitoring, and 3)risk reduction, and main banks play important roles in facilitating these benefits (Dow et al. 2011). For the pros and cons of business groups, see the survey of Carney et al. (2011).

In contrast to the market-centered corporate governance systems, the bank-centered systems of Japanese firms worked well in the 1980s (Aoki and Patrick 1993; La Porta et al. 2000).

Mergers of large banks result in three mega banks (Mitsubishi-UFJ, Mizuho, Sumitomo-Mitsui).

Almeida, Campello, and Weisbach (2004) formulate the precautionary demands for cash and present evidence that shows that financially constrained firms have a propensity to save cash flows. Opler et al. (1999) find that firms with strong growth opportunities and riskier cash flows have relatively high ratios of cash to total non-cash assets. Bates et al. (2009) document that increases in cash holdings among U.S. firms can be attributed to increasing precautionary demands for cash that are partly triggered by growing demand for R&D.

Lins et al. show that firms use lines of credit for the former type of precautionary demands, whereas firms prefer to preserve cash for the latter type of precautionary demands. However, recent survey research has shown that Japanese firms prefer to accumulate cash than have lines of credits for both precautionary demands (Sasaki et al. 2014).

Mukherjee, Makarius, and Stevens (2018) show that not only the reputation prominence but also reputation quality affects international expansion. Such a reputation effect may also have an impact on financing constraints. We discuss this possibility in subsection 4.4.1.

Singh et al. (2018;) present evidence that firms affiliated to business groups have an advantage in finding investment opportunities associated with pro-market reforms. Such information sharing effect may mitigate precautionary demands for cash prepared for unexpected investment opportunities. On the other hand, Pattnaik et al. (2018) argue that the existence of large business groups may result in entry barriers, which may affect precautionary demands for cash.

Dow and McGuire (2009) present evidence of profit tunneling of weakly affiliated keiretsu firms during strong economic times and propping up of these firms during recessions.

Recent studies find that increasing demands for financing R&D is one of the main drivers for increased cash balances (Bates et al. 2009). On the other hand, R&D literature argues that debt financing is not suitable for financing R&D because R&D investment in general has high risk and low collateral values (Hall 2002).

For example, Mitsubishi Motor Corporation raised funds by equity issuance when they faced financial difficulty in 2004 by allocating shares to other Mitsubishi Group firms.

We classify those diversified firms that have multiple segments but report sales from only one segment as diversified firms. In these cases, firms are diversified from the viewpoint of assets but not diversified from the viewpoint of sales. The results hold when we classify these firms as non-diversified firms.

Relatedly, Uchino (2013) shows that financially constrained firms with equity relationship with the main bank could borrow more money than independent financially constrained firms during the 2008 financial crisis.

We also estimate the regression in which we insert a continuous measure of diversification (Segments) instead of the diversity dummy (Diversity) as a proxy for industrial corporate diversification. Although the coefficients of the interaction terms between Cross and Segments become diminished, our main results for cross remain unchanged. In addition, we check the robustness of our results against the definitions of changes in cash holdings. Specifically, we use a definition of cash holdings that do not contain marketable securities to circumvent the impacts of changes in the market value of marketable securities. Although we do not reproduce the results, the coefficients of the business group variable and diversification variables are similar to those reported in Table 4.

The advantage of this method is that it captures the reputation effects of horizontal business groups directly. We also run regressions using the standard definition of horizontal group affiliation (participation for the presidential council) and confirm similar results.

In the self-selection equation, the coefficients of the two-year lagged Ebit/sales are negatively significant, suggesting that firms with low past profitability prefer to diversify to gain new investment opportunities. In contrast, current and one-year lagged Ebit/sales are positively significant, suggesting that the decision to diversify increases profitability. On the other hand, the coefficients of PNDIV are positive and statistically significant, indicating that the attractiveness of a diversified industry enhances corporate diversification.

We also conduct the robustness tests that address continuous measure of diversification and an alternative measure of cash holdings. The main results hold to these considerations.

Recent studies regarding business groups show that strongly connected business group firms exploit rents from weakly connected firms, the tunneling story also cannot consistently explain the relationship between horizontal business group affiliation and cash holding behavior. Although the tunneling story predicts that stronger business group firms have higher cash balances than weaker business group firms by exploiting weaker business group firms, the actual cash holding pattern is quite the opposite to this prediction. In fact, among firms with positive values of cross-shareholding ratio, the correlation between cross-shareholding ratio and cash holding ratio among firms interlocked in cross-shareholdings is −0.194, which is significant at the 1% level. This suggests that weakly affiliated firms have higher levels of cash balances than strongly affiliated firms.

In fact, firms affiliated with horizontal business groups depend on main banks to a lesser extent than other firms. Specifically, the average of bank-loans from main banks to total financial debt ratio is 28.5% for horizontal business group firms and 31.1% for other firms.

Recent studies find that increasing demands for financing R&D is one of the main drivers for increased cash balances (Bates et al. 2009).

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Titel: Business group affiliation, corporate diversification, and cash holdings
verfasst von: Kan Nakajima
Takafumi Sasaki
Publikationsdatum: 27.05.2020
Verlag: Springer US
Erschienen in: Asia Pacific Journal of Management / Ausgabe 1/2022
Print ISSN: 0217-4561
Elektronische ISSN: 1572-9958
DOI: https://doi.org/10.1007/s10490-020-09720-2

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