International diversification is one of the firm competitive strategies to reduce risk and increase its income. The easiest and most common method of international diversification is international trade, such as exports. Based on data released by the Central Bureau of Statistics, the value of the firm’s exports in Indonesia has doubled since 2000, from $ 62 billion to $ 145 billion in 2016. The growth in the export value is a global phenomenon and occurs throughout the world. It shows that firms around the globe understand the importance of diversification as a competitive advantage in business.
International diversification, product diversification, and firm cash holdings
Multinationality is a concept used to measure the level of involvement of a firm in international business. Multinationality of a firm can be measured as the ratio of foreign sales (exports) value to total sales. The higher the ratio, the higher the level of international diversification.
The high level of international diversification shows high involvement in international business and turn reduces the overall risk of the firm. International diversification allows firms to obtain diversified income.
Through export sales, firms obtain income from countries with different characteristics. The diversity of export destination areas will stabilize firm revenues due to reduced dependence on one country markets.
International diversification encourages firms not to save cash in large numbers of precautionary motives. Besides, firms that conduct international diversification will find it easier to find new sources of funding in various countries where they operate (Jang, 2017).
Flexibility in funding can drive the firm’s cash level low. Another reason for conducting international diversification is to sell their products on a broader market to get a scale of economic operations that will eventually increase revenue. The economic scale of operation refers to the reduction in unit costs resulting from an increase in the total output of a product. Based on these things, we assumed that there is a negative influence of international diversification on the level of corporate cash holdings.
In addition to international diversification, firms, in general, diversify their products. Product diversification is the firm’s strategy to expand business activities by producing and selling various product lines. International and product diversification is expected to increase profits, and they are common for multinational firms.
However, previous research showed that there is an inverse relationship between the two. The complexity of the management and coordination of the firm will also increase disproportionately with the increase in the product line and the target country in the marketing area. It will ultimately increase the costs of coordination and control. Therefore, firms that implement both diversification strategies will save more cash to finance more massive business activities. Consequently, we also suspect that product diversification weakens the negative relationship between international diversification and the level of cash ownership.
Method and Results
This research is conducted by first determining the sample with criteria: 1) firms listed in Indonesia Stock Exchange (BEI) and Euronext Amsterdam in the 2000-2016 period, 2) non-financial firms, 3) firms that conduct international sales (export) and provide complete data according to research needs. There are 125 sample firms. A total of 80 are listed on the IDX and 45 in Euronext Amsterdam, with a total of 883 observations. The analysis technique used is multiple linear regression.
The results of the analysis show that multinationality has a negative effect on the level of cash holdings in all sample groups (overall firm, Indonesian firm, and Dutch firm). The firm which performed international diversification will face lower risks.
Product diversification that is only done in one country will only reduce the risk of unsystematic. International diversification allows firms to minimize not only unsystematic risk but also a systematic risk.
Product diversification, as a moderating variable, shows a positive influence on the sample group of Indonesian firms. This positive relationship shows that product diversification weakens the adverse effects of international diversification on cash holdings. Firms that sell a variety of products in more diverse geographical areas have higher cash holding than firms that focus on one product.
In certain regions, among Dutch firms, product diversification does not moderate the influence of multinationality on the level of cash holdings. We argue that firms with capability and experience in product and international diversification can manage the dynamics of these two dimensions of diversification better. Such firms will be more efficient in managing their diversification strategies.
Author: I Made Sudana &NugrohoSasikirono
More detailed research details can be accessed at https://doi.org/10.1504/IJMEF.2019.100265 .
I Made Sudana, Fahima Budi Imaniar, NugrohoSasikirono, Sanju Kumar Singh. (2019). Diversification and cash holdings: comparison between Indonesia and the Netherlands firms. International Journal of Monetary Economics and Finance (IJMEF), Vol. 12, No. 2, pp. 133-151.
