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

This paper investigates whether free cash flow arguments or the internal capital market perspective explain diversification decisions. Based on a unique panel of hand-collected data from Italian firms (listed and unlisted) for the period 1980-2010, the results reveal, as a net effect, the predominant role of the internal capital market arguments. The benefits of unrelated diversification, avoiding costly external finance, outweighs its costs, based on opportunistic problems. Although the literature suggests that there are two forces working concurrently in affecting diversification decisions, in a context as Italy, financial benefits seem the prevailing motivation in unrelated diversification decisions. In addition, the internal capital market argument has a strong magnitude concerning to choices to diversify unrelated, especially with regard to firms sensitive to financial constraint problems