The propensity to save: The effect of Sarbanes-Oxley act

The Sarbanes-Oxley Act of 2002 (SOX) serves to increase transparency and improves the governance quality of publicly traded U.S. firms. Increased transparency reduces external financing costs, thereby decreasing the reliance on internal funds for investment. Improved governance quality mitigates managers' opportunistic cash savings. Both of these effects are predicted to affect a firm's cash policy. Employing the cumulant estimators (closed-form minimum distance estimators) in Erickson et al. (2014, Journal of Econometrics, 183, 211) to control the errors-in-variables bias in the cash-cash flow sensitivity model, we find that SOX reduces firms' propensity to save, and the effect is stronger for negative cash flow firms than positive cash flow firms. Further analysis reveals that the cash-cash flow sensitivity is conditional on a firm's financial constraint status and its existing governance quality.