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The Sarbanes Oxley Act of 2002: Implications for Compensation Contracts and Managerial Risk-Taking

Daniel A. Cohen
New York University - Department of Accounting, Taxation & Business Law

Aiyesha Dey
University of Chicago - Booth School of Business

Thomas Z. Lys
Northwestern University - Kellogg School of Management

November 9, 2007

Abstract:
The Sarbanes Oxley Act of 2002 (SOX) introduced several governance reforms that considerably increased the total risk exposure of CEOs. We examine the effects of these regulatory changes on compensation contracts of CEOs and their effect on risk taking subsequent to SOX. We find that while overall compensation did not change, salary and bonus compensation increased and option compensation decreased following the passage of SOX. The sensitivity of CEO's wealth to changes in shareholder wealth also decreased after SOX. These results indicate that the pay for performance sensitivity of CEO compensation has declined following SOX. Our results indicate that these changes reduced investments in research and development, and capital expenditures. We also document that the above changes in CEOs' pay for performance sensitivities and their risky investments following SOX are associated with a reduction in stock return volatility. However, we do not find any evidence indicating that these changes are associated with lower future operating performance.

Keywords: Sarbanes Oxley Act, Executive Compensation, Incentives, Regulation

JEL Classifications: J33, G38, G34

Working Paper Series

Date posted: July 26, 2004 ; Last revised: April 24, 2008

Suggested Citation

Cohen, Daniel A., Dey, Aiyesha and Lys, Thomas Z., The Sarbanes Oxley Act of 2002: Implications for Compensation Contracts and Managerial Risk-Taking (November 9, 2007 ). Available at SSRN: http://ssrn.com/abstract=1027448 or doi:10.2139/ssrn.568483

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Contact Information

Thomas Z. Lys (Contact Author) Northwestern University - Kellogg School of Management ( email ) 2001 Sheridan Road Department of Accounting & Information Systems Evanston, IL 60208 United States 847-491-2673 (Phone) 847-467-1202 (Fax)
Daniel A. Cohen New York University - Department of Accounting, Taxation & Business Law ( email ) 44 West 4th Street Suite 10-83 New York, NY 10012 United States 212-998-0267 (Phone) 212-995-4004 (Fax)
Aiyesha Dey University of Chicago - Booth School of Business ( email ) 5807 S. Woodlawn Avenue Chicago, IL 60637 United States 7737025865 (Phone) 7737020458 (Fax)