A Perspective on Regulatory Paradigms: The Case of IRS and Sarbanes-Oxley Approaches to Executive Compensation-Related Regulation

Abstract

In this paper we explore two regulatory paradigms, with an emphasis on the regulation of executive compensation. An example of the traditional rule-based paradigm is Internal Revenue Code Section 162(m) in which a tax-deductible cap was passed into law to limit executive compensation. We demonstrate that this approach yielded mixed results. While stronger pay/performance sensitivity has been documented, Section 162(m) appears to have actually exacerbated the level of executive compensation. We contrast the rules-based paradigm with an alternative paradigm illustrated by the Sarbanes-Oxley Act in which the U.S. Congress introduced a series of corporate governance initiatives into federal securities law. The transformation of the mode of regulatory intervention as reflected by SOX is shown to be fully consistent with recent changes in the generally accepted conceptual framework for financial reporting.

Keywords: IRC Section 162(m), Sarbanes-Oxley Act, executive compensation, pay-performance sensitivity, conceptual framework

JEL Classification: G38, J33