The Sarbanes Oxley Act of 2002: Implications for Compensation Structure and Risk-Taking Incentives of CEOs

This paper investigates the effect of the Sarbanes-Oxley Act (hereafter, SOX) on the compensation structure and the risk-taking incentives of CEOs as revealed by their research and development expenses and capital expenditures. We hypothesize that firms will respond to the additional liability imposed by SOX on corporate executives by altering the mix of incentive compensation to fixed salary awarded to them in order to provide insurance. Consistent with this claim, we find that there was a significant decline in the ratio of incentive compensation to salary after the passage of SOX. We also hypothesize and find that there was a significant decline in research and development expenses and capital expenditures made by CEOs after the passage of SOX. This result is obtained after controlling for the effects of the economic environment and changes in compensation structure on CEOs’ action choices. We interpret the above as evidence of some of the potential costs of this new regulation.

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