Corporate Governance Reform and Executive Incentives: Implications for Investments and Risk Taking


  • Accepted by Shivaram Rajgopal. We would like to thank Shiva Rajgopal (Editor), Steve Salterio (Editor in-Chief), two anonymous referees, Bill Beaver, Phil Berger, John Core, Ilia Dichev, Ian Gow, Paul Griffin, Wayne Guay, Mozaffar Khan, David Larcker, Charles Lee, Christian Leuz, Frank Selto, Abbie Smith, Laura Starks, Ross Watts, Paul Zarowin, Jerrold Zimmerman, and participants at the 2009 Stanford Summer Camp, the 2011 CAR conference, and seminar participants at MIT and at the University of Chicago for very useful comments and suggestions. All remaining errors are our own.


We investigate the mechanism through which the Sarbanes Oxley Act (SOX) was associated with changes in corporate investment strategies. We document that the passage of the governance regulations in SOX was followed by a significant decline in pay-performance sensitivity (Delta) and incentives to take risk (Vega) in CEOs' compensation contracts. These changes in compensation contracts are related to a decline in investments, including research and development expenditures, capital investments and acquisitions. Moreover, consistent with the rules in SOX directly affecting CEOs' incentives to take risk, we document that the decline in investments exceeds the amount that would be expected from changes in compensation packages alone. Finally, we also find evidence that the changes in investments are related to lower operating performances of firms, suggesting that these changes were costly to investors. Our evidence speaks to the debate on how corporate governance regulation interacts with firms' and managers' incentives, and ultimately affects corporate operating and investment strategies. Our study suggests that one indirect cost of such regulations in SOX is the significant reductions in corporate risk-taking activities in the post-SOX period. The changes in investments were in part due to changes in executive compensation contracts and in part related to increased executives' personal costs of engaging in risky activities.