Was Sarbanes-Oxley Costly? Evidence from Optimal Contracting on CEO Compensation

This paper investigates the effects of regulatory interventions on contracting relationships within firms by examining the impacts of the Sarbanes-Oxley (SOX) Act on CEO compensation. Using panel data of the S&P 1500 firms, it quantifies welfare gains from a principal-agent model with hidden information and hidden actions. It finds that SOX: (1) reduced the conflict of interest between shareholders and their CEOs, mainly by reducing shareholder loss from CEOs deviating from their goal of expected value maximization; (2) increased the cost of agency, or the risk premium CEOs are paid to align their interests with those of shareholders; (3) increased administrative costs in the primary sector (which includes utilities and energy) but the effect in the other two broadly defined sectors, services and consumer goods, was more nuanced; and (4) had no effect on the attitude of CEOs toward risk.