Changes in Bonus Contracts in the Post-Sarbanes-Oxley Era

Abstract

We examine whether the relation between earnings and bonuses changes after Sarbanes-Oxley. Theory predicts that, as the financial reporting system reduces the discretion allowed managers, firms will put more weight on earnings in compensation contracts to encourage effort. However, the increased risk imposed by Sarbanes-Oxley on executives may cause firms to temper this contracting outcome. We examine and find support for the joint hypothesis that the implementation of Sarbanes-Oxley and related reforms led to a decrease in earnings management and that firms responded by placing more weight on earnings in bonus contracts. We find no evidence that firms changed compensation contracts to compensate executives for assuming more risk.

Keywords: Executive compensation, bonuses, Sarbanes-Oxley

JEL Classification: M41, M43, J33, M52, G38