SOX Disclosure and the Effect of Internal Controls on Executive Compensation

We study the organizational impact of internal control systems, by examining 1,593 firms with 15,606 executives over 2002-2010. We find that internal control systems explain a sig- nificant amount of executive and, in particular, CFO compensation, after controlling for other governance, executive personal characteristics, firm, and macroeconomic determi- nants of pay. Moreover, the negative relationship between pay and internal control systems suggests that executives operating in firms with ineffective internal control systems earn greater compensation. The results of the longitudinal analysis suggest that firms with inef- fective internal control systems have greater agency problems and, consequently, greater levels of executive compensation. The CEO pay shows a nonsignificant relationship with internal control systems.