I sort of figured that the Sheogorath you see in the Shivering Isles is the original Sheogorath. Orginally, he was Jygalagg. The other Daedra got mad, cursed him, and changed him into Sheogorath. He was illusioned, but still had Daedric power. He created the realm of madness. At the end of every era, he changed into Jygalag to reclaim his old realm and return it into order, only to change back to Sheogorath and then make everything insane again. When the Oblivion PC come in, that's when things change. He, at the end when you imburse that staff into the Font of Madness, became a Daedric Prince right there. Immortal, cannot die, control over any and everything in the isles. (Of course, you can still die in game, but that's for gameplay reasons.) When he repelled Jygalg in battle, Jygalag became convinced that he had became a Daedric Prince, or close enough to one so that he wouldn't ever have to become Sheogorath again. Seeing that, he stopped the fight and left the new god his own land. Instead of two entities existing with only one person to be both, their were two people, two gods, two realms, etc...etc... Of course, the physical appearence of Sheogorath is whatever Bethesda decides it to be. Some peoples games may be and orc, a bosmer, a dunmer, an imperail, etc...etc... I kind of figure that the cannonical appearance of Oblivion's PC at the end of the whole expierence, is the way Sheogorath appears in the Shivering Isles. Beard, snake eyes, and "Sheogorath's Regalia".
Of course, maybe the whole thing was set up by the true Sheogorath, and the Isles you see in the expansion pack is just a fraction of Sheogorath's realm, and he decided to let you in and let oyu think you were a god, just drive you insane, because it entertained him...