What motivates directors to pursue long-term strategic risks? Economic incentives vs. fiduciary duty

Prior research in agency theory views outside directors as being mostly extrinsically motivated by the potential for financial rewards, and as such stresses the value of using director stock options and equity to incentivize outside directors to pursue strategic risks. We draw on and extend agency-theory by arguing that outside directors are primarily intrinsically motivated, and therefore excessive emphasis on pecuniary rewards and punishments can ironically subvert a director's motives away from strategic risk-taking. In particular, we claim that more important than extrinsic rewards and government regulations is creating a secure environment for directors so that they may exercise their fiduciary duties without fear of litigation. We test our theory on a sample of 196 S&P 500 firms from 2005 to 2015 and find that the pressures imposed on the board through external regulations and controls can often backfire and result in outside directors signing off on less risky expenditure. A strong implication of these findings is no real substitute exists to creating a safe environment for directors, where they have the freedom to pursue the long-term interests of the principals, even if this goes against the short-termism of capital markets.