How do independent directors view powerful executive risk-taking incentives? A quasi-natural experiment

Abstract

We explore how independent directors view managerial risk-taking incentives using a natural experiment. We exploit the passage of the Sarbanes-Oxley Act as an exogenous shock that raised board independence. Our difference-in-difference estimates show that independent directors view powerful risk-taking incentives unfavorably. Our results are consistent with the notion that strong managerial risk-taking incentives lead to excessive risk-taking and, as a result, are reduced in the presence of more effective governance, i.e. stronger board independence. Further analysis confirms the results, including fixed- and random-effects analysis, propensity score matching, and using Oster's (2017) method to test coefficient stability.