Contents lists available at ScienceDirect Journal of Business Research journal homepage: www.elsevier.com/locate/jbusres Inside directors and the underinvestment of financial slack towards R & D- intensity in high-technology firms Ibrahim A. Shaikh a,⁎ , Jonathan Paul O'Brien c , Lois Peters b a University of New Brunswick Fredericton, Faculty of Business Administration, Canada b Rensselaer Polytechnic Institute, Lally School of Management, United States c University of Nebraska-Lincoln, College of Business Administration, United States ARTICLE INFO Keywords: Agency theory Distress Financial slack Inside directors R & D-intensity Underinvestment ABSTRACT Agency theory emphasizes the role of outside directors in mitigating free cash flow (FCF) problems, such as overinvesting FCF's into negative NPV R & D projects. In this paper we draw on and extend agency theory to argue that the underinvestment of financial slack towards a persistently high R & D-intensity is actually a greater problem for high-tech firms. Specifically, we claim that inside directors play a critical role for the board in safeguarding R & D investment by monitoring the CEO, and mitigating informational asymmetries for in- dependent directors. We test our theory using a panel-data set of S & P 1500 firms in R & D-intensive industries from 1997 to 2007. Our empirical analysis reveals that inside directors positively influence the relationship between financial slack and R & D-intensity, and that their ability to ensure cash holdings are used to preserve R & D matters the most during periods of financial distress. 1. Introduction Agency theory (AT) has been used extensively in strategy research to study how corporate governance can promote R & D (Deutsch, 2005; Eisenhardt, 1989). Situations where agency costs are rampant is when managers have easy access to ample discretionary financial resources. On the one hand, readily available free cash flows allow risk-averse managers to more easily overinvest slack into negative NPV R & D, ra- ther than pay dividends or buyback shares (Jensen, 1993). On the other hand, having ample slack on hand prevents abrupt cuts to R & D when something goes wrong, thus helping preserve R & D at all costs and abating underinvestment (Myers, 1977). In other words, liquidity pre- vents risk-averse managers from forgoing R & D when times are bad, but too much slack weakens internal controls and may lead to the funding of negative NPV R & D projects. As a result, existing research has documented a curvilinear, inverted U-shaped, relationship between fi- nancial slack and R & D (see Geiger & Cashen, 2002; Nohria & Gulati, 1996 for reviews). 1 Even so, some studies now question the curved relationship between slack and R & D. For example, Lee (2015) finds a weak correlation be- tween slack and innovation in the Korean context, and Herold, Jayaraman, and Narayanaswamy (2006) find that while a curved relationship does exist in the US, it never truly becomes downward sloping. These studies, however, fail to offer a solid theoretical reason for why this is so, thereby adding to the recent confusion. In order to provide clarification, we extend AT by stressing how R & D-intensive industries often defy the short-term marginal calculus of traditional AT (O'Brien & Folta, 2009). Indeed, as Hall (2002) highlights, Jensen's FCF- thesis has had limited appeal for innovation scholars because it is concerned with industries where persisting with R & D at all costs is not critical for sustained rents. Conversely, relentlessly allocating slack into R & D is needed in high-tech industries because the gains from R & D quickly dissipate, and rents are frequently fleeting (Helfat, 1997). Consistent investment in R & D, while difficult and often coming at the cost of short-term earnings, is associated with several positive outcomes that generate increasing returns well into the future (Kor & Mahoney, 2005). We thus extend AT to also include underinvestment of financial slack into R & D as a more severe agency cost for firms in R & D-in- tensive industries. For our main effect, H1, we assert that the increasing benefits that accrue from holding large amounts of cash more than offsets the marginal costs associated with opportunistic managers oc- casionally overinvesting into negative NPV R&D projects (Mudambi & Swift, 2014). As a consequence, while we do assert that the positive relationship between financial slack and R & D somewhat levels http://dx.doi.org/10.1016/j.jbusres.2017.09.014 Received 1 July 2016; Received in revised form 6 September 2017; Accepted 8 September 2017 ⁎ Corresponding author. E-mail address: ishaikh@unb.ca (I.A. Shaikh). 1 We follow the literature and are concerned with a firm's unabsorbed financial slack. We use the terms cash-holdings, financial slack, slack, financial resources, free cash flows interchangeably in this study. Journal of Business Research 82 (2018) 192–201 0148-2963/ © 2017 Elsevier Inc. All rights reserved. MARK