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Directors' and officers' liability insurance and loan spreads

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  • Lin, Chen
  • Officer, Micah S.
  • Wang, Rui
  • Zou, Hong

Abstract

We analyze the effect of directors' and officers' liability insurance (D&O insurance) on the spreads charged on bank loans. We find that higher levels of D&O insurance coverage are associated with higher loan spreads and that this relation depends on loan characteristics in economically sensible ways and is attenuated by monitoring mechanisms. This association between loan spreads and D&O insurance coverage is robust to controlling for endogeneity (because both could be related to firm risk). Our evidence suggests that lenders view D&O insurance coverage as increasing credit risk (potentially via moral hazard or information asymmetry). Further analyses show that higher levels of D&O insurance coverage are associated with greater risk taking and higher probabilities of financial restatement due to aggressive financial reporting. While greater use of D&O insurance increases the cost of debt, we find some evidence that D&O insurance coverage appears to improve the value of large increases in capital expenditure for firms with better internal and external governance.

Suggested Citation

  • Lin, Chen & Officer, Micah S. & Wang, Rui & Zou, Hong, 2013. "Directors' and officers' liability insurance and loan spreads," Journal of Financial Economics, Elsevier, vol. 110(1), pages 37-60.
    • Handle: RePEc:eee:jfinec:v:110:y:2013:i:1:p:37-60
    DOI: 10.1016/j.jfineco.2013.04.005
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    References listed on IDEAS

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    More about this item

    Keywords

    Directors' and officers' liability insurance; Loan spreads; Credit risk; Cost of debt financing;
    All these keywords.

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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