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Is the Demand for Corporate Insurance a Habit? Evidence from Directors' and Officers' Insurance

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  • M. Martin Boyer

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Abstract

Of the many fundamental questions left unanswered in finance, one relates to corporate risk management practices. It is still relatively unclear what are the reasons that motivate risk neutral corporations to manage their idiosyncratic risk. Our contention in this paper is that corporate insurance purchases are driven by habit rather than an optimal approach to corporate risk management. Because public access to corporate insurance purchases and risk management strategies is limited at best, we examine a particular aspect of the corporate demand for insurance for which public information is available: Directors' and Officers' (D&O) insurance. Information regarding D&O insurance purchases has been publicly available in Canada since 1993. Our results suggest that the decision to insure as well as the amount of coverage purchased (policy limit and deductible) are more driven by the previous year's decision than any other. We find that a corporation's fundamental financial and governance measures do not appear to have any impact on the decision to purchase insurance nor on the amount of insurance to purchase. Our results suggest that corporations may not choose optimally their risk management decisions; rather they may rely more on a force of habit than on a clear and concise strategy to manage corporate risk. As a result, and in contrast to Core (1997, 2000) and Chalmers et al. (2002), we find no evidence of managerial opportunism in regards to D&O insurance coverage. Une des grandes questions fondamentales qui demeurent en finance est pourquoi des firmes présumément neutres au risque achètent de l'assurance et gèrent leur risque. Notre hypothèse est que l'achat d'assurance est plus lié aux habitudes prises par les corporations qu'à une décision étudiée de gérer les risques. Étant donné la quasi-impossibilité d'obtenir des données publiques sur l'achat d'assurance des corporations et leur gestion de risques, nous examinons un aspect particulier de cette demande pour laquelle l'information existe dans le public, soit l'assurance de la responsabilité civile des administrateurs et des dirigeants. Cette information est disponible dans le public au Canada depuis 1993 seulement. Nos résultats suggèrent que la décision de s'assurer et le niveau de couverture semblent être déterminés uniquement par la décision de la firme à l'année précédente. Ainsi aucun facteur fondamental (santé financière ou gouvernance) de l'entreprise ne semble pouvoir expliquer la décision d'une entreprise de s'assurer ni la limite son type de couverture. Nous concluons que les corporations ne gèrent pas leur risque de manière optimale puisqu'elles semblent baser leur décision d'assurance davantage sur leurs habitudes que sur une stratégie claire et concise de gestion des risques d'entreprise. Par conséquent, et contrairement aux résultats obtenus par Core (1997, 2000) et Chalmers et al. (2002), nous ne trouvons aucune raison d'affirmer que l'achat d'assurance est lié à l'opportunisme des dirigeants.

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Bibliographic Info

Paper provided by CIRANO in its series CIRANO Working Papers with number 2003s-42.

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Date of creation: 01 Jul 2003
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Handle: RePEc:cir:cirwor:2003s-42

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Keywords: Directors' and officers' insurance; habit formation; corporate insurance and risk management; board compensation; Assurance de la responsabilité civile des administrateurs et des dirigeants; formation d'habitude; assurance des corporations; rémunération des conseils d'administration;

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References

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  1. John Y. Campbell & John H. Cochrane, 1994. "By force of habit: a consumption-based explanation of aggregate stock market behavior," Working Papers 94-17, Federal Reserve Bank of Philadelphia.
  2. Philip D. Drake & Michael R. Vetsuypens, 1993. "IPO Underpricing and Insurance Against Legal Liability," Financial Management, Financial Management Association, vol. 22(1), Spring.
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  8. John M. R. Chalmers & Larry Y. Dann & Jarrad Harford, 2002. "Managerial Opportunism? Evidence from Directors' and Officers' Insurance Purchases," Journal of Finance, American Finance Association, vol. 57(2), pages 609-636, 04.
  9. Dionne, Georges & Garand, Martin, 2003. "Risk management determinants affecting firms' values in the gold mining industry: new empirical results," Economics Letters, Elsevier, vol. 79(1), pages 43-52, April.
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  14. Core, John E, 2000. "The Directors' and Officers' Insurance Premium: An Outside Assessment of the Quality of Corporate Governance," Journal of Law, Economics and Organization, Oxford University Press, vol. 16(2), pages 449-77, October.
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Cited by:
  1. Koch, Rosemarie & Stadtmann, Georg, 2010. "Das Gesetz zur Angemessenheit der Vorstandsvergütung," Discussion Papers 288, European University Viadrina Frankfurt (Oder), Department of Business Administration and Economics.
  2. Rochet, Jean Charles & Villeneuve, Stéphane, 2004. "Liquidity Risk and Corporate Demand for Hedging and Insurance," CEPR Discussion Papers 4755, C.E.P.R. Discussion Papers.
  3. Boyer, Martin, 2014. "Directors’ and officers’ insurance and shareholder protection," Journal of Financial Perspectives, EY Global FS Institute, vol. 2(1), pages 107-128.

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