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Directors' and Officers' Insurance and Shareholders' Protection

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  • M. Martin Boyer

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Abstract

Corporate directors are liable for the corporation's actions as well as their own. Strangely, and by far, the most likely plaintiffs in a lawsuit against corporate directors are the shareholders who appointed them in the first place. As a result, directors often require protection so that their own personal wealth is not expropriated in the event of a good faith error. There are three ways to protect a director's wealth: Corporate indemnification plans, Limited liability provisions and Directors' and Officers (D&O) insurance policies. Of the three types of protection, D&O insurance is arguably the strangest not because shareholders purchase it to protect directors in case of a lawsuit, but because it also protects shareholders. Using an original database, we test a set of hypotheses that should determine the demand for D&O insurance. Our analysis suggests that the D&O insurance demand is best explained as part of the directors' compensation package, managerial signalling and shareholders' wealth protection. D&O insurance also appears to be a substitute for financial institution monitoring. Surprisingly, managerial risk aversion and financial distress do not seem to play important roles. Our results lead us to conclude that D&O insurance is not designed to protect the directors' personal wealth as much as it is designed to protect the shareholders'. In that sense, our paper offers an original approach to one of the many fundamental questions in finance: What determines corporate risk management practices? En tant que représentants de l'entreprise, les administrateurs sont responsables des actes de l'entreprise. Étrangement, les plaignants les plus fréquents dans les causes contre les administrateurs sont les actionnaires qui les ont nommés initialement. Par conséquent, les administrateurs demandent à être protégés de telle sorte que leur richesse personnelle ne soit pas expropriée en cas d'une erreur de bonne foi de leur part. Il existe trois manières pour un administrateur de protéger sa richesse personnelle: les plans d'indemnisation, la responsabilité limitée et l'assurance de la responsabilité civile des administrateurs et des dirigeants. De ces trois outils, le dernier est probablement le plus étrange, non pas parce que les actionnaires l'achètent pour protéger les administrateurs en cas de poursuite, mais bien par ce qu'il protège également les actionnaires. À partir d'une base de données unique, nous testons un ensemble d'hypothèses qui devraient influencer la demande d'assurance des administrateurs. Notre analyse suggère que la demande d'assurance s'explique mieux si on la considère comme faisant partie de la rémunération des administrateurs, comme un signal de la qualité des administrateurs et comme un outil de protection pour les actionnaires. Les notions d'aversion pour le risque et de coûts de détresse financière ne semblent pas jouer un rôle important par ailleurs. Nos résultats nous permettent de conclure que l'assurance de la responsabilité civile des administrateurs et des dirigeants n'est pas là pour protéger la richesse personnelle des administrateurs, mais bien pour protéger la richesse des actionnaires. Cet article offre ainsi une vision nouvelle d'une des questions fondamentales en finance: Quels sont les déterminants de la gestion des risques?

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Bibliographic Info

Paper provided by CIRANO in its series CIRANO Working Papers with number 2003s-64.

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Date of creation: 01 Oct 2003
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Handle: RePEc:cir:cirwor:2003s-64

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Keywords: Directors' and Officers' Insurance; Corporate Insurance and Risk Management; Board Compensation; Assurance des administrateurs et des dirigeants; assurances et gestion des risques des entreprises; rémunération des administrateurs;

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References

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Citations

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Cited by:
  1. M. Martin Boyer & Amandine Hanon, 2009. "Protecting Directors and Officers from Liability Arising from Aggressive Earnings Management," CIRANO Working Papers 2009s-35, CIRANO.
  2. M. Martin Boyer, 2012. "Insurer Information, Insiders and Initial Public Offering," CIRANO Working Papers 2012s-30, CIRANO.
  3. M. Martin Boyer, 2004. "Is the Demand for Corporate Insurance a Habit? Evidence of Organizational Inertia from Directors' and Officers' Insurance," CIRANO Working Papers 2004s-33, CIRANO.
  4. Boyer, M. Martin & Stern, Léa H., 2012. "Is corporate governance risk valued? Evidence from directors' and officers' insurance," Journal of Corporate Finance, Elsevier, vol. 18(2), pages 349-372.

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