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Protecting Directors and Officers from Liability Arising from Aggressive Earnings Management

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  • M. Martin Boyer

    ()

  • Amandine Hanon

Abstract

A lingering topic in corporate governance is whether corporate directors should be protected against shareholder lawsuits and whether such protection reduces the incentives of directors to monitor appropriately the behaviour of corporate officers. To achieve this goal, we examine whether corporations whose corporate managers’ wealth is protected under a directors’ and officers’ liability insurance policy (D&O insurance hereafter) are more to report accounting results aggressively. Using discretionary accruals as our measure of accounting aggressiveness, the results in our paper suggest that the magnitude of discretionary accruals has no real impact on the demand for D&O insurance, be it on the decision to purchase insurance or on the amount of limit chosen. The positivity of discretionary accruals appears, however, to have an impact on the decision to purchase insurance. Surprisingly, although these insurance policies protect directors and officers in the event they make a “mistake” in their role as representatives of the company, directors do not seem to see this as an invitation to be a little less careful when overseeing the firm’s accounting practices. Un sujet qui demeure d’actualité quand on pense à la gouvernance des entreprises est le niveau de protection auquel les dirigeants devraient avoir droit en cas de poursuite par les actionnaires. Pour atteindre ce but, nous examinons s’il y a un lien entre la gestion agressive des courus discrétionnaires et la demande d’assurance de la responsabilité civile des administrateurs et dirigeants d’entreprise (ARCAD ci-après). Nous trouvons dans la présente étude que la taille des courus ne semble avoir aucun impact sur la demande d’assurance, que ce soit le fait même d’avoir un contrat ou la limite de la police. Le fait que les courus soient positifs semble toutefois avoir un impact sur le fait que les entreprises possèdent une ARCAD ou non. Nous demeurons perplexes de voir que même si l’ARCAD protège les dirigeants contre le coût de poursuites au civile, ces mêmes dirigeants ne voient pas cela comme une invitation au laxisme dans la supervision des pratiques comptables des entreprises.

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Bibliographic Info

Paper provided by CIRANO in its series CIRANO Working Papers with number 2009s-35.

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Date of creation: 01 Aug 2009
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Handle: RePEc:cir:cirwor:2009s-35

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Keywords: directors’ and officers’ liability insurance policy; aggressive accounting practices; earnings management ; ARCAD; pratiques comptables agressives; résultats financiers de gestion.;

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  1. Brook, Yaron & Rao, Ramesh K. S., 1994. "Shareholder Wealth Effects of Directors' Liability Limitation Provisions," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 29(03), pages 481-497, September.
  2. M. Martin Boyer, 2003. "Directors' and Officers' Insurance and Shareholders' Protection," CIRANO Working Papers 2003s-64, CIRANO.
  3. Simi Kedia & Thomas Philippon, 2005. "The Economics of Fraudulent Accounting," NBER Working Papers 11573, National Bureau of Economic Research, Inc.
  4. Chung, Hyeesoo H. & Wynn, Jinyoung P., 2008. "Managerial legal liability coverage and earnings conservatism," Journal of Accounting and Economics, Elsevier, vol. 46(1), pages 135-153, September.
  5. Fama, Eugene F & Jensen, Michael C, 1983. "Separation of Ownership and Control," Journal of Law and Economics, University of Chicago Press, vol. 26(2), pages 301-25, June.
  6. Tufano, Peter, 1996. " Who Manages Risk? An Empirical Examination of Risk Management Practices in the Gold Mining Industry," Journal of Finance, American Finance Association, vol. 51(4), pages 1097-1137, September.
  7. René M. Stulz, 1996. "Rethinking Risk Management," Journal of Applied Corporate Finance, Morgan Stanley, vol. 9(3), pages 8-25.
  8. Skinner, Douglas J., 1997. "Earnings disclosures and stockholder lawsuits," Journal of Accounting and Economics, Elsevier, vol. 23(3), pages 249-282, November.
  9. Mayers, David & Smith, Clifford W, Jr, 1982. "On the Corporate Demand for Insurance," The Journal of Business, University of Chicago Press, vol. 55(2), pages 281-96, April.
  10. 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.
  11. McNichols, Maureen F., 2000. "Research design issues in earnings management studies," Journal of Accounting and Public Policy, Elsevier, vol. 19(4-5), pages 313-345.
  12. Healy, Paul M., 1985. "The effect of bonus schemes on accounting decisions," Journal of Accounting and Economics, Elsevier, vol. 7(1-3), pages 85-107, April.
  13. Kothari, S.P. & Leone, Andrew J. & Wasley, Charles E., 2005. "Performance matched discretionary accrual measures," Journal of Accounting and Economics, Elsevier, vol. 39(1), pages 163-197, February.
  14. Gutierrez, M., 2000. "An Economic Analysis of Corporate Directors' Fiduciary Duties," Papers 0014, Centro de Estudios Monetarios Y Financieros-.
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