The Demand for Directors’ and Officers’ Liability Insurance by US Public Companies

This paper uses a unique US dataset to analyze the demand for Directors’ and Officers’ liability insurance. This insurance protects managers most ly from sha reholder litigation. Corporate insurance presents a much different environment than individual insurance and calls for in-depth empirical investigation of the reasons why corporation buy insurance at all. Risk aversion by itself is not sufficient to explain the behavior of corporations. Mayers and Smith (1982), MacMinn and Garven (2000), among others, propose that corporate insurance plays a role in mitigating agency problems within the corporation, bankruptcy risk as well as provides real-services efficiencies, among others. Applying dynamic panel data models, these theories are the basis for the empirical tests in this paper. Boyer’s (2003) hypothesis that D&O insurance is entirely habit driven is rejected, while some role for persistence is still confirmed. I confirm the real-services efficiencies hypothesis and the role of insurance in mitigating bankruptcy risk. Firms with higher returns appear to demand less insurance. Although alternative monitoring mechanisms over management and corporate governance do not appear to play a large role, I find some support that they are complements rather than substitutes. I fail to confirm the role of insurance in mitigating under-investment problems in growth companies. A size adjustment to the limits as a dependent variable is proposed for the first time and it is found to have implications for the results. The paper confirms some, but not all, well-established theories about the decision-making on corporate insurance and the significance of risk management using US panel data for the first time.