Director and officer liability protection and firm value: Unintended consequences

Abstract

This study sheds light on some of the unintended consequences of directors’ and officers’ (D&O) liability protection provisions. In particular, it examines whether D&O protection affects firm value. Using a sample of U.S. firms, we find that firms with greater director liability protection have significantly lower firm value as measured by Tobin's Q, and that the negative effect of director liability protection on firm value is more pronounced in the period before the Sarbanes-Oxley Act of 2002. These findings are consistent with the notion that director liability acts as a strong corporate governance mechanism and that protecting directors and officers does not preclude them from undertaking sub-optimal investments and less risky projects.