Directors' and Officers' Liability Insurance, Independent Director Behavior and Governance Effect

Abstract

We examine the effect of directors’ and officers’ liability insurance (D&O insurance) on the behavior of independent directors and the effectiveness of their governance role. We study three dimensions of director behavior – board meeting attendance, opinion and busyness. Based on director-level data of a sample of Chinese companies, we find a negative relation between D&O insurance and personal meeting attendance by independent directors and a positive relation between D&O insurance and meeting attendance by authorized representatives. The net effect on board meeting participation is negative as insured independent directors tend to incur greater attendance problem than their uninsured peers. We also find that D&O insurance has a negative impact on the willingness of independent directors to confront management and controlling shareholders by expressing a dissenting opinion in the face of agency conflicts. Moreover, insured independent directors are more inclined to take on additional directorships at other firms. We also find that D&O insurance reduces the effectiveness of independent directors in enhancing firm value and curbing firm violation. Our paper provides new evidence for the debate of the governance effect of D&O insurance and provides new insights into the incentives and behavior of independent directors.