Does directors' and officers' liability insurance induce empire building? Evidence from corporate labor investment

Abstract

This study examines whether directors' and officers' (D&O) insurance affects corporate employment decision-making. Using a 2006–2018 sample of Chinese public firms, we find that firms purchasing D&O insurance exhibit lower labor investment efficiency, reflected mainly in over-hiring. The findings are strengthened by a set of additional robustness tests to mitigate endogeneity concerns and selection bias. The negative relation between D&O insurance and labor investment efficiency is more pronounced in firms with weak corporate governance, a low proportion of female executives, high labor intensity and low legal risks. Further analysis suggests that inefficient labor investment leads to worse future firm performance. This study provides the first empirical evidence that D&O insurance increases managerial empire building tendencies via over-investment in labor, which, in turn, is detrimental to shareholder value.