Functions of Directors' and Officers' (D&O) Liability Insurance and Litigation Risk: An Empirical Legal Study of Taiwan

Abstract

This paper empirically analyzes the functions of directors’ and officers’ (D&O) liability insurance in corporate governance in Taiwan, it also reexamines the fundamental issue on the litigation risk of directors and officers. This research argues that litigation risk of directors, which is critically related to the fundamental function of insurance about indemnity, should be clarified before any legal revolution. This papers starts with examining whether the demand and functions of D&O insurance are influenced by directors’ and officers’ litigation risk. The monitoring hypothesis suggests that firms with weak corporate governance have a greater incentive to purchase D&O insurance. However, after empirically examining D&O insurance purchases and relevant litigations in Taiwan from 2008 to 2014, it is found that the monitoring hypothesis is not supported. The second part of this research moves on to detailed empirical test of signal hypothesis of D&O insurance and finds that it is supported. Considering risking behavior after insurance purchase may affect the functions of insurance, the third part analyzes possible opportunistic behavior caused by D&O insurance. It is found that the evidence about opportunistic behavior is not significant. Based on these findings, the paper further argues and concludes that D&O insurance should not be compulsory and legally capped in Taiwan.