Information Embedded in Directors and Officers Insurance Purchases

Abstract

We examine corporate purchases of Directors and Officers (D&O) liability insurance and find that in addition to governance quality it contains managers’ private information. In particular, we find that insider control in excess of insider share holdings is jointly associated with lower D&O coverage limits and higher firm performance. The result holds when deductibles, corporate governance characteristics and litigation risk factors are controlled for. Our finding is consistent with asymmetric information hypothesis in financial markets which posits that managers possess private information about firm risk. Our findings differ from extant literature that shows that D&O insurance purchases primarily reflect firm’s governance quality and litigation risk. The evidence supports the policy prescription advanced in earlier studies which call for mandatory public disclosure of D&O insurance purchases since it contains additional information for the market.