Political connections and directors' and officers' liability insurance – Evidence from China

Abstract

Political connections provide firms with legal advantages and can shield managers and directors away from litigation risk. Using a sample of Chinese public firms, we find that politically connected firms have lower demand for the directors' and officers' liability insurance (D&O insurance). The association is robust to Heckman two-step selection model, an examination of market reaction to the departure of politically connected managers, a difference-in-differences analysis surrounding the hiring of a politically connected CEO, and controlling for firm performance. The effect is attenuated for firms in regions with strong market development and legal environment, but is accentuated for firms that are less socially important to the local government. Our findings highlight a substitution effect between political connections and D&O insurance in protecting managers and directors against legal liability, and advance our understanding of the key drivers of D&O insurance purchase in emerging markets.