Why Firms Purchase Property Insurance?

Abstract

We investigate whether corporate finance incentives affect the extent of corporate hedging with property insurance. Using a database that contains detailed insurance information, we show that firms buy property insurance to reduce the expected costs of distress. Further, we document a scale effect: large firms purchase less insurance per unit of property. This is consistent with the notion that expected bankruptcy costs fall as firm size increases. We also show that the dividend payout ratio exerts a negative influence on property insurance coverage. This result is consistent with the view that firms with high payout ratio insure a smaller fraction of property because of cash flows in excess of investment needs, easy access to capital markets or both.