No abstract

We analyze a sample of 72 IPO firms that went public between 1992 and 1996 for which we have detailed proprietary information about the amount and cost of D&O liability insurance. If managers of IPO firms are exploiting superior inside information, we hypothesize that the amount of insurance coverage chosen will be related to the post-offering performance of the issuing firm's shares. Consistent with the hypothesis, we find a significant negative relation between the three-year post-IPO stock price performance and the insurance coverage purchased in conjunction with the IPO. One plausible interpretation is that, like insider securities transactions, D&O insurance decisions reveal opportunistic behavior by managers. This provides some motivation to argue that disclosure of the details of D&O insurance decisions, as is required in some other countries, is valuable. CORPORATE INSIDERS ARE WIDELY ACKNOWLEDGED to possess superior information about future prospects for the firms they manage, and to some degree to utilize that information to their private benefit. One well-known example that helps to establish this inference is that insider trades have been shown to contain information that helps to predict security returns. We refer to insiders' use of corporate information for private benefit as managerial opportunism. The managerial opportunism hypothesis says that rational managers, armed with superior information, choose to sell shares when the public valuation of the company's shares exceeds management's valuation estimate. In the context of insider trades, evidence by Seyhun~1986!, Lee~1997!, and Kahle~2000! provides support for the managerial opportunism hypothesis.We test the managerial opportunism hypothesis in another context. We examine the decision that informed insiders make concerning the purchase of directors' and officers'~D&O! liability insurance around the time when a company is preparing to sell its initial public offering~IPO! of stock. If managers are behaving opportunistically and taking the company public when the IPO shares are overvalued, then we posit that rational managers will adjust other decisions they make to balance the costs and benefits of ex-

No abstract

Economic distortions can arise when financial claims trade at prices set by an intermediary rather than direct negotiation between principals. We demonstrate the problem in a specific context, the exchange of open-end mutual fund shares. Mutual funds typically set fund share price~NAV! using an algorithm that fails to account for nonsynchronous trading in the fund's underlying securities. This results in predictable changes in NAV, which lead to exploitable trading opportunities. A modification to the pricing algorithm that corrects for nonsynchronous trading eliminates much of the predictability. However, there are many other potential sources of distortion when intermediaries set prices.

At least one co-author has disclosed a financial relationship of potential relevance for this research. Further information is available online at http://www.nber.org/papers/w18158.ack NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.