Why do firms purchase directors' and officers' liability insurance? – perspective from economic policy uncertainty

Abstract

PurposeThis study aims to investigate whether firms purchase directors' and officers' liability (D&O) insurance when the country-level economic policy uncertainty (EPU) is high.Design/methodology/approachThis study uses D&O insurance data from Chinese listed firms between 2003 and 2019 to conduct regression analyses to examine the association between D&O insurance and EPU.FindingsThe results show that government EPU, despite being an exogenous factor, increases the likelihood of firms' purchasing D&O insurance, and this effect is more pronounced when firms are exposed to great share price crash risk and high litigation risk, suggesting that firms intend to purchase D&O insurance possibly due to the accentuated stock price crash risk and litigation risk associated with EPU. In addition, the results indicate that the effect of EPU on the D&O insurance purchase decision is moderated by the provincial capital market development and internal control quality.Practical implicationsThe study highlights the role of uncertain economic policies in shareholder approval of D&O insurance purchases.Originality/valueThe study enriches the literature on the determinants of D&O insurance purchases by documenting novel evidence that country-level EPU is a key institutional factor shaping firms' decisions to purchase D&O insurance.

The impact of directors’ and officers’ liability insurance on firm’s investment efficiency: evidence from China

“…Li et al (2022a) find that firms' incentives to procure D&O insurance are primarily driven by economic factors in recent years. Supporting this argument, Jiang et al (2022) find that firms are more likely to purchase D&O insurance when operating in an external environment characterized by high economic policy uncertainty, which may lead to increased negative consequences for D&Os. A recent study by Hu and Fang (2022) reveals that the likelihood of a listed firm purchasing D&O insurance increases with the purchase behavior of peer firms.…”

“…D&O insurance is specifically designed and acquired to provide protection to D&Os against legal liability arising from their professional activities on behalf of the company. As a result, the key factors influencing the decision to purchase D&O insurance are the actual or perceived litigation risks faced by D&Os (Core, 1997; Jiang et al , 2022; Kao et al , 2020; Park, 2018; Zou et al , 2008). Kao et al (2020) find that conservative and risk-averse D&Os opt to purchase D&O insurance to mitigate litigation risks during initial public offerings.…”

“…For instance, D&O insurance coverage is present in 97% of US firms, 86% in Canada, 60%–70% in Hong Kong SAR, China (Yuan et al , 2016) and approximately 55% in Taiwan, China (Chiang and Chang, 2022; Li and Liao, 2014). However, by the end of 2019, only 9% of firms in Mainland China had obtained D&O insurance coverage (Jiang et al , 2022). This is surprising considering China's position as the world's second-largest insurance industry, yet D&O insurance adoption among Chinese listed firms remains relatively low (Hu and Fang, 2022; Jia et al , 2019).…”

“…However, the increasing attention from regulatory authorities and recent D&O insurance claims, such as the claim made by Luckin against Ping An Insurance Company, have motivated Chinese-listed firms to procure D&O insurance. This is evidenced by a tenfold increase in D&O insurance purchases from 2002 to 2019 (Jiang et al , 2022) and a subsequent increase of over 40% from 2019 to 2020 (Li et al , 2022b).…”

“…This possibility is evident in the descriptive statistics of their study and acknowledged in their discussions. In contrast, we use a commercial database that provides more reliable D&O insurance data, which has gained increased usage in recent years (Jiang et al , 2022; Wang et al , 2022). [3] Our results to some extent confirm the findings of Chen et al (2015).…”