Managerial Opportunism? Evidence from Directors' and Officers' Insurance Purchases

38 Pages Posted: 11 Sep 2000

See all articles by John Chalmers

John Chalmers

University of Oregon

Larry Dann

University of Oregon - Department of Finance

Jarrad Harford

University of Washington; European Corporate Governance Institute (ECGI)

Multiple version iconThere are 2 versions of this paper

Date Written: August 11, 2000

Abstract

Managers choose to spend corporate resources to purchase directors' and officers' liability insurance, which protects directors and officers from personal financial liability in lawsuits brought against the firm and its directors and officers. We investigate whether the amount of D&O insurance coverage chosen by managers of IPO firms, and the cost of that insurance, is related to post-IPO abnormal stock price performance. If managers of IPO firms are exploiting superior inside information in bringing their companies public when the expected offering price exceeds managers' private valuation estimate, we hypothesize that the amount of insurance coverage chosen will be related to the post-offering performance of the issuing firm's shares. 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. Consistent with the hypothesis, we find a significant negative relation between the 3-year post-IPO stock price performance and the amount of insurance coverage in place at the IPO date. We also analyze the pricing of D&O insurance by the insurers. Insurers charge more for insurance purchases that are larger than would be predicted by observable business risk proxies. However, insurers pool all abnormal insurance purchases together in that they do not distinguish between those who buy abnormally large insurance based on anticipated poor performance and those who buy extra insurance for other reasons (e.g., abnormally high risk aversion). Insurers do, however, appear to charge more to firms that buy more insurance and are subsequently sued, indicating that insurers are able to identify and price abnormal litigation risk. We argue that, similar to insider securities transactions, D&O insurance decisions reveal the private information of 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.

Suggested Citation

Chalmers, John and Dann, Larry Y. and Harford, Jarrad, Managerial Opportunism? Evidence from Directors' and Officers' Insurance Purchases (August 11, 2000). Available at SSRN: https://ssrn.com/abstract=239222 or http://dx.doi.org/10.2139/ssrn.239222

John Chalmers (Contact Author)

University of Oregon ( email )

Lundquist College of Business
1208 University of Oregon
Eugene, OR 97403
United States
541-346-3337 (Phone)

Larry Y. Dann

University of Oregon - Department of Finance ( email )

Lundquist College of Business
1208 University of Oregon
Eugene, OR 97403
United States
(541) 346-3330 (Phone)

Jarrad Harford

University of Washington ( email )

Box 353226
Seattle, WA 98195-3226
United States
206-543-4796 (Phone)
206-543-7472 (Fax)

HOME PAGE: http://faculty.washington.edu/jarrad/

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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