The effect of directors’ and officers’ liability insurance on stock investors’ perceptions of earning quality

Authors: Hsiu-Mei Liao, Li-Fen Tang, Jan-Zan Lee

Journal: Chiao Da Management Review. Dec. 2015, 35(2): 113-148.

Directors and officers liability insurance; Earnings response coefficients; Endogenous binary treatment model

Using the earnings response coefficients (ERC hereafter) as a proxy for stock investors’ perceptions of earnings quality, this study examines the effect of directors’ and officers’ liability insurance (D&O insurance hereafter) on the ERC. Using publicly-available D&O insurance data for public firms in Taiwan from 2008 to 2010, we employ an endogenous binary treatment model and other methods to control self-selection bias on the estimation of relationship between D&O insurance and ERC. The empirical results show that firms with D &O insurance have lower ERC than those without D&O insurance. In addition, we find that firms with higher D&O insurance coverage have lower ERC and firms with higher abnormal D&O insurance coverage will further deteriorate the ERC. These results imply that stock investors believing the purchase of D&O insurance may increase the risk of moral hazard from directors and officers, as it is not conducive to earnings quality, andtheir earnings information on responses to stock prices will thereby be reduced.