Is Corporate Governance Risk Valued? Evidence from Directors’ and Officers’ Insurance

Abstract:     
The role and duty of corporate directors and officers is in constant flux. If the company is sued, corporate directors and officers may be held personally liable for having breached their duty toward the firm’s stakeholders. As a consequence, before accepting to sit on the board of any organization would-be directors require that their personal wealth be protected; this protection is provided through what is known as a directors’ and officers’ liability insurance contract, or D&O insurance. In this paper, we examine whether D&O insurers charge a higher premium to firms that appear to have higher governance risk. We find that common equity firms pay lower D&O insurance premiums than income trusts, an alternative and, arguably, riskier ownership form. This result has wide-ranging implications for investors insofar as the information provided by D&O insurers provides investors with an unbiased signal of the firm’s governance risk. The signal is unbiased because it comes from an entity (i.e. the insurer) that has a direct financial incentive to correctly assess an organization’s governance risk, in contrast to other ad hoc governance measures and indices.

Number of Pages in PDF File: 45

Keywords: Corporate governance, D&O insurance, Initial public offerings, Income trusts

JEL Classification: G34, G22, J44, G32

working papers series