Directors’ and Officers’ Legal Liability Insurance, Audit Pricing, and Litigation Risk

32 Pages Posted: 22 Sep 2012

See all articles by Hyeesoo Hyun Chung

Hyeesoo Hyun Chung

California State University, Long Beach; Arizona State University (ASU) - School of Global Management and Leadership

Stephen A. Hillegeist

Arizona State University (ASU) - W. P. Carey School of Business, School of Accountancy

Jinyoung P. Wynn

Louisiana Tech University - School of Professional Accountancy

Multiple version iconThere are 2 versions of this paper

Date Written: September 21, 2012

Abstract

Directors’ and Officers’ (D&O) legal liability insurance is a common component of CEO compensation packages. We expect managers are more willing to engage in opportunistic behaviors when their personal assets are protected from litigation risk. Therefore, information about D&O policy details is potentially useful in assessing the degree of managerial opportunism. However, US firms are not required to disclose this information. We provide evidence on this issue by first examining the association between excess D&O coverage limits and audit fees. We hypothesize that external auditors charge higher fees for audit clients with excessively high legal liability insurance coverage. Using excess Directors’ and Officers’ (D&O) insurance coverage for Canadian firms as a composite measure of managerial opportunism, we find a positive association between excess D&O coverage limits and audit fees after controlling for numerous other audit fee determinants. Additional analyses indicate that auditors are more concerned about managerial opportunism in those firms where the potential costs (to the auditor) of opportunism are expected to be higher. Second, we find a positive association between excess D&O coverage limits and the likelihood of shareholder litigation. Our findings suggest that D&O insurance disclosures convey useful information to shareholders and other capital market participants.

Keywords: Directors’ & Officers’ insurance, audit fees, litigation risk, mandatory disclosure

JEL Classification: M4, G38, K22

Suggested Citation

Chung, Hyeesoo Hyun and Hillegeist, Stephen A. and Wynn, Jinyoung Park, Directors’ and Officers’ Legal Liability Insurance, Audit Pricing, and Litigation Risk (September 21, 2012). Available at SSRN: https://ssrn.com/abstract=2150286 or http://dx.doi.org/10.2139/ssrn.2150286

Hyeesoo Hyun Chung

California State University, Long Beach ( email )

1250 Bellflower Blvd.
Long Beach, CA 90840
United States

Arizona State University (ASU) - School of Global Management and Leadership ( email )

P.O. Box 37100
Phoenix, AZ 85069
United States

Stephen A. Hillegeist (Contact Author)

Arizona State University (ASU) - W. P. Carey School of Business, School of Accountancy ( email )

Tempe, AZ 85287-3706
United States
480-965-6614 (Phone)

Jinyoung Park Wynn

Louisiana Tech University - School of Professional Accountancy ( email )

Ruston, LA 71272
United States
(318) 257-3948 (Phone)
(318) 257-4253 (Fax)

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