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

51 Pages Posted: 15 Mar 2015

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: November 10, 2014

Abstract

Directors’ and officers’ (D&O) legal liability insurance is commonly provided to corporate executives and directors. Prior literature suggests managers are more willing to engage in opportunistic behaviors when their personal assets are more protected from litigation risk. Therefore, information about D&O policy details is potentially useful in assessing potential managerial opportunism. However, many countries, including the U.S., do not require firms to disclose this information. We provide evidence on whether mandatory D&O disclosures are likely to provide information about managerial opportunism that is incremental to that provided by other sources of information using a sample of Canadian firms, who are required to make D&O disclosures. We examine the association between excess D&O coverage limits and audit fees since auditors have extensive private information about the likelihood of managerial opportunism and strong incentives to incorporate this information into their audit fees. We find a positive association between excess D&O coverage limits and audit fees after controlling for numerous other audit fee determinants, including other proxies for managerial opportunism such as discretionary accruals and corporate governance variables. Additional analyses suggest auditors are more sensitive to potential managerial opportunism when managers are more likely to act on their opportunistic incentives. We also find a positive association between excess D&O coverage limits and the likelihood of future shareholder litigation. Our findings suggest that D&O insurance disclosures convey incremental information to shareholders and other capital market participants. As such, they suggest a beneficial role for mandatory D&O disclosures.

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

Suggested Citation

Chung, Hyeesoo Hyun and Hillegeist, Stephen A. and Wynn, Jinyoung Park, Directors’ and Officers’ Legal Liability Insurance, Audit Pricing, and Litigation Risk (November 10, 2014). Journal of Accounting and Public Policy, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2577074

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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