Agency Theory and Participating Policy Usage: Evidence from Stock Life Insurers

Abstract

Extant literature demonstrates that participating policies mitigate shareholder-policyholder incentive conflicts in stock insurance firms. However, extending the argument in Mayers and Smith (1994), we formally show that participating policies also exacerbate the shareholder-manager incentive conflicts in stock insurance firms. In this paper, we test whether hypotheses derived from agency theory explain the usage of participating life insurance policies by stock insurers. Our results are consistent with the argument that participating policy usage is dictated by the trade-off between the mitigation of the contracting costs of risk shifting and underinvestment, and the exacerbation of the incentive conflicts between managers and shareholders.

Keywords: agency theory, participating policies, risk shifting, underinvestment, managerial discretion

JEL Classification: G32, L22, G22