Directors' and Officers' Insurance and Shareholder Protection

Abstract

Corporate directors are liable for the corporation's actions as well as their own. Strangely, and by far, the most likely plaintiffs in a lawsuit against corporate directors are the shareholders who appointed them in the first place. As a result, directors often require protection so that their personal wealth is not expropriated in the event of a good faith error. There are three ways to protect a director's wealth: Corporate indemnification plans, Limited liability provisions and Directors' and officers' (D&O) insurance policies. Of the three types of protection, D&O insurance is arguably the strangest not because shareholders purchase it to protect directors in case of a lawsuit, but because it also protects shareholders. Using an original database, I test a set of hypotheses that should determine the demand for D&O insurance. Similar to Romano (1991a) and Gutiérrez (2003), my analysis suggests that D&O insurance protects the shareholders' wealth more than the directors'.

Keywords: Directors' and Officers' Insurance, Corporate Insurance and Risk Management, Board Compensation

JEL Classification: G34, G22, J44, G32