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The role of information: When is Directors’ and Officers’ insurance value-added?

Shih-Chung Chang, Yayuan Ren and Jason Yeh

Journal of Banking & Finance, 2018, vol. 97, issue C, 189-197

Abstract: The paper presents a model of shareholders' decisions to purchase Directors' and Officers' liability insurance (D&O insurance) for their directors. We consider the tradeoff between the governance enhancing effect and the moral hazard effect of D&O insurance and focus on the role of information in determining the optimal level of D&O insurance purchase. The model shows that when directors are well informed, the governance enhancing effect of D&O insurance dominates the moral hazard effect, and thus, D&O insurance adds value to the firm. When directors are under-informed, the best strategy for shareholders is not to provide D&O insurance for directors. The model further shows that the optimal level of D&O insurance, when it exists, increases in the quality of the information received by directors. These results imply cross-firm variations in D&O insurance purchase.

Keywords: Directors and Officers insurance; Information quality; Corporate governance (search for similar items in EconPapers)
JEL-codes: G30 G34 G22 (search for similar items in EconPapers)
Date: 2018
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Handle: RePEc:eee:jbfina:v:97:y:2018:i:c:p:189-197