Insurer Information, Insiders and Initial Public Offering

Abstract

This paper develops and tests hypotheses regarding the relationship between D&O insurance purchase and firm size, governance characteristics, and business risk, using a unique panel dataset on Canadian firms for years 1996-2005. The rich data permit examination of the determinants of insurance pricing, ownership, and coverage limits. The panel structure of the data also permits examination of the effects of insurance on corporate governance and earnings management. The paper adds to the literature by constructing empirical models motivated by theoretical considerations, controlling for firms' self-selection into insurance, and accounting for industry and year effects. Results provide strong statistical evidence for the view that D&O insurance markets take corporate risk into account, but insurance reduces the deterrent effects of potential liability for mismanagement. The findings suggest that mandatory disclosure of D&O insurance, as required in Canada, is not sufficient to control the moral hazard effects of insurance ownership.