Why do firms purchase directors' and officers' liability insurance? – perspective from economic policy uncertainty

Abstract

This study aims to investigate whether firms purchase directors' and officers' liability (D&O) insurance when the country-level economic policy uncertainty (EPU) is high. This study uses D&O insurance data from Chinese listed firms between 2003 and 2019 to conduct regression analyses to examine the association between D&O insurance and EPU. The results show that government EPU, despite being an exogenous factor, increases the likelihood of firms' purchasing D&O insurance, and this effect is more pronounced when firms are exposed to great share price crash risk and high litigation risk, suggesting that firms intend to purchase D&O insurance possibly due to the accentuated stock price crash risk and litigation risk associated with EPU. In addition, the results indicate that the effect of EPU on the D&O insurance purchase decision is moderated by the provincial capital market development and internal control quality. The study highlights the role of uncertain economic policies in shareholder approval of D&O insurance purchases. The study enriches the literature on the determinants of D&O insurance purchases by documenting novel evidence that country-level EPU is a key institutional factor shaping firms' decisions to purchase D&O insurance.

Keywords

• economic policy uncertainty
• directors’ and officers’ liability (d&o) insurance
• stock price crash risk
• litigation risk
• china