Managerial Opportunism? Evidence from Directors' and Officers' Insurance Purchases

Download or read book Managerial Opportunism? Evidence from Directors' and Officers' Insurance Purchases written by John Chalmers and published by . This book was released on 2002 with total page 38 pages. Available in PDF, EPUB and Kindle. Book excerpt: Managers choose to spend corporate resources to purchase directors' and officers' liability insurance, which protects directors and officers from personal financial liability in lawsuits brought against the firm and its directors and officers. We investigate whether the amount of Damp;O insurance coverage chosen by managers of IPO firms, and the cost of that insurance, is related to post-IPO abnormal stock price performance. If managers of IPO firms are exploiting superior inside information in bringing their companies public when the expected offering price exceeds managers' private valuation estimate, we hypothesize that the amount of insurance coverage chosen will be related to the post-offering performance of the issuing firm's shares. We analyze a sample of 72 IPO firms that went public between 1992 and 1996 for which we have detailed proprietary information about the amount and cost of Damp;O liability insurance. Consistent with the hypothesis, we find a significant negative relation between the 3-year post-IPO stock price performance and the amount of insurance coverage in place at the IPO date. We also analyze the pricing of Damp;O insurance by the insurers. Insurers charge more for insurance purchases that are larger than would be predicted by observable business risk proxies. However, insurers pool all abnormal insurance purchases together in that they do not distinguish between those who buy abnormally large insurance based on anticipated poor performance and those who buy extra insurance for other reasons (e.g., abnormally high risk aversion). Insurers do, however, appear to charge more to firms that buy more insurance and are subsequently sued, indicating that insurers are able to identify and price abnormal litigation risk. We argue that, similar to insider securities transactions, Damp;O insurance decisions reveal the private information of managers. This provides some motivation to argue that disclosure of the details of Damp;O insurance decisions, as is required in some other countries, is valuable.