Heterogeneous Beliefs and the Demand for D&O Insurance by Listed Companies

Heterogeneous Beliefs and the Demand for D&O Insurance by Listed Companies

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Article ID: iaor2016204
Volume: 82
Issue: 4
Start Page Number: 823
End Page Number: 852
Publication Date: Dec 2015
Journal: Journal of Risk and Insurance
Authors: , ,
Keywords: insurance, stock market
Abstract:

This article introduces a new rationale for the existence of ‘directors’ and officers’ (D&O) insurance. We use a model with volatile stock markets where shareholders design compensation schemes that incentivize managers to stimulate short‐term increases in stock prices that do not maximize long‐run stock market value. We show that D&O insurance provides a convenient instrument for the initial shareholders of a company to take advantage of differences in beliefs between insiders and outsiders in capital markets. The empirical results support the idea that both the insurance coverage and the premium are higher in the presence of new shareholders and volatile markets. The results prove robust in various empirical model specifications.

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