Is the Demand for Corporate Insurance a Habit? Evidence from Directors' and Officers' Insurance

Of the many fundamental questions left unanswered in finance, one relates to corporate risk management practices. It is still relatively unclear what are the reasons that motivate risk neutral corporations to manage their idiosyncratic risk. Our contention in this paper is that corporate insurance purchases are driven by habit rather than an optimal approach to corporate risk management. Because public access to corporate insurance purchases and risk management strategies is limited at best, we examine a particular aspect of the corporate demand for insurance for which public information is available: Directors' and Officers' (D&O) insurance. Information regarding D&O insurance purchases has been publicly available in Canada since 1993. Our results suggest that the decision to insure as well as the amount of coverage purchased (policy limit and deductible) are more driven by the previous year's decision than any other. We find that a corporation's fundamental financial and governance measures do not appear to have any impact on the decision to purchase insurance nor on the amount of insurance to purchase. Our results suggest that corporations may not choose optimally their risk management decisions; rather they may rely more on a force of habit than on a clear and concise strategy to manage corporate risk. As a result, and in contrast to Core (1997, 2000) and Chalmers et al. (2002), we find no evidence of managerial opportunism in regards to D&O insurance coverage.
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