Directors’ & Officers’ Liability, D&O Insurance and Moral Hazard: More Control of Moral Hazard by D&O Insurers Needed to Increase the Incentives of Directors and Supervisory Board Members

doi:10.2139/SSRN.2153129

Paper

Directors’ & Officers’ Liability, D&O Insurance and Moral Hazard: More Control of Moral Hazard by D&O Insurers Needed to Increase the Incentives of Directors and Supervisory Board Members

Published Sep 27, 2012 · W. Weterings

Organizational Behavior & Key Stakeholders eJournal

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Abstract

Directors and supervisory board members (officers) are increasingly being held personally liable. Directors & Officers (D&O) liability insurance offers directors and supervisory board members ample protection against directors' and officers' liability. On the one hand, this has many advantages for the directors and supervisory board members, the company and other concerned parties. It implies, for instance, that it is easier for a company to attract good directors. With a D&O insurance policy, there are also improved means of recovery for parties that have been injured, which also positively affects the compensatory and preventive functions of liability law. On the other hand, due to the presence of D&O insurance, there are fewer financial incentives vis-a-vis directors and officers to act with due care – the moral hazard. As a result, the preventive function of liability law is, in principle, undermined, or at least negatively affected, by the D&O insurance. D&O insurers can, however, take various measures in an attempt to mitigate the moral hazard. For potential injured parties, the company, the insurer and society, those measures are of tremendous importance for ensuring the risk of damage/loss remains as low as possible. Field research shows, however, that the moral hazard is being insufficiently addressed by D&O insurers in the Netherlands. There are restrictions to the instruments that the Dutch D&O insurers are currently using to reduce the moral hazard. What is more, not all possible instruments are being used. This most likely also holds true for D&O insurers in other European countries and in the United States (in light of the research of Baker & Griffith 2010). It is, however, necessary to ensure that the moral hazard is optimally addressed and that the incentives for careful acts of management from liability law continue to be retained as much as possible. That is why it is desirable for D&O insurers to start implementing a retention for the Side A coverage for (the liability of) directors and officers.

Study Snapshot

D&O insurers need to improve their control of moral hazard to increase the incentives for directors and officers to act with due care and maintain the preventive function of liability law.

PopulationOlder adults (50-71 years)

Sample size24

MethodsObservational

OutcomesBody Mass Index projections

ResultsSocial networks mitigate obesity in older groups.

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Paper

Directors’ & Officers’ Liability, D&O Insurance and Moral Hazard: More Control of Moral Hazard by D&O Insurers Needed to Increase the Incentives of Directors and Supervisory Board Members

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References

Ensuring Corporate Misconduct: How Liability Insurance Undermines Shareholder Litigation

Directors and Officers liability insurance can shield corporations from financial consequences of illegal acts, undermining shareholder litigation and corporate governance, but reforms can significantly rehabilitate the system.

The Missing Monitor in Corporate Governance: The Directors' & Officers' Liability Insurer

Directors' and officers' liability insurance (D&O) does not effectively monitor corporate governance or manage litigation defense costs, contributing to weak constraints on corporate managers and weakening shareholder litigation alignment.

Predicting Corporate Governance Risk: Evidence from the Directors' and Officers' Liability Insurance Market

Insurers assess corporate governance risk in underwriting Directors' and Officers' liability insurance, potentially preserving the deterrence function of corporate and securities law by forcing worse-governed firms to pay higher premiums.

Uncovering a Gatekeeper: Why the SEC Should Mandate Disclosure of Details Concerning Directors’ and Officers’ Liability Insurance Policies

The SEC should mandate disclosure of D&O policy details to better understand corporate governance quality and signal important information to investors and capital market participants.

Asymmetric Information and Learning: Evidence from the Automobile Insurance Market

New customers with driving experience choose higher insurance coverage, leading to more accidents, partly due to underreporting past claim history.

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