Directors’ And Officers’ Insurance And Opportunism In Accounting Choice

In this paper, the focus is on how excessive directors’ and officers’ liability insurance coverage is associated with risk-taking behavior in financial reporting. This study examines the implications of two alternative hypotheses. The opportunism hypothesis predicts that the covered executive is overly buffered from recourse via securities litigation, which leads to aggressive accounting choices. The alternative hypothesis is the economic insurance hypothesis which predicts that firms will over-invest in directors’ and officers’ liability insurance coverage independent of their aptitude for accounting manipulation because of the managers’ risk aversion. Aggressive accounting is measured using regulatory accounting enforcement actions and earnings restatements. I find evidence consistent with the opportunism hypothesis in both the enforcement action and restatement setting, suggesting that officers rely on excessive insurance in making financial reporting decisions. The findings have implications for managerial private information and its impact on financial reporting decisions.