We analyze the effect of directors' and officers' liability insurance (DandO insurance) on the spreads charged on bank loans. We find that higher levels of DandO insurance coverage are associated with higher loan spreads and that this relation depends on loan characteristics in economically sensible ways and is attenuated by monitoring mechanisms. This association between loan spreads and DandO insurance coverage is robust to controlling for endogeneity (because both could be related to firm risk). Our evidence suggests that lenders view DandO insurance coverage as increasing credit risk (potentially via moral hazard or information asymmetry). Further analyses show that higher levels of DandO insurance coverage are associated with greater risk taking and higher probabilities of financial restatement due to aggressive financial reporting. While greater use of DandO insurance increases the cost of debt, we find some evidence that DandO insurance coverage appears to improve the value of large increases in capital expenditure for firms with better internal and external governance.
Bibliographical noteFinancial support provided from the Research Grants Council of the Hong Kong Special Administrative Region, China (Project No. T31/717/12R) and a GRF grant from Research Grants Council of the Hong Kong Special Administrative Region, China (Project No. 154811).
- Cost of debt financing
- Credit risk
- Directors' and officers' liability insurance
- Loan spreads