Does Managerial Legal Liability Affect Corporate Diversification?

We examine the effect of directors' and officers' liability insurance (D&O insurance) on corporate diversification and firm value. D&O insurance can encourage managers to take risks and lower diversification, but it can also entrench managers and lead to empire building. Because higher D&O insurance coverage shields managers from market discipline and exacerbates agency problems associated with managerial opportunism, we argue that managers are more likely to exhibit higher levels of diversification that destroy shareholders' value. Using archival data from a sample of 1,332 Taiwanese listed firms in the period 2008-2014, we find that excess D&O insurance coverage is associated with higher levels of corporate diversification, more specifically, unrelated diversification. In addition, we find that corporate diversification, and unrelated diversification in particular, reduces firm value for firms with excess D&O coverage. Our results show that, in the context of Taiwan, D&O insurance affects diversification and firm value. Therefore, D&O insurance is a useful source of information for shareholders when they make investment decisions. In addition, this study offers insights for policy makers who are interested in regulating D&O insurance and its related disclosures.