Directors' and Officers' Legal Liability Insurance and Internal Control Weaknesses

Directors' and officers' (D&O) legal liability insurance releases directors and officers from the threat of litigation and personal liability stemming from their decisions on behalf of the corporation. While researchers have examined some of the determinants of internal control weaknesses, it is not clear whether excess D&O coverage motivates managers to weaken the quality of firms' internal controls. This study examines whether excess D&O coverage affects the effectiveness of internal controls. Based on a sample of Taiwanese listed firms for the period 2008 to 2012, we find that firms with excess D&O coverage exhibit a greater likelihood of internal control weaknesses. This finding is driven primarily by company-level weaknesses rather than by account-level weaknesses. Because the disclosure of D&O insurance may convey additional information about managers' actions, our findings have implications for other emerging markets.