Directors' and Officers' Liability Insurance and Agency Costs-Based on the Relationship Between Internal and External Governance

Since the introduction of directors' and officers' liability (D&O) insurance into the Chinese market in 2002, the debate over the external supervision and opportunism hypotheses has raised wide concern in both theory and practice. This study uses data of Chinese listed companies from 2010 to 2020 to examine the impact of D&O insurance on agency costs to further clarify the actual effect of D&O insurance in China. The empirical results show that the purchase of D&O insurance significantly reduces agency costs and supports the external supervision hypothesis of liability insurance. After controlling for the endogeneity problem, the conclusion remains robust. In addition, mechanism analysis suggests that the impact could be more pronounced when institutional investors' shareholding is lower, the proportion of independent directors is higher, and the degree of equity balances is better. Further research finds that reducing the agency costs of D&O insurance can improve financial performance and corporate value. By enriching the literature on D&O insurance and agency costs, this study can not only help listed companies and investors fully understand the role of D&O insurance, but also adduce implications for regulatory authorities to supervise companies that have purchased D&O insurance and provide insight for investors seeking to invest in such enterprises.