Pricing of Responsible Financial Reporting: The Perspective from Directors’ & Officers’ Liability Insurers

This paper studies whether and how responsible (or irresponsible) financial reporting practices are priced by insurers that sell Directors’ and Officers’ (D&O) insurance products to public firms. As D&O insurers typically assume the liabilities arising from shareholder litigation, the insurance premiums they charge for D&O policy coverage reflect their assessment of a company’s litigation risk, which, under many circumstances, can be reduced by responsible financial reporting choices and strong corporate governance practices. Using a sample of public firms in the Tillinghast D&O insurance surveys conducted between 2001 and 2004, we document that firms with lower earnings quality or prior restatements of financial numbers pay higher D&O insurance premiums after controlling for other economic factors that shape a firm’s litigation environment