Does Disclosure of D&O Liability Insurance Policies Influence Investor Perceptions of Earnings Management?

In response to the financial frauds that precipitated the “Great Recession of 2007,” Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in July of 2010. In addition to enhancing the budget of the enforcement division of the Securities and Exchange Commission, the act also provides new monetary incentives for whistleblowers to report fraud. As a result of the act’s passing, shareholder litigation against company directors and officers is expected to increase dramatically in future years (Polikoff and Huskins 2011). While many of these future securities lawsuits will result in substantial financial settlements paid to shareholders, the majority of these payouts will not be funded by the companies themselves, but by their insurance carriers. 1 Directors’ and Officers’ (D&O) insurance policies, which are purchased by a substantial portion of U.S. corporations, can be structured to cover, not only the costs of defending litigation, but also the related settlement or judgment (Towers & Watson 2011). Therefore, director and officer exposure to liability is at the forefront of the new legislation. Unlike some international regulatory regimes, the SEC does not require U.S. registrants to disclose the details of their D&O insurance policies and few firms voluntarily provide this information (Griffith 2005). 2 As a result, existing empirical research on the effects of the