The role of directors' and officers' insurance in financial reporting and class action securities litigation.

Abstract

This dissertation investigates how D&O insurance affects financial reporting and litigation decisions both internal and external to the firm. Specifically, the dissertation focuses on how excessive D&O coverage is associated with risk-taking behavior in financial reporting. I measure aggressive accounting by the need to restate earnings. I find that unexpected D&O coverage results in aggressive financial reporting, which is more likely to lead to a restatement of earnings. In addition, plaintiffs appear to estimate the firm's D&O coverage when deciding whether to file a class action securities litigation claim. The dissertation assesses litigation risk by predicting class action lawsuit filings, and determines that D&O coverage is positively associated with litigation risk. Furthermore, I show that settlement amounts are increasing in D&O coverage limits and restated net income. In sum, a firm with a high coverage limit is more likely to restate earnings, be sued, and settle for more than a firm with a low coverage limit, all else equal. These findings are accomplished using the most comprehensive samples of D&O insurance coverage, class action securities filings, and settlements used to date. Thus, even though a firm's D&O insurance purchase choice is unobservable to investors, the amount of D&O coverage underlies many of managers' and plaintiffs' decisions.