Directors' and officers' liability insurance and investment efficiency: Evidence from Taiwan

• We examine how D&O insurance affects investment efficiency using Taiwanese data.
• The degree of over-investment increases with the level of D&O insurance coverage.
• This association is more pronounced for firms with lower director ownership.
• It is also more pronounced for firms with lower institutional holdings.
• The adverse effect of D&O insurance is weakened if the insurer is domestic-owned.

Prior studies suggest that directors' and officers' (D&O) insurance induces moral hazard and reduces incentives on behalf of stockholders. As a result, we argue that purchasing D&O insurance exhibits lower investment efficiency. Using data from Taiwan between 2008 and 2010, which is mandatorily disclosed and thus serves as an ideal sample, we test for an adverse relation between D&O insurance and investment efficiency and explore factors that affect the magnitude of that adverse relation. The results show that the level of D&O insurance coverage is positively associated with over-investment. Further analyses suggest that the positive association is more pronounced in firms with lower levels of director ownership or institutional holdings and weakened when firms purchase from domestic rather than foreign insurers. Overall, we conclude that D&O insurance has an impact on corporate investment decisions, especially in terms of over-investment, and that better corporate governance mechanisms help mitigate the inefficiency problems caused by D&O insurance.