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Does Information Matter The Effects of Directorslsquo and Officersrsquo Insurance on Shareholder Wealth
Derrick WH Fung and Jason J H Yeh
The Chinese University of Hong Kong
For NTU Economics Seminar
Imperative Virtue or Inevitable Evil bull ldquoIn the current environment companies have a strong incentive
to adopt rigorous governance procedures because those that fail to do so will be unable to attract top quality directors and will pay a risk premium in terms of both director compensation and possibly officer and director liability insurancerdquo
-- Cynthia A Glassman SEC Commissioner in a speech delivered to the National Economistsrsquo Club April 7 2003
bull The full speech by US SEC Commissioner Cynthia A Glassman can be viewed at httpwwwsecgovnewsspeechspch040703caghtm
Motivationbull DampO insurance is very
common in directorrsquos compensation schemes
bull According to the 2012 ldquoDirectors and Officers Liability Surveyrdquo conducted by Towers Watson the surveyed firms purchase DampO insurance for their directors with a median policy limit of US$75m
bull The purchase of DampO insurance is not limited to a few business class only
bull Large Mainland corporation buyers
Motivationbull If DampO insurance is so common does it enhance firm value from the shareholderrsquos
perspective
bull Based on literature there are generally two streams of views
Monitoring Effect
DampO insurance helps the firm recruit and retain talented outside directors (Holderness 1990 MacMinn et al
2012)
DampO insurers who have to cover the liabilities of directorsrsquo bad decisions
help improve the firmrsquos corporate governance
(Holderness 1990 OrsquoSullivan 1997)
Moral Hazard Effect
DampO insurance undermines the disciplinary effect of shareholder
litigation on directors and leads to opportunistic managerial behavior (Chalmers et al 2002 Barrese and
Scordis 2006 Lin et al 2011)
Conceptual Frameworkhellip Chang et al (2004)
bull When the information cost is high outside directors are less effective in monitoring the firm even given the right incentives (Duchin et al 2010) Hence we argue that outside directors rely more on DampO insurance to cover their liabilities for bad decisions resulting in a higher level of moral hazard effect
Firm ValueMoral Hazard Effect
Information Cost
Compensation Linked to Firm Value
Director Reputation
Monitoring Effect
right incentives mitigate moral hazard effect
higher level of moral hazard effect when information cost is higher and
vice versa
negative effect
positive effect
Hypothesisbull Hypothesis 1 Ignoring the information cost to independent directors the
monitoring effect offsets the moral hazard effect and increasing DampO insurance coverage does not affect firm value on average
bull Hypothesis 2 When the information cost to independent directors is low the monitoring effect dominates the moral hazard effect and increasing DampO insurance coverage improves firm value
bull Hypothesis 3 When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and increasing DampO insurance coverage does not improve firm value
Databull As Canadian public firms are required to disclose information about DampO
insurance in their proxy statements this research uses a sample of firms on the SampPTSX Composite Index listed on the Toronto Stock Exchange from 2010 to 2014
Firms on the SampPTSX Composite Index from 2010 to 2014
DampO Insurance Data- whether the firm has
purchased DampO insurance
- the coverage limit- the premium paid
(hand-collected from proxy statements)
Board Characteristics Data
- compensation to directors
- board size- number of independent
directors- average number of committees on which
each independent director serves
(hand-collected from proxy statements)
Firm Value and Characteristics Data- annual stock return
- market capitalization- Tobinrsquos Q- firm age
- total assets- book leverage ratio
(downloaded from Compustat)
Measure of information cost to independent directors
bull We then divide our whole sample into 3 subgroups according to their corresponding information cost
bull As most decision making takes place at the committee level (Kesner 1988) and independent directors who serve on multiple monitoring committees have a more complete understanding of the firm and can make more informed decisions (Faleye et al 2011) we argue that the information cost decreases with the number of committees on which each independent director serves
Empirical Modelbull The baseline empirical model is
Vjt+1 = αICRjt + helliphellip + fj + st + ejt (1)
where j represents a firm t represents a year V is the firm value ICR is the insurance coverage ratio f is the firm-specific effect s is the year-specific effect and e is the error term
bull To eliminate the firm-specific effect we run a regression on the first differences as follows
Vjt+1 ndash Vjt = α(ICRjt ndash ICRjt-1) + control variablest + (st ndash st-1)+ (ejt
ndash ejt-1) (2)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variables Regression (2) is then run on the whole sample and the 3 subgroups with different information cost separately
Empirical Results
Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
1266(147)
1800(213)
5701(538)
-0390(-070)
Board size 0928(220)
2047(438)
1905(213)
0590(089)
Book leverage ratio -0918(-020)
-10586(-159)
-18329(-148)
8365(187)
Firm age 0152(168)
0317(285)
0533(332)
-0176(-133)
Log(Market value of equity) -5083(-402)
-7255(-268)
-8588(-438)
-1659(-139)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0234 0320 0341 0241
Observations 633 217 197 219
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Empirical ResultsRegression of change in market capitalization on change in insurance coverage ratio
Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2263(104)
4120(187)
6750(378)
-0267(-011)
Board size -0166(-017)
2134(159)
1966(112)
-3813(-292)
Book leverage ratio 6390(067)
-6279(-037)
4262(020)
15630(280)
Firm age 0021(015)
0094(073)
0650(140)
0071(021)
Log(Market value of equity) -10311(-558)
-13539(-240)
-14728(-354)
-6882(-227)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0245 0383 0299 0258
Observations 633 217 197 219
Empirical ResultsRegression of change in stock price on change in insurance coverage ratio
Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2045(102)
4055(217)
5914(396)
-0686(-039)
Board size 0097(014)
2063(171)
1476(120)
-2164(-237)
Book leverage ratio 1821(022)
-10527(-083)
-25572(-140)
15082(330)
Firm age 0167(129)
0302(192)
0796(205)
0076(033)
Log(Market value of equity) -7036(-365)
-10476(-176)
-11480(-354)
-2344(-107)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0327 0459 0383 0364
Observations 643 217 207 219
Self-selection correction
bull If a firm endogenously makes its decision to purchase DampO insurance we have to control the potential self-selection bias by employing the Heckmanrsquos (1979) two-stage regression
bull In the selection eq we model the firmrsquos decision to purchase DampO insurance
bull In the effect eq the coefficient estimates obtained above are used to construct the inverse Mills ratio which is the selection bias correction term to control for the possibility that the firmrsquos decision to purchase DampO insurance is endogeneously determined The inverse Mills ratio is then added to effect equation as one of the control variables
Self-selection correction Empirical Results
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Panel A Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()0470(115)
1787(263)
5348(371)
-1558(-309)
Board size 0838(175)
0326(030)
1339(171)
0227(034)
Book leverage ratio 1473(041)
0063(001)
15877(205)
-3771(-067)
Firm age 0228(266)
0463(282)
0263(168)
0049(044)
Log(Market value of equity) -5399(-595)
-6850(-350)
-5690(-338)
-1605(-136)
ρ 0150(066)
0281(075)
-0499(-170)
0460(138)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in market capitalization on change in insurance coverage ratio
Panel B Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0699(082)
4873(345)
6178(295)
-3507(-286)
Board size 1998(224)
-2525(-088)
1713(154)
1023(076)
Book leverage ratio 19437(263)
36428(234)
44051(376)
10878(091)
Firm age 0280(178)
1058(289)
0149(068)
-0035(-016)
Log(Market value of equity) -7681(-445)
-9662(-231)
-8954(-366)
-1257(-054)
ρ 0839(1885)
0965(3021)
-0761(-377)
0955(2885)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in stock price on change in insurance coverage ratio
Panel C Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0625(077)
4631(339)
5390(296)
-3198(-273)
Board size 1891(222)
-1886(-078)
1284(120)
0770(058)
Book leverage ratio 17770(255)
33879(230)
40422(385)
-1096(-009)
Firm age 0409(271)
1103(348)
0293(142)
0141(065)
Log(Market value of equity) -7093(-430)
-9441(-245)
-7073(-307)
-2080(-090)
ρ 0820(1644)
0953(2772)
-0808(-529)
0873(969)
Year fixed effects Yes Yes Yes Yes
Observations 343 101 114 128
Scatter Plots by Groups (All firms)
Scatter Plots Low Info Cost Group
Scatter Plots Medium Info Cost Group
Scatter Plots High Info Cost Group
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Imperative Virtue or Inevitable Evil bull ldquoIn the current environment companies have a strong incentive
to adopt rigorous governance procedures because those that fail to do so will be unable to attract top quality directors and will pay a risk premium in terms of both director compensation and possibly officer and director liability insurancerdquo
-- Cynthia A Glassman SEC Commissioner in a speech delivered to the National Economistsrsquo Club April 7 2003
bull The full speech by US SEC Commissioner Cynthia A Glassman can be viewed at httpwwwsecgovnewsspeechspch040703caghtm
Motivationbull DampO insurance is very
common in directorrsquos compensation schemes
bull According to the 2012 ldquoDirectors and Officers Liability Surveyrdquo conducted by Towers Watson the surveyed firms purchase DampO insurance for their directors with a median policy limit of US$75m
bull The purchase of DampO insurance is not limited to a few business class only
bull Large Mainland corporation buyers
Motivationbull If DampO insurance is so common does it enhance firm value from the shareholderrsquos
perspective
bull Based on literature there are generally two streams of views
Monitoring Effect
DampO insurance helps the firm recruit and retain talented outside directors (Holderness 1990 MacMinn et al
2012)
DampO insurers who have to cover the liabilities of directorsrsquo bad decisions
help improve the firmrsquos corporate governance
(Holderness 1990 OrsquoSullivan 1997)
Moral Hazard Effect
DampO insurance undermines the disciplinary effect of shareholder
litigation on directors and leads to opportunistic managerial behavior (Chalmers et al 2002 Barrese and
Scordis 2006 Lin et al 2011)
Conceptual Frameworkhellip Chang et al (2004)
bull When the information cost is high outside directors are less effective in monitoring the firm even given the right incentives (Duchin et al 2010) Hence we argue that outside directors rely more on DampO insurance to cover their liabilities for bad decisions resulting in a higher level of moral hazard effect
Firm ValueMoral Hazard Effect
Information Cost
Compensation Linked to Firm Value
Director Reputation
Monitoring Effect
right incentives mitigate moral hazard effect
higher level of moral hazard effect when information cost is higher and
vice versa
negative effect
positive effect
Hypothesisbull Hypothesis 1 Ignoring the information cost to independent directors the
monitoring effect offsets the moral hazard effect and increasing DampO insurance coverage does not affect firm value on average
bull Hypothesis 2 When the information cost to independent directors is low the monitoring effect dominates the moral hazard effect and increasing DampO insurance coverage improves firm value
bull Hypothesis 3 When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and increasing DampO insurance coverage does not improve firm value
Databull As Canadian public firms are required to disclose information about DampO
insurance in their proxy statements this research uses a sample of firms on the SampPTSX Composite Index listed on the Toronto Stock Exchange from 2010 to 2014
Firms on the SampPTSX Composite Index from 2010 to 2014
DampO Insurance Data- whether the firm has
purchased DampO insurance
- the coverage limit- the premium paid
(hand-collected from proxy statements)
Board Characteristics Data
- compensation to directors
- board size- number of independent
directors- average number of committees on which
each independent director serves
(hand-collected from proxy statements)
Firm Value and Characteristics Data- annual stock return
- market capitalization- Tobinrsquos Q- firm age
- total assets- book leverage ratio
(downloaded from Compustat)
Measure of information cost to independent directors
bull We then divide our whole sample into 3 subgroups according to their corresponding information cost
bull As most decision making takes place at the committee level (Kesner 1988) and independent directors who serve on multiple monitoring committees have a more complete understanding of the firm and can make more informed decisions (Faleye et al 2011) we argue that the information cost decreases with the number of committees on which each independent director serves
Empirical Modelbull The baseline empirical model is
Vjt+1 = αICRjt + helliphellip + fj + st + ejt (1)
where j represents a firm t represents a year V is the firm value ICR is the insurance coverage ratio f is the firm-specific effect s is the year-specific effect and e is the error term
bull To eliminate the firm-specific effect we run a regression on the first differences as follows
Vjt+1 ndash Vjt = α(ICRjt ndash ICRjt-1) + control variablest + (st ndash st-1)+ (ejt
ndash ejt-1) (2)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variables Regression (2) is then run on the whole sample and the 3 subgroups with different information cost separately
Empirical Results
Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
1266(147)
1800(213)
5701(538)
-0390(-070)
Board size 0928(220)
2047(438)
1905(213)
0590(089)
Book leverage ratio -0918(-020)
-10586(-159)
-18329(-148)
8365(187)
Firm age 0152(168)
0317(285)
0533(332)
-0176(-133)
Log(Market value of equity) -5083(-402)
-7255(-268)
-8588(-438)
-1659(-139)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0234 0320 0341 0241
Observations 633 217 197 219
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Empirical ResultsRegression of change in market capitalization on change in insurance coverage ratio
Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2263(104)
4120(187)
6750(378)
-0267(-011)
Board size -0166(-017)
2134(159)
1966(112)
-3813(-292)
Book leverage ratio 6390(067)
-6279(-037)
4262(020)
15630(280)
Firm age 0021(015)
0094(073)
0650(140)
0071(021)
Log(Market value of equity) -10311(-558)
-13539(-240)
-14728(-354)
-6882(-227)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0245 0383 0299 0258
Observations 633 217 197 219
Empirical ResultsRegression of change in stock price on change in insurance coverage ratio
Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2045(102)
4055(217)
5914(396)
-0686(-039)
Board size 0097(014)
2063(171)
1476(120)
-2164(-237)
Book leverage ratio 1821(022)
-10527(-083)
-25572(-140)
15082(330)
Firm age 0167(129)
0302(192)
0796(205)
0076(033)
Log(Market value of equity) -7036(-365)
-10476(-176)
-11480(-354)
-2344(-107)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0327 0459 0383 0364
Observations 643 217 207 219
Self-selection correction
bull If a firm endogenously makes its decision to purchase DampO insurance we have to control the potential self-selection bias by employing the Heckmanrsquos (1979) two-stage regression
bull In the selection eq we model the firmrsquos decision to purchase DampO insurance
bull In the effect eq the coefficient estimates obtained above are used to construct the inverse Mills ratio which is the selection bias correction term to control for the possibility that the firmrsquos decision to purchase DampO insurance is endogeneously determined The inverse Mills ratio is then added to effect equation as one of the control variables
Self-selection correction Empirical Results
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Panel A Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()0470(115)
1787(263)
5348(371)
-1558(-309)
Board size 0838(175)
0326(030)
1339(171)
0227(034)
Book leverage ratio 1473(041)
0063(001)
15877(205)
-3771(-067)
Firm age 0228(266)
0463(282)
0263(168)
0049(044)
Log(Market value of equity) -5399(-595)
-6850(-350)
-5690(-338)
-1605(-136)
ρ 0150(066)
0281(075)
-0499(-170)
0460(138)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in market capitalization on change in insurance coverage ratio
Panel B Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0699(082)
4873(345)
6178(295)
-3507(-286)
Board size 1998(224)
-2525(-088)
1713(154)
1023(076)
Book leverage ratio 19437(263)
36428(234)
44051(376)
10878(091)
Firm age 0280(178)
1058(289)
0149(068)
-0035(-016)
Log(Market value of equity) -7681(-445)
-9662(-231)
-8954(-366)
-1257(-054)
ρ 0839(1885)
0965(3021)
-0761(-377)
0955(2885)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in stock price on change in insurance coverage ratio
Panel C Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0625(077)
4631(339)
5390(296)
-3198(-273)
Board size 1891(222)
-1886(-078)
1284(120)
0770(058)
Book leverage ratio 17770(255)
33879(230)
40422(385)
-1096(-009)
Firm age 0409(271)
1103(348)
0293(142)
0141(065)
Log(Market value of equity) -7093(-430)
-9441(-245)
-7073(-307)
-2080(-090)
ρ 0820(1644)
0953(2772)
-0808(-529)
0873(969)
Year fixed effects Yes Yes Yes Yes
Observations 343 101 114 128
Scatter Plots by Groups (All firms)
Scatter Plots Low Info Cost Group
Scatter Plots Medium Info Cost Group
Scatter Plots High Info Cost Group
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Motivationbull DampO insurance is very
common in directorrsquos compensation schemes
bull According to the 2012 ldquoDirectors and Officers Liability Surveyrdquo conducted by Towers Watson the surveyed firms purchase DampO insurance for their directors with a median policy limit of US$75m
bull The purchase of DampO insurance is not limited to a few business class only
bull Large Mainland corporation buyers
Motivationbull If DampO insurance is so common does it enhance firm value from the shareholderrsquos
perspective
bull Based on literature there are generally two streams of views
Monitoring Effect
DampO insurance helps the firm recruit and retain talented outside directors (Holderness 1990 MacMinn et al
2012)
DampO insurers who have to cover the liabilities of directorsrsquo bad decisions
help improve the firmrsquos corporate governance
(Holderness 1990 OrsquoSullivan 1997)
Moral Hazard Effect
DampO insurance undermines the disciplinary effect of shareholder
litigation on directors and leads to opportunistic managerial behavior (Chalmers et al 2002 Barrese and
Scordis 2006 Lin et al 2011)
Conceptual Frameworkhellip Chang et al (2004)
bull When the information cost is high outside directors are less effective in monitoring the firm even given the right incentives (Duchin et al 2010) Hence we argue that outside directors rely more on DampO insurance to cover their liabilities for bad decisions resulting in a higher level of moral hazard effect
Firm ValueMoral Hazard Effect
Information Cost
Compensation Linked to Firm Value
Director Reputation
Monitoring Effect
right incentives mitigate moral hazard effect
higher level of moral hazard effect when information cost is higher and
vice versa
negative effect
positive effect
Hypothesisbull Hypothesis 1 Ignoring the information cost to independent directors the
monitoring effect offsets the moral hazard effect and increasing DampO insurance coverage does not affect firm value on average
bull Hypothesis 2 When the information cost to independent directors is low the monitoring effect dominates the moral hazard effect and increasing DampO insurance coverage improves firm value
bull Hypothesis 3 When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and increasing DampO insurance coverage does not improve firm value
Databull As Canadian public firms are required to disclose information about DampO
insurance in their proxy statements this research uses a sample of firms on the SampPTSX Composite Index listed on the Toronto Stock Exchange from 2010 to 2014
Firms on the SampPTSX Composite Index from 2010 to 2014
DampO Insurance Data- whether the firm has
purchased DampO insurance
- the coverage limit- the premium paid
(hand-collected from proxy statements)
Board Characteristics Data
- compensation to directors
- board size- number of independent
directors- average number of committees on which
each independent director serves
(hand-collected from proxy statements)
Firm Value and Characteristics Data- annual stock return
- market capitalization- Tobinrsquos Q- firm age
- total assets- book leverage ratio
(downloaded from Compustat)
Measure of information cost to independent directors
bull We then divide our whole sample into 3 subgroups according to their corresponding information cost
bull As most decision making takes place at the committee level (Kesner 1988) and independent directors who serve on multiple monitoring committees have a more complete understanding of the firm and can make more informed decisions (Faleye et al 2011) we argue that the information cost decreases with the number of committees on which each independent director serves
Empirical Modelbull The baseline empirical model is
Vjt+1 = αICRjt + helliphellip + fj + st + ejt (1)
where j represents a firm t represents a year V is the firm value ICR is the insurance coverage ratio f is the firm-specific effect s is the year-specific effect and e is the error term
bull To eliminate the firm-specific effect we run a regression on the first differences as follows
Vjt+1 ndash Vjt = α(ICRjt ndash ICRjt-1) + control variablest + (st ndash st-1)+ (ejt
ndash ejt-1) (2)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variables Regression (2) is then run on the whole sample and the 3 subgroups with different information cost separately
Empirical Results
Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
1266(147)
1800(213)
5701(538)
-0390(-070)
Board size 0928(220)
2047(438)
1905(213)
0590(089)
Book leverage ratio -0918(-020)
-10586(-159)
-18329(-148)
8365(187)
Firm age 0152(168)
0317(285)
0533(332)
-0176(-133)
Log(Market value of equity) -5083(-402)
-7255(-268)
-8588(-438)
-1659(-139)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0234 0320 0341 0241
Observations 633 217 197 219
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Empirical ResultsRegression of change in market capitalization on change in insurance coverage ratio
Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2263(104)
4120(187)
6750(378)
-0267(-011)
Board size -0166(-017)
2134(159)
1966(112)
-3813(-292)
Book leverage ratio 6390(067)
-6279(-037)
4262(020)
15630(280)
Firm age 0021(015)
0094(073)
0650(140)
0071(021)
Log(Market value of equity) -10311(-558)
-13539(-240)
-14728(-354)
-6882(-227)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0245 0383 0299 0258
Observations 633 217 197 219
Empirical ResultsRegression of change in stock price on change in insurance coverage ratio
Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2045(102)
4055(217)
5914(396)
-0686(-039)
Board size 0097(014)
2063(171)
1476(120)
-2164(-237)
Book leverage ratio 1821(022)
-10527(-083)
-25572(-140)
15082(330)
Firm age 0167(129)
0302(192)
0796(205)
0076(033)
Log(Market value of equity) -7036(-365)
-10476(-176)
-11480(-354)
-2344(-107)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0327 0459 0383 0364
Observations 643 217 207 219
Self-selection correction
bull If a firm endogenously makes its decision to purchase DampO insurance we have to control the potential self-selection bias by employing the Heckmanrsquos (1979) two-stage regression
bull In the selection eq we model the firmrsquos decision to purchase DampO insurance
bull In the effect eq the coefficient estimates obtained above are used to construct the inverse Mills ratio which is the selection bias correction term to control for the possibility that the firmrsquos decision to purchase DampO insurance is endogeneously determined The inverse Mills ratio is then added to effect equation as one of the control variables
Self-selection correction Empirical Results
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Panel A Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()0470(115)
1787(263)
5348(371)
-1558(-309)
Board size 0838(175)
0326(030)
1339(171)
0227(034)
Book leverage ratio 1473(041)
0063(001)
15877(205)
-3771(-067)
Firm age 0228(266)
0463(282)
0263(168)
0049(044)
Log(Market value of equity) -5399(-595)
-6850(-350)
-5690(-338)
-1605(-136)
ρ 0150(066)
0281(075)
-0499(-170)
0460(138)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in market capitalization on change in insurance coverage ratio
Panel B Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0699(082)
4873(345)
6178(295)
-3507(-286)
Board size 1998(224)
-2525(-088)
1713(154)
1023(076)
Book leverage ratio 19437(263)
36428(234)
44051(376)
10878(091)
Firm age 0280(178)
1058(289)
0149(068)
-0035(-016)
Log(Market value of equity) -7681(-445)
-9662(-231)
-8954(-366)
-1257(-054)
ρ 0839(1885)
0965(3021)
-0761(-377)
0955(2885)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in stock price on change in insurance coverage ratio
Panel C Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0625(077)
4631(339)
5390(296)
-3198(-273)
Board size 1891(222)
-1886(-078)
1284(120)
0770(058)
Book leverage ratio 17770(255)
33879(230)
40422(385)
-1096(-009)
Firm age 0409(271)
1103(348)
0293(142)
0141(065)
Log(Market value of equity) -7093(-430)
-9441(-245)
-7073(-307)
-2080(-090)
ρ 0820(1644)
0953(2772)
-0808(-529)
0873(969)
Year fixed effects Yes Yes Yes Yes
Observations 343 101 114 128
Scatter Plots by Groups (All firms)
Scatter Plots Low Info Cost Group
Scatter Plots Medium Info Cost Group
Scatter Plots High Info Cost Group
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Motivationbull If DampO insurance is so common does it enhance firm value from the shareholderrsquos
perspective
bull Based on literature there are generally two streams of views
Monitoring Effect
DampO insurance helps the firm recruit and retain talented outside directors (Holderness 1990 MacMinn et al
2012)
DampO insurers who have to cover the liabilities of directorsrsquo bad decisions
help improve the firmrsquos corporate governance
(Holderness 1990 OrsquoSullivan 1997)
Moral Hazard Effect
DampO insurance undermines the disciplinary effect of shareholder
litigation on directors and leads to opportunistic managerial behavior (Chalmers et al 2002 Barrese and
Scordis 2006 Lin et al 2011)
Conceptual Frameworkhellip Chang et al (2004)
bull When the information cost is high outside directors are less effective in monitoring the firm even given the right incentives (Duchin et al 2010) Hence we argue that outside directors rely more on DampO insurance to cover their liabilities for bad decisions resulting in a higher level of moral hazard effect
Firm ValueMoral Hazard Effect
Information Cost
Compensation Linked to Firm Value
Director Reputation
Monitoring Effect
right incentives mitigate moral hazard effect
higher level of moral hazard effect when information cost is higher and
vice versa
negative effect
positive effect
Hypothesisbull Hypothesis 1 Ignoring the information cost to independent directors the
monitoring effect offsets the moral hazard effect and increasing DampO insurance coverage does not affect firm value on average
bull Hypothesis 2 When the information cost to independent directors is low the monitoring effect dominates the moral hazard effect and increasing DampO insurance coverage improves firm value
bull Hypothesis 3 When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and increasing DampO insurance coverage does not improve firm value
Databull As Canadian public firms are required to disclose information about DampO
insurance in their proxy statements this research uses a sample of firms on the SampPTSX Composite Index listed on the Toronto Stock Exchange from 2010 to 2014
Firms on the SampPTSX Composite Index from 2010 to 2014
DampO Insurance Data- whether the firm has
purchased DampO insurance
- the coverage limit- the premium paid
(hand-collected from proxy statements)
Board Characteristics Data
- compensation to directors
- board size- number of independent
directors- average number of committees on which
each independent director serves
(hand-collected from proxy statements)
Firm Value and Characteristics Data- annual stock return
- market capitalization- Tobinrsquos Q- firm age
- total assets- book leverage ratio
(downloaded from Compustat)
Measure of information cost to independent directors
bull We then divide our whole sample into 3 subgroups according to their corresponding information cost
bull As most decision making takes place at the committee level (Kesner 1988) and independent directors who serve on multiple monitoring committees have a more complete understanding of the firm and can make more informed decisions (Faleye et al 2011) we argue that the information cost decreases with the number of committees on which each independent director serves
Empirical Modelbull The baseline empirical model is
Vjt+1 = αICRjt + helliphellip + fj + st + ejt (1)
where j represents a firm t represents a year V is the firm value ICR is the insurance coverage ratio f is the firm-specific effect s is the year-specific effect and e is the error term
bull To eliminate the firm-specific effect we run a regression on the first differences as follows
Vjt+1 ndash Vjt = α(ICRjt ndash ICRjt-1) + control variablest + (st ndash st-1)+ (ejt
ndash ejt-1) (2)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variables Regression (2) is then run on the whole sample and the 3 subgroups with different information cost separately
Empirical Results
Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
1266(147)
1800(213)
5701(538)
-0390(-070)
Board size 0928(220)
2047(438)
1905(213)
0590(089)
Book leverage ratio -0918(-020)
-10586(-159)
-18329(-148)
8365(187)
Firm age 0152(168)
0317(285)
0533(332)
-0176(-133)
Log(Market value of equity) -5083(-402)
-7255(-268)
-8588(-438)
-1659(-139)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0234 0320 0341 0241
Observations 633 217 197 219
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Empirical ResultsRegression of change in market capitalization on change in insurance coverage ratio
Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2263(104)
4120(187)
6750(378)
-0267(-011)
Board size -0166(-017)
2134(159)
1966(112)
-3813(-292)
Book leverage ratio 6390(067)
-6279(-037)
4262(020)
15630(280)
Firm age 0021(015)
0094(073)
0650(140)
0071(021)
Log(Market value of equity) -10311(-558)
-13539(-240)
-14728(-354)
-6882(-227)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0245 0383 0299 0258
Observations 633 217 197 219
Empirical ResultsRegression of change in stock price on change in insurance coverage ratio
Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2045(102)
4055(217)
5914(396)
-0686(-039)
Board size 0097(014)
2063(171)
1476(120)
-2164(-237)
Book leverage ratio 1821(022)
-10527(-083)
-25572(-140)
15082(330)
Firm age 0167(129)
0302(192)
0796(205)
0076(033)
Log(Market value of equity) -7036(-365)
-10476(-176)
-11480(-354)
-2344(-107)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0327 0459 0383 0364
Observations 643 217 207 219
Self-selection correction
bull If a firm endogenously makes its decision to purchase DampO insurance we have to control the potential self-selection bias by employing the Heckmanrsquos (1979) two-stage regression
bull In the selection eq we model the firmrsquos decision to purchase DampO insurance
bull In the effect eq the coefficient estimates obtained above are used to construct the inverse Mills ratio which is the selection bias correction term to control for the possibility that the firmrsquos decision to purchase DampO insurance is endogeneously determined The inverse Mills ratio is then added to effect equation as one of the control variables
Self-selection correction Empirical Results
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Panel A Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()0470(115)
1787(263)
5348(371)
-1558(-309)
Board size 0838(175)
0326(030)
1339(171)
0227(034)
Book leverage ratio 1473(041)
0063(001)
15877(205)
-3771(-067)
Firm age 0228(266)
0463(282)
0263(168)
0049(044)
Log(Market value of equity) -5399(-595)
-6850(-350)
-5690(-338)
-1605(-136)
ρ 0150(066)
0281(075)
-0499(-170)
0460(138)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in market capitalization on change in insurance coverage ratio
Panel B Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0699(082)
4873(345)
6178(295)
-3507(-286)
Board size 1998(224)
-2525(-088)
1713(154)
1023(076)
Book leverage ratio 19437(263)
36428(234)
44051(376)
10878(091)
Firm age 0280(178)
1058(289)
0149(068)
-0035(-016)
Log(Market value of equity) -7681(-445)
-9662(-231)
-8954(-366)
-1257(-054)
ρ 0839(1885)
0965(3021)
-0761(-377)
0955(2885)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in stock price on change in insurance coverage ratio
Panel C Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0625(077)
4631(339)
5390(296)
-3198(-273)
Board size 1891(222)
-1886(-078)
1284(120)
0770(058)
Book leverage ratio 17770(255)
33879(230)
40422(385)
-1096(-009)
Firm age 0409(271)
1103(348)
0293(142)
0141(065)
Log(Market value of equity) -7093(-430)
-9441(-245)
-7073(-307)
-2080(-090)
ρ 0820(1644)
0953(2772)
-0808(-529)
0873(969)
Year fixed effects Yes Yes Yes Yes
Observations 343 101 114 128
Scatter Plots by Groups (All firms)
Scatter Plots Low Info Cost Group
Scatter Plots Medium Info Cost Group
Scatter Plots High Info Cost Group
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Conceptual Frameworkhellip Chang et al (2004)
bull When the information cost is high outside directors are less effective in monitoring the firm even given the right incentives (Duchin et al 2010) Hence we argue that outside directors rely more on DampO insurance to cover their liabilities for bad decisions resulting in a higher level of moral hazard effect
Firm ValueMoral Hazard Effect
Information Cost
Compensation Linked to Firm Value
Director Reputation
Monitoring Effect
right incentives mitigate moral hazard effect
higher level of moral hazard effect when information cost is higher and
vice versa
negative effect
positive effect
Hypothesisbull Hypothesis 1 Ignoring the information cost to independent directors the
monitoring effect offsets the moral hazard effect and increasing DampO insurance coverage does not affect firm value on average
bull Hypothesis 2 When the information cost to independent directors is low the monitoring effect dominates the moral hazard effect and increasing DampO insurance coverage improves firm value
bull Hypothesis 3 When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and increasing DampO insurance coverage does not improve firm value
Databull As Canadian public firms are required to disclose information about DampO
insurance in their proxy statements this research uses a sample of firms on the SampPTSX Composite Index listed on the Toronto Stock Exchange from 2010 to 2014
Firms on the SampPTSX Composite Index from 2010 to 2014
DampO Insurance Data- whether the firm has
purchased DampO insurance
- the coverage limit- the premium paid
(hand-collected from proxy statements)
Board Characteristics Data
- compensation to directors
- board size- number of independent
directors- average number of committees on which
each independent director serves
(hand-collected from proxy statements)
Firm Value and Characteristics Data- annual stock return
- market capitalization- Tobinrsquos Q- firm age
- total assets- book leverage ratio
(downloaded from Compustat)
Measure of information cost to independent directors
bull We then divide our whole sample into 3 subgroups according to their corresponding information cost
bull As most decision making takes place at the committee level (Kesner 1988) and independent directors who serve on multiple monitoring committees have a more complete understanding of the firm and can make more informed decisions (Faleye et al 2011) we argue that the information cost decreases with the number of committees on which each independent director serves
Empirical Modelbull The baseline empirical model is
Vjt+1 = αICRjt + helliphellip + fj + st + ejt (1)
where j represents a firm t represents a year V is the firm value ICR is the insurance coverage ratio f is the firm-specific effect s is the year-specific effect and e is the error term
bull To eliminate the firm-specific effect we run a regression on the first differences as follows
Vjt+1 ndash Vjt = α(ICRjt ndash ICRjt-1) + control variablest + (st ndash st-1)+ (ejt
ndash ejt-1) (2)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variables Regression (2) is then run on the whole sample and the 3 subgroups with different information cost separately
Empirical Results
Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
1266(147)
1800(213)
5701(538)
-0390(-070)
Board size 0928(220)
2047(438)
1905(213)
0590(089)
Book leverage ratio -0918(-020)
-10586(-159)
-18329(-148)
8365(187)
Firm age 0152(168)
0317(285)
0533(332)
-0176(-133)
Log(Market value of equity) -5083(-402)
-7255(-268)
-8588(-438)
-1659(-139)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0234 0320 0341 0241
Observations 633 217 197 219
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Empirical ResultsRegression of change in market capitalization on change in insurance coverage ratio
Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2263(104)
4120(187)
6750(378)
-0267(-011)
Board size -0166(-017)
2134(159)
1966(112)
-3813(-292)
Book leverage ratio 6390(067)
-6279(-037)
4262(020)
15630(280)
Firm age 0021(015)
0094(073)
0650(140)
0071(021)
Log(Market value of equity) -10311(-558)
-13539(-240)
-14728(-354)
-6882(-227)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0245 0383 0299 0258
Observations 633 217 197 219
Empirical ResultsRegression of change in stock price on change in insurance coverage ratio
Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2045(102)
4055(217)
5914(396)
-0686(-039)
Board size 0097(014)
2063(171)
1476(120)
-2164(-237)
Book leverage ratio 1821(022)
-10527(-083)
-25572(-140)
15082(330)
Firm age 0167(129)
0302(192)
0796(205)
0076(033)
Log(Market value of equity) -7036(-365)
-10476(-176)
-11480(-354)
-2344(-107)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0327 0459 0383 0364
Observations 643 217 207 219
Self-selection correction
bull If a firm endogenously makes its decision to purchase DampO insurance we have to control the potential self-selection bias by employing the Heckmanrsquos (1979) two-stage regression
bull In the selection eq we model the firmrsquos decision to purchase DampO insurance
bull In the effect eq the coefficient estimates obtained above are used to construct the inverse Mills ratio which is the selection bias correction term to control for the possibility that the firmrsquos decision to purchase DampO insurance is endogeneously determined The inverse Mills ratio is then added to effect equation as one of the control variables
Self-selection correction Empirical Results
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Panel A Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()0470(115)
1787(263)
5348(371)
-1558(-309)
Board size 0838(175)
0326(030)
1339(171)
0227(034)
Book leverage ratio 1473(041)
0063(001)
15877(205)
-3771(-067)
Firm age 0228(266)
0463(282)
0263(168)
0049(044)
Log(Market value of equity) -5399(-595)
-6850(-350)
-5690(-338)
-1605(-136)
ρ 0150(066)
0281(075)
-0499(-170)
0460(138)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in market capitalization on change in insurance coverage ratio
Panel B Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0699(082)
4873(345)
6178(295)
-3507(-286)
Board size 1998(224)
-2525(-088)
1713(154)
1023(076)
Book leverage ratio 19437(263)
36428(234)
44051(376)
10878(091)
Firm age 0280(178)
1058(289)
0149(068)
-0035(-016)
Log(Market value of equity) -7681(-445)
-9662(-231)
-8954(-366)
-1257(-054)
ρ 0839(1885)
0965(3021)
-0761(-377)
0955(2885)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in stock price on change in insurance coverage ratio
Panel C Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0625(077)
4631(339)
5390(296)
-3198(-273)
Board size 1891(222)
-1886(-078)
1284(120)
0770(058)
Book leverage ratio 17770(255)
33879(230)
40422(385)
-1096(-009)
Firm age 0409(271)
1103(348)
0293(142)
0141(065)
Log(Market value of equity) -7093(-430)
-9441(-245)
-7073(-307)
-2080(-090)
ρ 0820(1644)
0953(2772)
-0808(-529)
0873(969)
Year fixed effects Yes Yes Yes Yes
Observations 343 101 114 128
Scatter Plots by Groups (All firms)
Scatter Plots Low Info Cost Group
Scatter Plots Medium Info Cost Group
Scatter Plots High Info Cost Group
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Hypothesisbull Hypothesis 1 Ignoring the information cost to independent directors the
monitoring effect offsets the moral hazard effect and increasing DampO insurance coverage does not affect firm value on average
bull Hypothesis 2 When the information cost to independent directors is low the monitoring effect dominates the moral hazard effect and increasing DampO insurance coverage improves firm value
bull Hypothesis 3 When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and increasing DampO insurance coverage does not improve firm value
Databull As Canadian public firms are required to disclose information about DampO
insurance in their proxy statements this research uses a sample of firms on the SampPTSX Composite Index listed on the Toronto Stock Exchange from 2010 to 2014
Firms on the SampPTSX Composite Index from 2010 to 2014
DampO Insurance Data- whether the firm has
purchased DampO insurance
- the coverage limit- the premium paid
(hand-collected from proxy statements)
Board Characteristics Data
- compensation to directors
- board size- number of independent
directors- average number of committees on which
each independent director serves
(hand-collected from proxy statements)
Firm Value and Characteristics Data- annual stock return
- market capitalization- Tobinrsquos Q- firm age
- total assets- book leverage ratio
(downloaded from Compustat)
Measure of information cost to independent directors
bull We then divide our whole sample into 3 subgroups according to their corresponding information cost
bull As most decision making takes place at the committee level (Kesner 1988) and independent directors who serve on multiple monitoring committees have a more complete understanding of the firm and can make more informed decisions (Faleye et al 2011) we argue that the information cost decreases with the number of committees on which each independent director serves
Empirical Modelbull The baseline empirical model is
Vjt+1 = αICRjt + helliphellip + fj + st + ejt (1)
where j represents a firm t represents a year V is the firm value ICR is the insurance coverage ratio f is the firm-specific effect s is the year-specific effect and e is the error term
bull To eliminate the firm-specific effect we run a regression on the first differences as follows
Vjt+1 ndash Vjt = α(ICRjt ndash ICRjt-1) + control variablest + (st ndash st-1)+ (ejt
ndash ejt-1) (2)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variables Regression (2) is then run on the whole sample and the 3 subgroups with different information cost separately
Empirical Results
Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
1266(147)
1800(213)
5701(538)
-0390(-070)
Board size 0928(220)
2047(438)
1905(213)
0590(089)
Book leverage ratio -0918(-020)
-10586(-159)
-18329(-148)
8365(187)
Firm age 0152(168)
0317(285)
0533(332)
-0176(-133)
Log(Market value of equity) -5083(-402)
-7255(-268)
-8588(-438)
-1659(-139)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0234 0320 0341 0241
Observations 633 217 197 219
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Empirical ResultsRegression of change in market capitalization on change in insurance coverage ratio
Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2263(104)
4120(187)
6750(378)
-0267(-011)
Board size -0166(-017)
2134(159)
1966(112)
-3813(-292)
Book leverage ratio 6390(067)
-6279(-037)
4262(020)
15630(280)
Firm age 0021(015)
0094(073)
0650(140)
0071(021)
Log(Market value of equity) -10311(-558)
-13539(-240)
-14728(-354)
-6882(-227)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0245 0383 0299 0258
Observations 633 217 197 219
Empirical ResultsRegression of change in stock price on change in insurance coverage ratio
Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2045(102)
4055(217)
5914(396)
-0686(-039)
Board size 0097(014)
2063(171)
1476(120)
-2164(-237)
Book leverage ratio 1821(022)
-10527(-083)
-25572(-140)
15082(330)
Firm age 0167(129)
0302(192)
0796(205)
0076(033)
Log(Market value of equity) -7036(-365)
-10476(-176)
-11480(-354)
-2344(-107)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0327 0459 0383 0364
Observations 643 217 207 219
Self-selection correction
bull If a firm endogenously makes its decision to purchase DampO insurance we have to control the potential self-selection bias by employing the Heckmanrsquos (1979) two-stage regression
bull In the selection eq we model the firmrsquos decision to purchase DampO insurance
bull In the effect eq the coefficient estimates obtained above are used to construct the inverse Mills ratio which is the selection bias correction term to control for the possibility that the firmrsquos decision to purchase DampO insurance is endogeneously determined The inverse Mills ratio is then added to effect equation as one of the control variables
Self-selection correction Empirical Results
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Panel A Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()0470(115)
1787(263)
5348(371)
-1558(-309)
Board size 0838(175)
0326(030)
1339(171)
0227(034)
Book leverage ratio 1473(041)
0063(001)
15877(205)
-3771(-067)
Firm age 0228(266)
0463(282)
0263(168)
0049(044)
Log(Market value of equity) -5399(-595)
-6850(-350)
-5690(-338)
-1605(-136)
ρ 0150(066)
0281(075)
-0499(-170)
0460(138)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in market capitalization on change in insurance coverage ratio
Panel B Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0699(082)
4873(345)
6178(295)
-3507(-286)
Board size 1998(224)
-2525(-088)
1713(154)
1023(076)
Book leverage ratio 19437(263)
36428(234)
44051(376)
10878(091)
Firm age 0280(178)
1058(289)
0149(068)
-0035(-016)
Log(Market value of equity) -7681(-445)
-9662(-231)
-8954(-366)
-1257(-054)
ρ 0839(1885)
0965(3021)
-0761(-377)
0955(2885)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in stock price on change in insurance coverage ratio
Panel C Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0625(077)
4631(339)
5390(296)
-3198(-273)
Board size 1891(222)
-1886(-078)
1284(120)
0770(058)
Book leverage ratio 17770(255)
33879(230)
40422(385)
-1096(-009)
Firm age 0409(271)
1103(348)
0293(142)
0141(065)
Log(Market value of equity) -7093(-430)
-9441(-245)
-7073(-307)
-2080(-090)
ρ 0820(1644)
0953(2772)
-0808(-529)
0873(969)
Year fixed effects Yes Yes Yes Yes
Observations 343 101 114 128
Scatter Plots by Groups (All firms)
Scatter Plots Low Info Cost Group
Scatter Plots Medium Info Cost Group
Scatter Plots High Info Cost Group
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Databull As Canadian public firms are required to disclose information about DampO
insurance in their proxy statements this research uses a sample of firms on the SampPTSX Composite Index listed on the Toronto Stock Exchange from 2010 to 2014
Firms on the SampPTSX Composite Index from 2010 to 2014
DampO Insurance Data- whether the firm has
purchased DampO insurance
- the coverage limit- the premium paid
(hand-collected from proxy statements)
Board Characteristics Data
- compensation to directors
- board size- number of independent
directors- average number of committees on which
each independent director serves
(hand-collected from proxy statements)
Firm Value and Characteristics Data- annual stock return
- market capitalization- Tobinrsquos Q- firm age
- total assets- book leverage ratio
(downloaded from Compustat)
Measure of information cost to independent directors
bull We then divide our whole sample into 3 subgroups according to their corresponding information cost
bull As most decision making takes place at the committee level (Kesner 1988) and independent directors who serve on multiple monitoring committees have a more complete understanding of the firm and can make more informed decisions (Faleye et al 2011) we argue that the information cost decreases with the number of committees on which each independent director serves
Empirical Modelbull The baseline empirical model is
Vjt+1 = αICRjt + helliphellip + fj + st + ejt (1)
where j represents a firm t represents a year V is the firm value ICR is the insurance coverage ratio f is the firm-specific effect s is the year-specific effect and e is the error term
bull To eliminate the firm-specific effect we run a regression on the first differences as follows
Vjt+1 ndash Vjt = α(ICRjt ndash ICRjt-1) + control variablest + (st ndash st-1)+ (ejt
ndash ejt-1) (2)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variables Regression (2) is then run on the whole sample and the 3 subgroups with different information cost separately
Empirical Results
Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
1266(147)
1800(213)
5701(538)
-0390(-070)
Board size 0928(220)
2047(438)
1905(213)
0590(089)
Book leverage ratio -0918(-020)
-10586(-159)
-18329(-148)
8365(187)
Firm age 0152(168)
0317(285)
0533(332)
-0176(-133)
Log(Market value of equity) -5083(-402)
-7255(-268)
-8588(-438)
-1659(-139)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0234 0320 0341 0241
Observations 633 217 197 219
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Empirical ResultsRegression of change in market capitalization on change in insurance coverage ratio
Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2263(104)
4120(187)
6750(378)
-0267(-011)
Board size -0166(-017)
2134(159)
1966(112)
-3813(-292)
Book leverage ratio 6390(067)
-6279(-037)
4262(020)
15630(280)
Firm age 0021(015)
0094(073)
0650(140)
0071(021)
Log(Market value of equity) -10311(-558)
-13539(-240)
-14728(-354)
-6882(-227)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0245 0383 0299 0258
Observations 633 217 197 219
Empirical ResultsRegression of change in stock price on change in insurance coverage ratio
Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2045(102)
4055(217)
5914(396)
-0686(-039)
Board size 0097(014)
2063(171)
1476(120)
-2164(-237)
Book leverage ratio 1821(022)
-10527(-083)
-25572(-140)
15082(330)
Firm age 0167(129)
0302(192)
0796(205)
0076(033)
Log(Market value of equity) -7036(-365)
-10476(-176)
-11480(-354)
-2344(-107)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0327 0459 0383 0364
Observations 643 217 207 219
Self-selection correction
bull If a firm endogenously makes its decision to purchase DampO insurance we have to control the potential self-selection bias by employing the Heckmanrsquos (1979) two-stage regression
bull In the selection eq we model the firmrsquos decision to purchase DampO insurance
bull In the effect eq the coefficient estimates obtained above are used to construct the inverse Mills ratio which is the selection bias correction term to control for the possibility that the firmrsquos decision to purchase DampO insurance is endogeneously determined The inverse Mills ratio is then added to effect equation as one of the control variables
Self-selection correction Empirical Results
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Panel A Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()0470(115)
1787(263)
5348(371)
-1558(-309)
Board size 0838(175)
0326(030)
1339(171)
0227(034)
Book leverage ratio 1473(041)
0063(001)
15877(205)
-3771(-067)
Firm age 0228(266)
0463(282)
0263(168)
0049(044)
Log(Market value of equity) -5399(-595)
-6850(-350)
-5690(-338)
-1605(-136)
ρ 0150(066)
0281(075)
-0499(-170)
0460(138)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in market capitalization on change in insurance coverage ratio
Panel B Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0699(082)
4873(345)
6178(295)
-3507(-286)
Board size 1998(224)
-2525(-088)
1713(154)
1023(076)
Book leverage ratio 19437(263)
36428(234)
44051(376)
10878(091)
Firm age 0280(178)
1058(289)
0149(068)
-0035(-016)
Log(Market value of equity) -7681(-445)
-9662(-231)
-8954(-366)
-1257(-054)
ρ 0839(1885)
0965(3021)
-0761(-377)
0955(2885)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in stock price on change in insurance coverage ratio
Panel C Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0625(077)
4631(339)
5390(296)
-3198(-273)
Board size 1891(222)
-1886(-078)
1284(120)
0770(058)
Book leverage ratio 17770(255)
33879(230)
40422(385)
-1096(-009)
Firm age 0409(271)
1103(348)
0293(142)
0141(065)
Log(Market value of equity) -7093(-430)
-9441(-245)
-7073(-307)
-2080(-090)
ρ 0820(1644)
0953(2772)
-0808(-529)
0873(969)
Year fixed effects Yes Yes Yes Yes
Observations 343 101 114 128
Scatter Plots by Groups (All firms)
Scatter Plots Low Info Cost Group
Scatter Plots Medium Info Cost Group
Scatter Plots High Info Cost Group
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Measure of information cost to independent directors
bull We then divide our whole sample into 3 subgroups according to their corresponding information cost
bull As most decision making takes place at the committee level (Kesner 1988) and independent directors who serve on multiple monitoring committees have a more complete understanding of the firm and can make more informed decisions (Faleye et al 2011) we argue that the information cost decreases with the number of committees on which each independent director serves
Empirical Modelbull The baseline empirical model is
Vjt+1 = αICRjt + helliphellip + fj + st + ejt (1)
where j represents a firm t represents a year V is the firm value ICR is the insurance coverage ratio f is the firm-specific effect s is the year-specific effect and e is the error term
bull To eliminate the firm-specific effect we run a regression on the first differences as follows
Vjt+1 ndash Vjt = α(ICRjt ndash ICRjt-1) + control variablest + (st ndash st-1)+ (ejt
ndash ejt-1) (2)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variables Regression (2) is then run on the whole sample and the 3 subgroups with different information cost separately
Empirical Results
Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
1266(147)
1800(213)
5701(538)
-0390(-070)
Board size 0928(220)
2047(438)
1905(213)
0590(089)
Book leverage ratio -0918(-020)
-10586(-159)
-18329(-148)
8365(187)
Firm age 0152(168)
0317(285)
0533(332)
-0176(-133)
Log(Market value of equity) -5083(-402)
-7255(-268)
-8588(-438)
-1659(-139)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0234 0320 0341 0241
Observations 633 217 197 219
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Empirical ResultsRegression of change in market capitalization on change in insurance coverage ratio
Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2263(104)
4120(187)
6750(378)
-0267(-011)
Board size -0166(-017)
2134(159)
1966(112)
-3813(-292)
Book leverage ratio 6390(067)
-6279(-037)
4262(020)
15630(280)
Firm age 0021(015)
0094(073)
0650(140)
0071(021)
Log(Market value of equity) -10311(-558)
-13539(-240)
-14728(-354)
-6882(-227)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0245 0383 0299 0258
Observations 633 217 197 219
Empirical ResultsRegression of change in stock price on change in insurance coverage ratio
Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2045(102)
4055(217)
5914(396)
-0686(-039)
Board size 0097(014)
2063(171)
1476(120)
-2164(-237)
Book leverage ratio 1821(022)
-10527(-083)
-25572(-140)
15082(330)
Firm age 0167(129)
0302(192)
0796(205)
0076(033)
Log(Market value of equity) -7036(-365)
-10476(-176)
-11480(-354)
-2344(-107)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0327 0459 0383 0364
Observations 643 217 207 219
Self-selection correction
bull If a firm endogenously makes its decision to purchase DampO insurance we have to control the potential self-selection bias by employing the Heckmanrsquos (1979) two-stage regression
bull In the selection eq we model the firmrsquos decision to purchase DampO insurance
bull In the effect eq the coefficient estimates obtained above are used to construct the inverse Mills ratio which is the selection bias correction term to control for the possibility that the firmrsquos decision to purchase DampO insurance is endogeneously determined The inverse Mills ratio is then added to effect equation as one of the control variables
Self-selection correction Empirical Results
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Panel A Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()0470(115)
1787(263)
5348(371)
-1558(-309)
Board size 0838(175)
0326(030)
1339(171)
0227(034)
Book leverage ratio 1473(041)
0063(001)
15877(205)
-3771(-067)
Firm age 0228(266)
0463(282)
0263(168)
0049(044)
Log(Market value of equity) -5399(-595)
-6850(-350)
-5690(-338)
-1605(-136)
ρ 0150(066)
0281(075)
-0499(-170)
0460(138)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in market capitalization on change in insurance coverage ratio
Panel B Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0699(082)
4873(345)
6178(295)
-3507(-286)
Board size 1998(224)
-2525(-088)
1713(154)
1023(076)
Book leverage ratio 19437(263)
36428(234)
44051(376)
10878(091)
Firm age 0280(178)
1058(289)
0149(068)
-0035(-016)
Log(Market value of equity) -7681(-445)
-9662(-231)
-8954(-366)
-1257(-054)
ρ 0839(1885)
0965(3021)
-0761(-377)
0955(2885)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in stock price on change in insurance coverage ratio
Panel C Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0625(077)
4631(339)
5390(296)
-3198(-273)
Board size 1891(222)
-1886(-078)
1284(120)
0770(058)
Book leverage ratio 17770(255)
33879(230)
40422(385)
-1096(-009)
Firm age 0409(271)
1103(348)
0293(142)
0141(065)
Log(Market value of equity) -7093(-430)
-9441(-245)
-7073(-307)
-2080(-090)
ρ 0820(1644)
0953(2772)
-0808(-529)
0873(969)
Year fixed effects Yes Yes Yes Yes
Observations 343 101 114 128
Scatter Plots by Groups (All firms)
Scatter Plots Low Info Cost Group
Scatter Plots Medium Info Cost Group
Scatter Plots High Info Cost Group
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Empirical Modelbull The baseline empirical model is
Vjt+1 = αICRjt + helliphellip + fj + st + ejt (1)
where j represents a firm t represents a year V is the firm value ICR is the insurance coverage ratio f is the firm-specific effect s is the year-specific effect and e is the error term
bull To eliminate the firm-specific effect we run a regression on the first differences as follows
Vjt+1 ndash Vjt = α(ICRjt ndash ICRjt-1) + control variablest + (st ndash st-1)+ (ejt
ndash ejt-1) (2)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variables Regression (2) is then run on the whole sample and the 3 subgroups with different information cost separately
Empirical Results
Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
1266(147)
1800(213)
5701(538)
-0390(-070)
Board size 0928(220)
2047(438)
1905(213)
0590(089)
Book leverage ratio -0918(-020)
-10586(-159)
-18329(-148)
8365(187)
Firm age 0152(168)
0317(285)
0533(332)
-0176(-133)
Log(Market value of equity) -5083(-402)
-7255(-268)
-8588(-438)
-1659(-139)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0234 0320 0341 0241
Observations 633 217 197 219
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Empirical ResultsRegression of change in market capitalization on change in insurance coverage ratio
Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2263(104)
4120(187)
6750(378)
-0267(-011)
Board size -0166(-017)
2134(159)
1966(112)
-3813(-292)
Book leverage ratio 6390(067)
-6279(-037)
4262(020)
15630(280)
Firm age 0021(015)
0094(073)
0650(140)
0071(021)
Log(Market value of equity) -10311(-558)
-13539(-240)
-14728(-354)
-6882(-227)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0245 0383 0299 0258
Observations 633 217 197 219
Empirical ResultsRegression of change in stock price on change in insurance coverage ratio
Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2045(102)
4055(217)
5914(396)
-0686(-039)
Board size 0097(014)
2063(171)
1476(120)
-2164(-237)
Book leverage ratio 1821(022)
-10527(-083)
-25572(-140)
15082(330)
Firm age 0167(129)
0302(192)
0796(205)
0076(033)
Log(Market value of equity) -7036(-365)
-10476(-176)
-11480(-354)
-2344(-107)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0327 0459 0383 0364
Observations 643 217 207 219
Self-selection correction
bull If a firm endogenously makes its decision to purchase DampO insurance we have to control the potential self-selection bias by employing the Heckmanrsquos (1979) two-stage regression
bull In the selection eq we model the firmrsquos decision to purchase DampO insurance
bull In the effect eq the coefficient estimates obtained above are used to construct the inverse Mills ratio which is the selection bias correction term to control for the possibility that the firmrsquos decision to purchase DampO insurance is endogeneously determined The inverse Mills ratio is then added to effect equation as one of the control variables
Self-selection correction Empirical Results
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Panel A Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()0470(115)
1787(263)
5348(371)
-1558(-309)
Board size 0838(175)
0326(030)
1339(171)
0227(034)
Book leverage ratio 1473(041)
0063(001)
15877(205)
-3771(-067)
Firm age 0228(266)
0463(282)
0263(168)
0049(044)
Log(Market value of equity) -5399(-595)
-6850(-350)
-5690(-338)
-1605(-136)
ρ 0150(066)
0281(075)
-0499(-170)
0460(138)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in market capitalization on change in insurance coverage ratio
Panel B Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0699(082)
4873(345)
6178(295)
-3507(-286)
Board size 1998(224)
-2525(-088)
1713(154)
1023(076)
Book leverage ratio 19437(263)
36428(234)
44051(376)
10878(091)
Firm age 0280(178)
1058(289)
0149(068)
-0035(-016)
Log(Market value of equity) -7681(-445)
-9662(-231)
-8954(-366)
-1257(-054)
ρ 0839(1885)
0965(3021)
-0761(-377)
0955(2885)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in stock price on change in insurance coverage ratio
Panel C Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0625(077)
4631(339)
5390(296)
-3198(-273)
Board size 1891(222)
-1886(-078)
1284(120)
0770(058)
Book leverage ratio 17770(255)
33879(230)
40422(385)
-1096(-009)
Firm age 0409(271)
1103(348)
0293(142)
0141(065)
Log(Market value of equity) -7093(-430)
-9441(-245)
-7073(-307)
-2080(-090)
ρ 0820(1644)
0953(2772)
-0808(-529)
0873(969)
Year fixed effects Yes Yes Yes Yes
Observations 343 101 114 128
Scatter Plots by Groups (All firms)
Scatter Plots Low Info Cost Group
Scatter Plots Medium Info Cost Group
Scatter Plots High Info Cost Group
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Empirical Results
Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
1266(147)
1800(213)
5701(538)
-0390(-070)
Board size 0928(220)
2047(438)
1905(213)
0590(089)
Book leverage ratio -0918(-020)
-10586(-159)
-18329(-148)
8365(187)
Firm age 0152(168)
0317(285)
0533(332)
-0176(-133)
Log(Market value of equity) -5083(-402)
-7255(-268)
-8588(-438)
-1659(-139)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0234 0320 0341 0241
Observations 633 217 197 219
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Empirical ResultsRegression of change in market capitalization on change in insurance coverage ratio
Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2263(104)
4120(187)
6750(378)
-0267(-011)
Board size -0166(-017)
2134(159)
1966(112)
-3813(-292)
Book leverage ratio 6390(067)
-6279(-037)
4262(020)
15630(280)
Firm age 0021(015)
0094(073)
0650(140)
0071(021)
Log(Market value of equity) -10311(-558)
-13539(-240)
-14728(-354)
-6882(-227)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0245 0383 0299 0258
Observations 633 217 197 219
Empirical ResultsRegression of change in stock price on change in insurance coverage ratio
Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2045(102)
4055(217)
5914(396)
-0686(-039)
Board size 0097(014)
2063(171)
1476(120)
-2164(-237)
Book leverage ratio 1821(022)
-10527(-083)
-25572(-140)
15082(330)
Firm age 0167(129)
0302(192)
0796(205)
0076(033)
Log(Market value of equity) -7036(-365)
-10476(-176)
-11480(-354)
-2344(-107)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0327 0459 0383 0364
Observations 643 217 207 219
Self-selection correction
bull If a firm endogenously makes its decision to purchase DampO insurance we have to control the potential self-selection bias by employing the Heckmanrsquos (1979) two-stage regression
bull In the selection eq we model the firmrsquos decision to purchase DampO insurance
bull In the effect eq the coefficient estimates obtained above are used to construct the inverse Mills ratio which is the selection bias correction term to control for the possibility that the firmrsquos decision to purchase DampO insurance is endogeneously determined The inverse Mills ratio is then added to effect equation as one of the control variables
Self-selection correction Empirical Results
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Panel A Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()0470(115)
1787(263)
5348(371)
-1558(-309)
Board size 0838(175)
0326(030)
1339(171)
0227(034)
Book leverage ratio 1473(041)
0063(001)
15877(205)
-3771(-067)
Firm age 0228(266)
0463(282)
0263(168)
0049(044)
Log(Market value of equity) -5399(-595)
-6850(-350)
-5690(-338)
-1605(-136)
ρ 0150(066)
0281(075)
-0499(-170)
0460(138)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in market capitalization on change in insurance coverage ratio
Panel B Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0699(082)
4873(345)
6178(295)
-3507(-286)
Board size 1998(224)
-2525(-088)
1713(154)
1023(076)
Book leverage ratio 19437(263)
36428(234)
44051(376)
10878(091)
Firm age 0280(178)
1058(289)
0149(068)
-0035(-016)
Log(Market value of equity) -7681(-445)
-9662(-231)
-8954(-366)
-1257(-054)
ρ 0839(1885)
0965(3021)
-0761(-377)
0955(2885)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in stock price on change in insurance coverage ratio
Panel C Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0625(077)
4631(339)
5390(296)
-3198(-273)
Board size 1891(222)
-1886(-078)
1284(120)
0770(058)
Book leverage ratio 17770(255)
33879(230)
40422(385)
-1096(-009)
Firm age 0409(271)
1103(348)
0293(142)
0141(065)
Log(Market value of equity) -7093(-430)
-9441(-245)
-7073(-307)
-2080(-090)
ρ 0820(1644)
0953(2772)
-0808(-529)
0873(969)
Year fixed effects Yes Yes Yes Yes
Observations 343 101 114 128
Scatter Plots by Groups (All firms)
Scatter Plots Low Info Cost Group
Scatter Plots Medium Info Cost Group
Scatter Plots High Info Cost Group
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Empirical ResultsRegression of change in market capitalization on change in insurance coverage ratio
Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2263(104)
4120(187)
6750(378)
-0267(-011)
Board size -0166(-017)
2134(159)
1966(112)
-3813(-292)
Book leverage ratio 6390(067)
-6279(-037)
4262(020)
15630(280)
Firm age 0021(015)
0094(073)
0650(140)
0071(021)
Log(Market value of equity) -10311(-558)
-13539(-240)
-14728(-354)
-6882(-227)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0245 0383 0299 0258
Observations 633 217 197 219
Empirical ResultsRegression of change in stock price on change in insurance coverage ratio
Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2045(102)
4055(217)
5914(396)
-0686(-039)
Board size 0097(014)
2063(171)
1476(120)
-2164(-237)
Book leverage ratio 1821(022)
-10527(-083)
-25572(-140)
15082(330)
Firm age 0167(129)
0302(192)
0796(205)
0076(033)
Log(Market value of equity) -7036(-365)
-10476(-176)
-11480(-354)
-2344(-107)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0327 0459 0383 0364
Observations 643 217 207 219
Self-selection correction
bull If a firm endogenously makes its decision to purchase DampO insurance we have to control the potential self-selection bias by employing the Heckmanrsquos (1979) two-stage regression
bull In the selection eq we model the firmrsquos decision to purchase DampO insurance
bull In the effect eq the coefficient estimates obtained above are used to construct the inverse Mills ratio which is the selection bias correction term to control for the possibility that the firmrsquos decision to purchase DampO insurance is endogeneously determined The inverse Mills ratio is then added to effect equation as one of the control variables
Self-selection correction Empirical Results
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Panel A Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()0470(115)
1787(263)
5348(371)
-1558(-309)
Board size 0838(175)
0326(030)
1339(171)
0227(034)
Book leverage ratio 1473(041)
0063(001)
15877(205)
-3771(-067)
Firm age 0228(266)
0463(282)
0263(168)
0049(044)
Log(Market value of equity) -5399(-595)
-6850(-350)
-5690(-338)
-1605(-136)
ρ 0150(066)
0281(075)
-0499(-170)
0460(138)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in market capitalization on change in insurance coverage ratio
Panel B Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0699(082)
4873(345)
6178(295)
-3507(-286)
Board size 1998(224)
-2525(-088)
1713(154)
1023(076)
Book leverage ratio 19437(263)
36428(234)
44051(376)
10878(091)
Firm age 0280(178)
1058(289)
0149(068)
-0035(-016)
Log(Market value of equity) -7681(-445)
-9662(-231)
-8954(-366)
-1257(-054)
ρ 0839(1885)
0965(3021)
-0761(-377)
0955(2885)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in stock price on change in insurance coverage ratio
Panel C Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0625(077)
4631(339)
5390(296)
-3198(-273)
Board size 1891(222)
-1886(-078)
1284(120)
0770(058)
Book leverage ratio 17770(255)
33879(230)
40422(385)
-1096(-009)
Firm age 0409(271)
1103(348)
0293(142)
0141(065)
Log(Market value of equity) -7093(-430)
-9441(-245)
-7073(-307)
-2080(-090)
ρ 0820(1644)
0953(2772)
-0808(-529)
0873(969)
Year fixed effects Yes Yes Yes Yes
Observations 343 101 114 128
Scatter Plots by Groups (All firms)
Scatter Plots Low Info Cost Group
Scatter Plots Medium Info Cost Group
Scatter Plots High Info Cost Group
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Empirical ResultsRegression of change in stock price on change in insurance coverage ratio
Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
2045(102)
4055(217)
5914(396)
-0686(-039)
Board size 0097(014)
2063(171)
1476(120)
-2164(-237)
Book leverage ratio 1821(022)
-10527(-083)
-25572(-140)
15082(330)
Firm age 0167(129)
0302(192)
0796(205)
0076(033)
Log(Market value of equity) -7036(-365)
-10476(-176)
-11480(-354)
-2344(-107)
Year fixed effects Yes Yes Yes Yes
48 FamandashFrench industry fixed effects
Yes Yes Yes Yes
R2 0327 0459 0383 0364
Observations 643 217 207 219
Self-selection correction
bull If a firm endogenously makes its decision to purchase DampO insurance we have to control the potential self-selection bias by employing the Heckmanrsquos (1979) two-stage regression
bull In the selection eq we model the firmrsquos decision to purchase DampO insurance
bull In the effect eq the coefficient estimates obtained above are used to construct the inverse Mills ratio which is the selection bias correction term to control for the possibility that the firmrsquos decision to purchase DampO insurance is endogeneously determined The inverse Mills ratio is then added to effect equation as one of the control variables
Self-selection correction Empirical Results
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Panel A Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()0470(115)
1787(263)
5348(371)
-1558(-309)
Board size 0838(175)
0326(030)
1339(171)
0227(034)
Book leverage ratio 1473(041)
0063(001)
15877(205)
-3771(-067)
Firm age 0228(266)
0463(282)
0263(168)
0049(044)
Log(Market value of equity) -5399(-595)
-6850(-350)
-5690(-338)
-1605(-136)
ρ 0150(066)
0281(075)
-0499(-170)
0460(138)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in market capitalization on change in insurance coverage ratio
Panel B Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0699(082)
4873(345)
6178(295)
-3507(-286)
Board size 1998(224)
-2525(-088)
1713(154)
1023(076)
Book leverage ratio 19437(263)
36428(234)
44051(376)
10878(091)
Firm age 0280(178)
1058(289)
0149(068)
-0035(-016)
Log(Market value of equity) -7681(-445)
-9662(-231)
-8954(-366)
-1257(-054)
ρ 0839(1885)
0965(3021)
-0761(-377)
0955(2885)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in stock price on change in insurance coverage ratio
Panel C Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0625(077)
4631(339)
5390(296)
-3198(-273)
Board size 1891(222)
-1886(-078)
1284(120)
0770(058)
Book leverage ratio 17770(255)
33879(230)
40422(385)
-1096(-009)
Firm age 0409(271)
1103(348)
0293(142)
0141(065)
Log(Market value of equity) -7093(-430)
-9441(-245)
-7073(-307)
-2080(-090)
ρ 0820(1644)
0953(2772)
-0808(-529)
0873(969)
Year fixed effects Yes Yes Yes Yes
Observations 343 101 114 128
Scatter Plots by Groups (All firms)
Scatter Plots Low Info Cost Group
Scatter Plots Medium Info Cost Group
Scatter Plots High Info Cost Group
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Self-selection correction
bull If a firm endogenously makes its decision to purchase DampO insurance we have to control the potential self-selection bias by employing the Heckmanrsquos (1979) two-stage regression
bull In the selection eq we model the firmrsquos decision to purchase DampO insurance
bull In the effect eq the coefficient estimates obtained above are used to construct the inverse Mills ratio which is the selection bias correction term to control for the possibility that the firmrsquos decision to purchase DampO insurance is endogeneously determined The inverse Mills ratio is then added to effect equation as one of the control variables
Self-selection correction Empirical Results
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Panel A Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()0470(115)
1787(263)
5348(371)
-1558(-309)
Board size 0838(175)
0326(030)
1339(171)
0227(034)
Book leverage ratio 1473(041)
0063(001)
15877(205)
-3771(-067)
Firm age 0228(266)
0463(282)
0263(168)
0049(044)
Log(Market value of equity) -5399(-595)
-6850(-350)
-5690(-338)
-1605(-136)
ρ 0150(066)
0281(075)
-0499(-170)
0460(138)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in market capitalization on change in insurance coverage ratio
Panel B Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0699(082)
4873(345)
6178(295)
-3507(-286)
Board size 1998(224)
-2525(-088)
1713(154)
1023(076)
Book leverage ratio 19437(263)
36428(234)
44051(376)
10878(091)
Firm age 0280(178)
1058(289)
0149(068)
-0035(-016)
Log(Market value of equity) -7681(-445)
-9662(-231)
-8954(-366)
-1257(-054)
ρ 0839(1885)
0965(3021)
-0761(-377)
0955(2885)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in stock price on change in insurance coverage ratio
Panel C Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0625(077)
4631(339)
5390(296)
-3198(-273)
Board size 1891(222)
-1886(-078)
1284(120)
0770(058)
Book leverage ratio 17770(255)
33879(230)
40422(385)
-1096(-009)
Firm age 0409(271)
1103(348)
0293(142)
0141(065)
Log(Market value of equity) -7093(-430)
-9441(-245)
-7073(-307)
-2080(-090)
ρ 0820(1644)
0953(2772)
-0808(-529)
0873(969)
Year fixed effects Yes Yes Yes Yes
Observations 343 101 114 128
Scatter Plots by Groups (All firms)
Scatter Plots Low Info Cost Group
Scatter Plots Medium Info Cost Group
Scatter Plots High Info Cost Group
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Self-selection correction Empirical Results
Regression of change in Tobinrsquos Q on change in insurance coverage ratio
Panel A Change in Tobinrsquos Q ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()0470(115)
1787(263)
5348(371)
-1558(-309)
Board size 0838(175)
0326(030)
1339(171)
0227(034)
Book leverage ratio 1473(041)
0063(001)
15877(205)
-3771(-067)
Firm age 0228(266)
0463(282)
0263(168)
0049(044)
Log(Market value of equity) -5399(-595)
-6850(-350)
-5690(-338)
-1605(-136)
ρ 0150(066)
0281(075)
-0499(-170)
0460(138)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in market capitalization on change in insurance coverage ratio
Panel B Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0699(082)
4873(345)
6178(295)
-3507(-286)
Board size 1998(224)
-2525(-088)
1713(154)
1023(076)
Book leverage ratio 19437(263)
36428(234)
44051(376)
10878(091)
Firm age 0280(178)
1058(289)
0149(068)
-0035(-016)
Log(Market value of equity) -7681(-445)
-9662(-231)
-8954(-366)
-1257(-054)
ρ 0839(1885)
0965(3021)
-0761(-377)
0955(2885)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in stock price on change in insurance coverage ratio
Panel C Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0625(077)
4631(339)
5390(296)
-3198(-273)
Board size 1891(222)
-1886(-078)
1284(120)
0770(058)
Book leverage ratio 17770(255)
33879(230)
40422(385)
-1096(-009)
Firm age 0409(271)
1103(348)
0293(142)
0141(065)
Log(Market value of equity) -7093(-430)
-9441(-245)
-7073(-307)
-2080(-090)
ρ 0820(1644)
0953(2772)
-0808(-529)
0873(969)
Year fixed effects Yes Yes Yes Yes
Observations 343 101 114 128
Scatter Plots by Groups (All firms)
Scatter Plots Low Info Cost Group
Scatter Plots Medium Info Cost Group
Scatter Plots High Info Cost Group
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Self-selection correction Empirical Results
Regression of change in market capitalization on change in insurance coverage ratio
Panel B Change in market capitalization ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0699(082)
4873(345)
6178(295)
-3507(-286)
Board size 1998(224)
-2525(-088)
1713(154)
1023(076)
Book leverage ratio 19437(263)
36428(234)
44051(376)
10878(091)
Firm age 0280(178)
1058(289)
0149(068)
-0035(-016)
Log(Market value of equity) -7681(-445)
-9662(-231)
-8954(-366)
-1257(-054)
ρ 0839(1885)
0965(3021)
-0761(-377)
0955(2885)
Year fixed effects Yes Yes Yes Yes
Observations 340 101 111 128
Self-selection correction Empirical Results
Regression of change in stock price on change in insurance coverage ratio
Panel C Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0625(077)
4631(339)
5390(296)
-3198(-273)
Board size 1891(222)
-1886(-078)
1284(120)
0770(058)
Book leverage ratio 17770(255)
33879(230)
40422(385)
-1096(-009)
Firm age 0409(271)
1103(348)
0293(142)
0141(065)
Log(Market value of equity) -7093(-430)
-9441(-245)
-7073(-307)
-2080(-090)
ρ 0820(1644)
0953(2772)
-0808(-529)
0873(969)
Year fixed effects Yes Yes Yes Yes
Observations 343 101 114 128
Scatter Plots by Groups (All firms)
Scatter Plots Low Info Cost Group
Scatter Plots Medium Info Cost Group
Scatter Plots High Info Cost Group
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Self-selection correction Empirical Results
Regression of change in stock price on change in insurance coverage ratio
Panel C Change in stock price ()
All Low information
cost
Medium information
cost
High information
cost
(1) (2) (3) (4)
Δ Insurance coverage ratio ()
0625(077)
4631(339)
5390(296)
-3198(-273)
Board size 1891(222)
-1886(-078)
1284(120)
0770(058)
Book leverage ratio 17770(255)
33879(230)
40422(385)
-1096(-009)
Firm age 0409(271)
1103(348)
0293(142)
0141(065)
Log(Market value of equity) -7093(-430)
-9441(-245)
-7073(-307)
-2080(-090)
ρ 0820(1644)
0953(2772)
-0808(-529)
0873(969)
Year fixed effects Yes Yes Yes Yes
Observations 343 101 114 128
Scatter Plots by Groups (All firms)
Scatter Plots Low Info Cost Group
Scatter Plots Medium Info Cost Group
Scatter Plots High Info Cost Group
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Scatter Plots by Groups (All firms)
Scatter Plots Low Info Cost Group
Scatter Plots Medium Info Cost Group
Scatter Plots High Info Cost Group
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Scatter Plots Low Info Cost Group
Scatter Plots Medium Info Cost Group
Scatter Plots High Info Cost Group
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Scatter Plots Medium Info Cost Group
Scatter Plots High Info Cost Group
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Scatter Plots High Info Cost Group
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Empirical Resultsbull The empirical results suggest that the effectiveness of DampO insurance depends
on the information cost which support our hypothesis 1 2 and 3
bull If a firm has an insurance coverage ratio equal to the sample mean (168) and increases its insurance coverage ratio by half (084) then the Tobinrsquos Q market capitalization and stock price in the subsequent year will respectively increase by 151 346 and 341 for the group with a low information cost and 479 567 and 497 for the group with a medium information cost
bull Next we explore the following robustness testsbull Is change in DampO insurance coverage endogenously determined
bull Are empirical results dependent on the choice of proxy for information cost
bull Are there alternative interpretation of empirical results
bull Does decreasing the information cost improve firm value
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Is change in DampO insurance coverage endogenously determined
bull If change in the DampO insurance coverage ratio is endogenously determined then we should use the instrumental variable approach to deal with the endogeneity issue
bull A body of research argues that DampO insurance coverage is determined by a number of factors such as the director compensation package (Chang et al 2015) directorsrsquo risk-aversion (Parry and Parry 1991) financial distress (Core 1997) litigation risk (Chalmers et al 2002) and firm complexity (Boyer 2014)
bull We run regressions to determine whether these factors do affect the dynamic change in DampO insurance coverage ratio
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Is change in DampO insurance coverage endogenously determined
Δ Insurance coverage ratio ()
(1) (2) (3)Δ Director compensation in cash (C$m)
-1031(-052)
-1022(-051)
Δ Director compensation in stocks (C$m)
-0827(-030)
Δ Director compensation in options (C$m)
-0432(-070)
Δ Director compensation in stocks and options (C$m)
-0514(-160)
Δ Total director compensation (C$m)
-0593(-128)
Δ Number of independent directors
-0076(-095)
-0076(-094)
-0075(-093)
Δ Book leverage ratio -0421(-084)
-0421(-084)
-0412(-085)
Δ Complexity -0082(-140)
-0082(-142)
-0082(-147)
Acquirer -0173(-106)
-0178(-124)
-0180(-124)
Divestor 1649(139)
1656(140)
1656(140)
Annual stock return (t-1) () 0001(036)
0001(036)
0001(035)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0178 0178 0178Observations 621 621 621
Regression of change in insurance coverage ratio on changes in director compensation risk-aversion of
directors financial distress complexity and litigation risk Δ Insurance coverage ratio
() (1) (2) (3)Director compensation in cash (C$m)
0159(017)
0170(018)
Director compensation in stocks (C$m)
0327(024)
Director compensation in options (C$m)
-0061(-007)
Director compensation in stocks and options (C$m)
0073(007)
Total director compensation (C$m)
0111(014)
Number of independent directors
0010(031)
0014(038)
0014(036)
Book leverage ratio -0005(-001)
0002(001)
0002(001)
Complexity -0105(-177)
-0106(-179)
-0106(-178)
Acquirer -0193(-115)
-0197(-118)
-0198(-122)
Divestor 1628(139)
1631(139)
1632(138)
Annual stock return (t-1) () 0002(077)
0002(076)
0002(076)
Year fixed effects Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes
R2 0176 0176 0176Observations 621 621 621
Regression of change in insurance coverage ratio on the static position of director compensation risk-aversion of
directors financial distress complexity and litigation risk
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Is change in DampO insurance coverage endogenously determined
bull As complexity is marginally correlated with change in DampO insurance coverage ratio we use complexity as an instrumental variable and compare the instrumental variable estimates to ordinary least squares estimates by the Hausman specification test which returns χ2 statistics less than 399 and p-values more than 055
bull Therefore we conclude that the endogeneity issue for change in DampO insurance coverage is not material and application of the instrumental variable approach is not necessary
(Note Typically growth firms have more complex investment opportunities and a higher ratio of market value of equity to book value of equity Hence we define complexity as the ratio of market value of equity to book value of equity)
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Are empirical results dependent on the choice of proxy for information cost
bull One may still be skeptical of whether our empirical results are robust to other measures of information cost
bull Coffee (1999) and Stulz (1999) argue that firms cross-listed in the US are subject to higher standard of disclosure requirements and hence are more transparent Baker et al (2002) and Lang et al (2003) also find that firms cross-listed in the US have more analyst coverage and media attention resulting in better information environments
bull Following the above findings we assume that firms in our sample which are cross-listed in the US have lower information cost and we construct a cross-listing dummy variable to proxy for the low information cost environment
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Are empirical results dependent on the choice of proxy for information cost
Regression of change in firm value on change in insurance coverage ratio Change in firm value
Change in Tobinrsquos Q () Change in market capitalization ()
Change in stock price ()
(1) (2) (3) (4) (5) (6)Δ Insurance coverage ratio ()
1266(147)
2263(104)
2045(102)
Δ Insurance coverage ratio () x Cross-listing dummy variable
4057(198)
6458(265)
5843(242)
Board size 0928(220)
0916(224)
-0166(-017)
-0174(-018)
0097(014)
0090(012)
Book leverage ratio -0918(-020)
-2223(-045)
6390(067)
4317(041)
1821(022)
-0016(-000)
Firm age 0152(168)
0159(177)
0021(015)
0031(022)
0167(129)
0176(140)
Log(Market value of equity)
-5083(-402)
-5022(-390)
-10311(-558)
-10221(-556)
-7036(-365)
-6955(-358)
Year fixed effects Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes
R2 0234 0234 0245 0243 0327 0325Observations 633 633 633 633 643 643
The regression results suggest that increasing insurance coverage ratio enhances firm value for the firms with low information cost (as proxied by their dual listing in the US)
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Are there alternative interpretation of empirical results
bull If firms with a low information cost have lower DampO insurance coverage when compared to firms with a high information cost one may argue that the effectiveness of changing DampO insurance coverage depends on a firmrsquos initial level of insurance coverage instead of its information cost
bull However we find that the group of firms with a low information cost has a DampO insurance coverage ratio of 197 which is not statistically different from the DampO insurance coverage ratio of 175 for the group of firms with a high information cost Testing the difference in average DampO insurance coverage ratio between these two groups yields a p-value of 0446
bull Therefore we rule out the explanation that the positive relation between DampO insurance coverage and firm value for firms with a low information cost is due to their initial level of insurance coverage
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Does decreasing the information cost improve firm value
bull We construct a subsample of firms whose change in DampO insurance coverage limit is zero (including those firms that do not have any DampO insurance) and run the following regression
Vjt+1 ndash Vjt = α(information costjt ndash information costjt-1) + control variablest + (st ndash st-
1)+ (ejt ndash ejt-1)
where (Vjt+1 ndash Vjt) is represented by the changes in Tobinrsquos Q market capitalization and stock price from year t to year t+1 We include board size book leverage ratio firm age and the logarithm of the market value of equity as control variablest
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Does decreasing the information cost improve firm value
Change in firm value Change in Tobinrsquos Q () Change in market capitalization () Change in stock price () Firms with no change in DampO coverage limit All Firms without
DampO insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
All Firms without DampO
insurance
Firms with DampO
insurance
(1) (2) (3) (4) (5) (6) (7) (8) (9)Δ Information cost -18681
(-211)-17253(-117)
-12477(-135)
-1208(-015)
-1985(-023)
9374(065)
-6332(-065)
-12475(-103)
8854(068)
Board size 0893(228)
1299(277)
0536(089)
-0292(-030)
0023(002)
0123(008)
-0144(-019)
0433(060)
-0022(-001)
Book leverage ratio 0542(012)
1235(015)
-1925(-026)
13668(171)
10653(076)
31753(160)
5424(067)
4598(033)
16981(096)
Firm age 0166(150)
0263(252)
0055(032)
0057(037)
0191(124)
-0295(-079)
0201(127)
0367(266)
-0148(-042)
Log(Market value of equity) -5945(-344)
-6856(-279)
-5391(-177)
-11198(-336)
-13022(-481)
-9013(-172)
-8432(-277)
-9402(-357)
-7241(-134)
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes48 FamandashFrench industry fixed effects
Yes Yes Yes Yes Yes Yes Yes Yes Yes
R2 0262 0246 0365 0273 0278 0371 0353 0358 0420Observations 551 286 265 551 286 265 560 293 267
Regression of change in firm value on change in information cost for firms without change in DampO coverage limit
Based on these ambiguous regression results we can hardly conclude any association between the information cost and firm value if we keep the insurance coverage limit constant
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Conclusionbull When the information cost to independent directors is low the
monitoring effect dominates the moral hazard effect and DampO insurance improves firm value which is reflected in changes of Tobinrsquos Q market capitalization and stock price in the subsequent year
bull When the information cost to independent directors is high the moral hazard effect dominates the monitoring effect and there is no statistically significant relationship between DampO insurance and firm value
bull The optimal level of DampO insurance varies across firms according to the information cost structure Our results show that the abolition of DampO insurance does not add value to all firms contrary to the viewpoint of some scholars
Thank You for Your Attention
QampA
Thank You for Your Attention
QampA
