4. Discussion of mandatory disclosure of D&O insurance information
4.4 Cost and benefit analysis of mandatory disclosure
4.4.2.2 Decrease transaction cost
In addition to indemnification, this paper would like to further explore the essential function and meaning of D&O insurance. As this paper and previous literature argue, D&O insurance may have the signal function to convey the information about insured firms to the market. However, is this sufficient to justify the current D&O insurance system, or even further promotion for D&O insurance in the future? Is this mechanism economically efficient? This is also related to
- 33 -
the economic productivity of D&O insurance. A Productive policy is a policy that can correct market failure and enhance social welfare. D&O insurance can signal the qualities of insured firms, but this function could easily be substituted by other similar mechanisms, such as a more complete financial disclosure system. If D&O insurance is not beneficial for social welfare, then it is merely costly and instrumental. D&O insurance cannot be justified and deserves less promotion. In contrast, if D&O insurance could generate or save social welfare, then it is productive and worth more promotion. In short, what is the function and meaning of D&O insurance in corporate governance?
Trading gains, including trading securities, do not generate additional welfare.123 Since the gain of one party is also the loss the other. Usually, investors and analysts in the market have to collect information by themselves. In this way, wasteful duplication124 may be created – investors and analysts incur expenses in surveying identical information. Even though the transaction is successful, these costs have to be paid. This transaction cost will decrease overall social welfare. In contrast, mandatory disclosure of D&O insurance information is expected to minimize the social cost caused by individual investigation.125 As such, it is usually believed that mandatory disclosure systems reduce such duplication waste. In addition, empirical evidence has indicated that mandatory disclosure systems can reduce price dispersion and increase allocative efficiency of capital market.126 Similarly, in D&O insurance issues, its signal effect has been recognized, but it cannot be provided voluntarily. Hence, investors and analysts in the market may have to spend duplicative efforts to disclose the information of a particular firm and thus the transaction cost will increase. On the opposite side, a mandatory disclosure system of D&O insurance information can provide such information to all the participants in the market. This can reduce the transaction action of duplication investigation and waste. In conclusion, this paper argues that even though the information of D&O insurance cannot create additional social welfare, a mandatory disclosure system of D&O insurance is beneficial for deceasing transaction costs of the market and thus saving social welfare. D&O insurance and its mandatory disclosure system are productive. In addition to its original function of indemnification, the signal function and mandatory disclosure of D&O insurance is justified and worth more promotion in the future.
123 Coffee, supra note 26, at 733.
124 Id.
125 Id.
126 Id. at 751-52.
- 34 - 4.4.2.3 Risk assessment and portfolio revision
Insurers usually have more knowledge and profession than average investors. The D&O insurance package, the assessment of insured firms by insurers, can provide one useful signal for investors. Needless to say, insurers may suffer loss from their judgment and thus they will be more serious about the evaluation of insured firms. Professor John C. Coffee argues that the rational investor needs information to optimize his portfolio even in an efficient market.127 Professor Sean J. Griffith also suggests that D&O insurance information can provide another data point for analysts in evaluating firms.128 This paper argues that this is also sustainable regarding D&O insurance information. According to previous empirical evidence, D&O insurance is helpful in conveying information about insured firms. Similar to other information in the securities market, information about D&O insurance also can provide more signals and contribute to rational investors optimizing their investment portfolios and strategies.
4.4.3 Summary
After the cost and benefit analysis of D&O insurance and its disclosure system, this paper argues that the importance of D&O insurance in corporate governance and its mandatory disclosure are justified and worth more promotion. The major cost of a mandatory disclosure system, the inducement of litigation, is not supported by theory or empirical evidence. Regarding benefit, with the professional assessment by insurers, D&O insurance can save the cost of investigation by individual investors. D&O insurance contributes by saving transaction costs and social welfare. D&O insurance and its mandatory disclosure are productive, economically justified, and not instrumental. Promotions and a complete disclosure system are expected to benefit corporate governance and save welfare.
127 Id. at 747.
128 Griffith, supra note 9, at 1185.
- 35 - 5. Conclusion and Suggestion
If D&O insurance information can accurately signal the qualities of insured firms, for the purpose of transparency and improving corporate governance, it would be reasonable to disclose such information. Professor Sean J. Griffith argues that the information about the types of D&O insurance, prices, amounts, limits, and retentions can signal the quality of the insured companies,129 and thus this information is required to be disclosed. However, because of market failure, where information about D&O insurance is seldom voluntarily provided, the SEC in the United States should mandate disclosure of details of D&O insurance policies.130
In the empirical study of Taiwan, is can be found that D&O insurance has positive effect to the market. If market failure happens and information about D&O insurance cannot be voluntarily provided, Taiwan authorities should also mandate the disclosure of D&O insurance policies.
Market failure of supplying the information about D&O insurance is also supported by the empirical evidence in this research. Before 2008, when the disclosure of D&O insurance became partially mandatory, the rate of voluntary disclosure was very low. This indicates that because of the characteristics of a public good and the free-rider effect, a voluntary disclosure system failed in Taiwan. Even after the partially mandatory disclosure policy, more sensitive data like insurance premium is still not disclosed. After cost and benefit analysis, this paper argues that a current mandatory disclosure system could be justified and promoted. In addition to the purchase of D&O insurance (Yes/No), insured person, the identity of insurer, coinsurer and coinsurance rate (if any), limit, retention, insurance period and status (new case or renewal), which have been disclosed mandatorily, insurance premium, and the type of insurance policy should be also disclosed mandatorily in the future.
129 Id. at 1182-85.
130 Id. at 1203-07.
- 36 -
Reference
1. ANDERSON, DAVID RAY, SWEENEY, DENNIS, & WILLIAMS, THOMAS, STATISTICS FOR
BUSINESS AND ECONOMICS, Cengage Learning (2010).
2. ASTERIOU,DIMITRIOS &HAL, L STEPHEN G.,APPLIED ECONOMETRICS, Palgrave Macmillan (2011).
3. AZEVEDO, JOÃO PEDRO, DAVID, ANTONIO, BASTOS, FABIANO RODRIGUES, & PINEDA, EMILIO, FISCAL ADJUSTMENT AND INCOME INEQUALITY: SUB-NATIONAL EVIDENCE FROM
BRAZIL, International Monetary Fund (2014).
4. Baker, Tom, & Griffith, Sean J., Predicting Corporate Governance Risk: Evidence from the Directors' & Officers' Liability Insurance Market, 74 U. CHI.L.REV. 487 (2007).
5. Baker, Tom, & Griffith, Sean J., The Missing Monitor in Corporate Governance: The Directors' and Officers' Liability Insurer, 95 GEO.L.J. 1795 (2007).
6. BAKER,TOM,INSURANCE LAW AND POLICY:CASES AND MATERIALS, Aspen Publishers (2d ed. 2008).
7. Baker, Tom, On the Genealogy of Moral Hazard, 75 TEX.L.REV. 237 (1996).
8. BATINA, RAYMOND G., & IHORI, TOSHIHIRO, PUBLIC GOODS: THEORIES AND EVIDENCE, Springer Science & Business Media, (2005).
9. Biel, William Scott, Whistling past the Waste Site: Directors' and Officers' Personal Liability for Environmental Decisions and the Role of Liability Insurance Coverage, 140 U.
PA.L.REV.241 (1991).
10. Black, Bernard, Cheffins, Brian, & Klausner, Michael, Outside Director Liability, 58 STAN. L.REV. 1055 (2006).
11. BLACK'S LAW DICTIONARY (9th ed. 2009).
12. Boyer, M. Martin, Directors' and Officers' Insurance and Shareholder Protection (Mar.
2005), available at SSRN: http://ssrn.com/abstract=886504 (last visited Jul. 10, 2015).
13. CAMERON, ADRIAN COLIN, & TRIVEDI, P. K., MICROECONOMETRICS USING STATA, Stata Press (2009).
14. Coffee, John C., Market Failure and the Economic Case for a Mandatory Disclosure System, 70VA.L.REV.722(1984).
- 37 -
15. Coffee, John C., Reforming the Securities Class Action: An Essay on Deterrence and Its Implementation, 106COLUM.L.REV.1534 (2006).
16. Cox, James D., & Thomas, Randall S., Mapping the American Shareholder Litigation Experience: A Survey of Empirical Studies of the Enforcement of the U.S. Securities Law, in CORPORATE GOVERNANCE MODELS AND THE LIABILITY OF DIRECTORS AND MANAGERS
(2010).
17. Cutting, Curt, Turning Point for Rule 10b-5: Will Congressional Reforms Protect Small Corporations, 56 OHIO ST.L.J. 555 (1995).
18. Goldwasser, Dan L., Directors' and Officers' Liability Insurance 1994, 692 PLI/COMM 9 (1994).
19. Gorter, Harry de, Nielson, David J., & Rausser, Gordon C., Productive and Predatory Public Policies: Research Expenditures and Producer Subsidies in Agriculture,74AM.J.
AGRI.ECON.27(1992).
20. Griffith, Sean J., Uncovering a Gatekeeper: Why the SEC Should Mandate Disclosure of Details concerning Directors' and Officers' Liability Insurance Policies, 154U.PA.L.REV. 1147(2006).
21. HACKETT,STEVEN C.,&MOORE,MICHAEL C.,ENVIRONMENTAL AND NATURAL RESOURCES
ECONOMICS:THEORY,POLICY, AND THE SUBSTANTIAL SOCIETY,M.E. Sharpe (2011).
22. HIRSCHMAN, ALBERT O., EXIT, VOICE, AND LOYALTY:RESPONSES TO DECLINE IN FIRMS, ORGANIZATIONS, AND STATES,HARVARD UNIVERSITY PRESS (1970).
23. Hunter, Travis S., Ambiguity in the Air: Why Judicial Interpretation of Insurance Policy Terms Should Force Insurance Companies to Pay for Global Warming Litigation, 113PENN
ST.L.REV. 267 (2008).
24. La Porta, Rafael, Lopez-De-Silanes, Florencio, & Shleifer, Andrei, Corporate Ownership around the World, 54J.FIN.471 (1999).
25. Liaow, Taying, Examining Corporate Management and Directors' Liability: A Review of Stockholders' Derivative Suits under Taiwan's Company Law, 37 SOCIOECON.L. AND INST. REV. 103 (2006).
26. Lin, Yu-Hsin, Overseeing Controlling Shareholders: Do Independent Directors Constrain Tunneling in Taiwan?, 12SAN DIEGO INT'L L.J.363 (2011).
27. MACMILLAN,PUBLIC FINANCE AND PUBLIC POLICY,Worth Publishers (2004).
- 38 -
28. MANKIW,N.GREGORY,PRINCIPLES OF ECONOMICS,Cengage Learning (2011).
29. MARCHETTI, ANNE M., SARBANES-OXLEY ONGOING COMPLIANCE GUIDE:KEY PROCESSES AND SUMMARY CHECKLISTS,John Wiley & Sons (2007).
30. Mehra, Salil K., & Yanbei, Meng, Against Antitrust Functionalism: Reconsidering China's Antimonopoly Law, 49 VA.J.INT'L L. 379 (2009).
31. MICELI,THOMAS J.,THE ECONOMIC APPROACH TO LAW,Stanford University Press (2009).
32. Monteleone, Joseph P., & Grotell, Emy Poulad, Symposium: Coverage for Employment Practices Liability under Various Policies: Commercial General Liability, Homeowners', Umbrella, Workers' Compensation, and Directors' and Officers' Liability Policies, 21 W.
NEW ENG.L.REV.249 (1999).
33. Pistor, Katharina, Keinan, Yoram, Kleinheisterkamp, Jan, & West, Mark D., The Evolution of Corporate Law: A Cross-Country Comparison, 23U.PA.J.INT'L ECON.L. 791 (2002).
34. REZAEE, ZABIHOLLAH, CORPORATE GOVERNANCE POST-SARBANES-OXLEY:REGULATIONS, REQUIREMENTS, AND INTEGRATED PROCESSES,John Wiley & Sons (2007).
35. Sarra, Janis, Corporate Governance in Global Capital Markets, Canadian and International Developments, 76TUL.L.REV.1691 (2002).
36. Schulte, David J., The Debatable Case for Securities Disclosure Regulation, 13J.CORP.L.
535 (1988).
37. Shen, Kuan-Ling, Class Action in Taiwan: A New System Created Using the Theory of
“Right of Procedure Options”, 5 NAT'L TAIWAN U.L.REV. 39 (2010).
38. The Metropolitan Corporate Counsel, Project: Corporate Counsel - Law Firms; D&O Insurance: Now You See It, Now You Don't (Jun. 2005), available at http://www.metrocorpcounsel.com/articles/5509/project-corporate-counsel-law-firms-do-insurance-now-you-see-it-now-you-dont (last visited Jul. 10, 2015).
39. Ventoruzzo, Marco, Freeze-Outs: Transcontinental Analysis and Reform Proposals, 50VA. J.INT'L L.841 (2010).
40. Wang, Wallace Wen-Yeu, & Pang, Carol Yuan-Chi, Minority Controlling Shareholders: An Analytical Framework and Its Application to Taiwan, 2 NAT'L TAIWAN U. L. REV. 81 (2007).
41. WANG, WALLACE WEN-YEU, Kun Ssu Fa Lun [Corporation law]. Taipei, Taiwan: Angle (3d ed. 2005).
- 39 -
42. Wang, Wallace, The Relationship between the Deterrence Effect of D&O insurance and Corporate Governance, 156 TAIWAN L.REV.141(2008).
43. Washington, George T., The Corporation Executive's Living Wage, 54HARV.L.REV.733 (1941).
44. Weber, Anke, An Empirical Analysis of the 2000 Corporate Tax Reform in Germany:
Effects on Ownership and Control in Listed Companies, 29INT'L REV.L.&ECON.57 (2009).
45. WINSTON, GORDON C. & TEICHGRAEBER, RICHARD F., THE BOUNDARIES OF ECONOMICS, Cambridge University Press (1988).
46. WOOLDRIDGE,JEFFREY M,ECONOMETRIC ANALYSIS OF CROSS SECTION AND PANEL DATA, MIT Press (2010).