Summary:
This paper investigates the relationship between the purchase of Directors' and Officers' Liability Insurance (D&O insurance) and tunneling behavior by major shareholders in Chinese listed companies, focusing on the second type of agency problem, known as “tunneling”, which occurs in markets with a concentrated ownership structure. In such markets, major shareholders often have substantial control over the company, enabling them to engage in misappropriation of company resources that harm the interests of minority shareholders. The paper explores whether D&O insurance can serve as an effective mechanism to mitigate the opportunistic behavior of controlling shareholders and protect the interests of minority shareholders. Tunneling behavior is a significant issue in emerging markets, where large shareholders, who often hold a controlling stake, may use various mechanisms such as related-party transactions and asset stripping to transfer wealth from the company to themselves. Previous studies have primarily focused on internal governance mechanisms, such as the role of independent directors and the supervisory board, to address this issue. However, this paper expands the literature by introducing D&O insurance as a potential solution to constrain tunneling behavior by improving corporate governance and strengthening external oversight. Drawing on a dataset of Chinese A-share listed companies from 2013 to 2022, the study empirically examines the impact of purchasing D&O insurance on the level of tunneling behavior, measured by related-party transactions. The empirical results indicate that companies that purchase D&O insurance experience a 4.2% reduction in tunneling levels, suggesting that this insurance serves as an effective tool to reduce major shareholders' ability to exploit the company for personal gain. This finding aligns with the hypothesis that D&O insurance, by providing coverage for directors and officers against potential lawsuits, helps mitigate the risk of opportunistic behavior by controlling shareholders. The paper further explores the mechanisms through which D&O insurance exerts its influence. The analysis reveals that D&O insurance leads to improvements in the quality of information disclosure and strengthens the internal control systems of the company. By enhancing transparency and accountability, D&O insurance reduces the likelihood of misconduct by directors and officers, including collusion with major shareholders to engage in tunneling behavior. This finding underscores the importance of D&O insurance as an external governance mechanism, complementing traditional internal governance practices. In addition, the study investigates the heterogeneity of the effect of D&O insurance across different types of companies. It is found that the effectiveness of D&O insurance in curbing tunneling behavior is more pronounced in companies located in regions with well-established rule of law environment and higher levels of marketization. The impact is also more significant in non-state enterprises. These findings suggest that the context in which a company operates, including the legal and regulatory environment, plays a crucial role in determining the effectiveness of D&O insurance as a governance tool. Another key aspect of the paper is the exploration of the impact of tunneling behavior on company performance. The study demonstrates that tunneling behavior has a negative effect on the financial performance of companies, particularly in terms of profitability and stock performance. However, the purchase of D&O insurance mitigates these negative effects by reducing the extent of tunneling and improving the overall governance structure of the company. This highlights the dual role of D&O insurance in both preventing tunneling and enhancing corporate performance. This research contributes to the growing body of literature on corporate governance by providing a novel perspective on addressing tunneling behavior. The study offers empirical evidence supporting the idea that D&O insurance can serve as an effective tool in reducing the agency problem posed by major shareholders, thus improving governance practices in companies with concentrated ownership structures. Furthermore, the findings have important policy implications. They suggest that encouraging the adoption of D&O insurance in Chinese listed companies could help enhance corporate governance and protect the interests of minority shareholders, thereby fostering more sustainable and transparent business practices in the long term. In conclusion, the paper enriches the understanding of how external governance mechanisms like D&O insurance can complement traditional internal governance mechanisms to mitigate agency problems, particularly in markets with concentrated ownership. The study's findings provide practical insights for regulators, policymakers, and corporate managers seeking to improve governance frameworks and reduce the prevalence of tunneling. The results suggest that promoting the use of D&O insurance could play a key role in strengthening corporate governance, protecting investors, and ultimately contributing to the stability and sustainability of the market.
王正文, 韩子涵, 李委铮, 耿志祥. 董事高管责任保险与大股东掏空[J]. 金融研究, 2025, 540(6): 189-206.
WANG Zhengwen, HAN Zihan, LI Weizheng, GENG Zhixiang. Directors' and Officers' Liability Insurance and Major Shareholders' Tunneling Behavior. Journal of Financial Research, 2025, 540(6): 189-206.
Beck, T., R. Levine, and A. Levkov, 2010, “Big Bad Banks？ The Winners and Losers From Bank Deregulation in the United States,” The Journal of Finance, 65(5), pp.1637～1667.
[19]
Burke, M., S. M. Hsiang, and E. Miguel, 2015, “Global Non-linear Effect of Temperature on Economic Production,” Nature, 527(7577), pp.235～239.
[20]
Chen, X., F. Wen, J. Xiao, and G. G. Tian, 2024, “Weathering the Risk: How Climate Uncertainty Fuels Corporate Fraud,” Journal of Business Ethics, pp.1～29.
[21]
Chen, Z., O. Z. Li, and H. Zou, 2016, “Directors and Officers Liability Insurance and the Cost of Equity,” Journal of Accounting and Economics, 61(1), pp.100～120.
[22]
Chiang, Y. M. and P. R. Chang, 2022, “Overinvestment, Ownership Structure, and Directors' and Officers' Liability Insurance,” International Review of Economics ＆ Finance, 78, pp.38～50.
[23]
Claessens, S., S. Djankov, J. Fan, and L. Lang, 1999, “Expropriation of Minority Shareholders in East Asia,” Working paper, World Bank.
[24]
Dahya, J., O. Dimitrov, and J. J. McConnell, 2006, “Dominant Shareholders, Corporate Boards, and Corporate Value: A cross-country Analysis,” Journal of Financial Economics, 87(1), pp.73～100.
[25]
Guo, Kun, Qiang Ji, and Dayong Zhang, 2024, “A Dataset to Mmeasure Global Climate Physical Risk,” Data in Brief, 54, No.110502
[26]
Jiang, G., C. M. C. Lee, and H. Yue, 2010, “Tunneling Through Intercorporate Loans: The China Experience,” Journal of Financial Economics, 98(1), pp.1～20.
[27]
La Porta, R., F. Lopez-de-Silanes, A. Shleifer, and R. Vishny, 2002, “Investor Protection and Corporate Valuation,” The journal of finance, 57(3), pp.1147～1170.
[28]
Li, T., T. Yang, and J. Zhu, 2022, “Directors' and Officers' liability Lnsurance: Evidence From Independent Directors' Voting,” Journal of Banking ＆ Finance, 138, No.106425.
[29]
Lin, C., M. S. Officer, R. Wang, and H. Zou, 2013, “Directors' and Officers' Liability Insurance and Loan Spreads,” Journal of Financial Economics, 110(1), pp.37～60.
