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The Interrelationship among Normal and Abnormal D&O Insurance Coverage, Institutional Investor
Characteristics and Audit Fees

Thus, we expect that as the normal D&O insurance increases, it effectively enhances
corporate governance, which in turn reduces audit risk and audit fees. On the other hand,
if a company purchases an excessive amount of D&O insurance, most prior literature
supports managerial opportunism hypothesis; that is, excessive D&O insurance provides

incentives for managers to engage in opportunistic behavior and thus increases litigation
risk. Hence, we expect that as abnormal D&O insurance increases, both audit risk and
audit fees increase. Based on these two prior hypotheses, in this study, we further propose

the following hypotheses:
Hypothesis 1a: Holding other conditions constant, the higher the normal D&O insurance,
the lower the audit fees.

Hypothesis 1b: Holding other conditions constant, the higher the abnormal D&O

insurance, the higher the audit fees.

We use the data of firms listed in the Taiwan Stock Exchange and Taipei Exchange

from 2013 to 2018 from the Taiwan Economic Journal (TEJ). To estimate normal and
abnormal D&O insurance coverage, we use Equation (2) to regress DOICOV, D&O
insurance coverage scaled by the year-end equity, on several determinants of D&O
insurance. The normal D&O insurance coverage (NORMAL) is the fitted value of
DOICOV, and the abnormal D&O insurance coverage (ABNORMAL) is the residual from

Equation (2).
To test Hypotheses 1a and 1b, we use Equation (1) to regress the natural logarithm of
audit fees (LNAF) on NORMAL, ABNORMAL, and other control variables. We predict the

sign of β in Equation (1) to be negative and the sign of β in Equation (1) to be positive.
1
2
As mentioned before, institutional investors play a significant role in corporate
governance. According to prior literature, institutional investors who have insurance
business relationships with the D&O insured companies may have information advantages
that can enhance their monitoring ability, thereby improving corporate governance and

reducing audit risk and audit fees. On the other hand, institutional investors in insurance
business relationships may also have potential conflicts of interest and may be afraid of
losing current or potential business if they oppose management’s decisions. Therefore,

they may not play a supervisory role to monitor the D&O insured companies, thereby

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