Abstract

This study evaluates whether earnings conservatism increases when firms with high debt
contracting demands purchase directors’ and officers’ insurance (D&O). We expect that the
purchase of D&O insurance is positively associated with earnings conservatism only when
firms have higher debt-based contracting demands. We find that firms having D&O
insurance and higher external demand for debts report more earnings conservatism. These
results are consistent with prior studies (Ahmed, Billings, Morton, & Stanford-Harris, 2002;
Watts, 2003) that debtholders demand greater earnings conservatism as a means of
addressing agency problems. This study also provides evidence that debtholders appear to be
the primary driver of the demand for earnings conservatism.  

Keywords

D&O insurancedebt contractingearnings conservatism