Abstract

This paper first examines the relationship between the appropriateness of D&O insurance coverage and audit fees. The results show that if the firm purchases appropriate (normal) D&O insurance coverage, as the normal D&O insurance coverage increases, the auditor charges lower audit fees. However, if the firm purchases excess (abnormal) D&O insurance coverage, it has an adverse effect on the directors’ and managers’ behavior and increases the litigation risk. Hence, as the abnormal D&O insurance coverage increases, the auditor charges higher audit fees. Further analysis examines the interaction effect between the D&O insurance coverage and institutional investors who have insurance business relationships with the D&O insured companies on audit fees. The examination reveals that when the firm purchases appropriate D&O insurance coverage, the institutional investor in the insurance business relationship has an information advantage, which enhances the monitoring mechanism. Thus, the auditor charges lower audit fees for the client who has an institutional investor in the insurance business relationship. On the other hand, when the firm purchases excess D&O insurance coverage, due to conflicts of interest, an institutional investor will be afraid of losing current or potential business if they oppose management’s decisions. The institutional investor will be less likely to deter the directors’ and managers’ opportunistic behavior, which increases the firm’s litigation risk. Thus, the auditor charges higher audit fees for the client who purchases abnormal D&O insurance coverage and has an institutional investor in the insurance business relationship.  

Keywords

directors’ and officers’ insurancenormal D&O insurance coverageabnormal D&O insurance coverageinstitutional investor in insurance business relationshipaudit fees