Benefiting from Insurance : An empirical analysis of directors’ and officers’ liability insurance on Canadian corporations’ capital structure

Abstract

In this thesis, we examine the role of Directors’ and Officers’ Liability Insurance, as a proxy of comprehensive corporate insurance, in strategic risk management within corporations and its impact on various aspects of a firm’s capital structure. Our empirical study is grounded in a dataset containing Canadian corporations listed on the S&P/TSX Index, examining insurance and financial data to understand how alternations in insurance premium levels affect a firm’s capital structure, valuation, and risk profile. Our findings indicate that insurance reduces the asset volatility, lowers cost of debt and positively influence its leverage. Furthermore, enhanced insurance appears to beneficially affect the enterprise value, likely due to increased tax benefits from increased leverage and an improved risk profile. The application of the Leland model in this research allows us for the validation of our findings by examining the connection between insurance and asset volatility, as determined through the Merton model. Our analysis implies that insurance will reduce the asset volatility thus enhancing its risk profile. Leland’s theory further supports our findings, asserting that a reduction in asset volatility will yield similar changes in its capital structure. Overall, our findings suggest that insurance is advantageous for companies, leading to reduced volatility and cost of debt, and positively impacting the firm’s leverage and enterprise value.