The Missing Monitor in Corporate Governance: The Directors' and Officers' Liability Insurer

<p> This article reports the results of empirical research on the monitoring role of directors&rsquo; and of&filig;cers&rsquo; liability insurance (D&amp;O insurance) companies in American corporate governance. Economic theory provides three reasons to expect D&amp;O insurers to serve as corporate governance monitors: &filig;rst, monitoring provides insurers with a way to manage moral hazard; second, monitoring provides bene&filig;ts to shareholders who might not otherwise need the risk distribution that D&amp;O insurance provides; and third, the &ldquo;bonding&rdquo; provided by risk distribution gives insurers a comparative advantage in monitoring. Nevertheless, we &filig;nd that D&amp;O insurers neither monitor corporate governance during the life of the insurance contract nor manage litigation defense costs once claims arise. Our &filig;ndings raise signi&filig;cant questions about the value of D&amp;O insurance for shareholders as well as the deterrent effect of corporate and securities liability. After exploring various explanations for these &filig;ndings, we conclude that the absence of monitoring is due, at least in part, to the agency problem in the corporate context. Our analysis thus suggests that the existing form of corporate D&amp;O insurance both results from and contributes to the relatively weak constraints on corporate managers. Corporate managers buy D&amp;O coverage for self-serving reasons, and the coverage itself, because it does not control moral hazard, reduces the extent to which shareholder litigation aligns managers &rsquo;and shareholders &rsquo;incentives.</p>