The effect of directors' and officers' liability insurance on tunneling: Evidence from China

Abstract This study examines the effect of Directors' and Officers' Liability Insurance (D&O insurance) on corporate tunneling activities, a typical agency problem. Using the universe of Chinese publicly‐traded companies from 2003 to 2020, we find lower growth of tunneling activities within firms whose managers are covered by D&O insurance. The results remain robust after addressing endogeneity concerns and using alternative measures. In addition, the effect of D&O insurance is stronger when firms have better access to insurance providers and when tunneling activities are more likely to occur. Moreover, when tunneling is controlled, D&O insurance is found to promote operating performance. Overall, the results indicate that D&O insurance can function as an effective governance component.