The effect of directors and officers liability insurance on audit effort

Abstract

This study investigates the effect of directors and officers liability insurance (hereafter, D&O liability insurance) on audit effort of auditors. D&O liability insurance is a liability insurance payable to top executives of a company as indemnification for losses or litigation costs from the lawsuits. Companies carry D&O liability insurance for the purpose of protecting their directors and officers from the legal actions. However, according to prior studies, the managers of their companies with D&O liability insurance may become more risk seeker, and they take more risks for their decision. If D&O liability insurance causes more risks at the company, auditors for the companies may use the information of D&O liability insurance as a risk factor at the audit engagement. This study examines whether D&O liability insurance has a significant influence audit effort of auditors empirically. We use the mandatory disclosed Korean data of D&O liability insurance for testing the association between D&O liability insurance and audit effort. From the results, we find that auditors use D&O liability insurance information for setting the amount of audit effort. Also, both Big4 and Non-Big4 use D&O liability insurance as useful information.