Governance-Linked D&O Market-based governance: Leveraging D&O insurance to drive corporate governance

In an earlier paper the authors discussed how D&O insurance can be used to reduce the governance risk facing insurers, by linking coverage to contractual obligations to follow best practice governance controls. In this paper they place governance-linked D&O insurance within the broader context of the way in which the conflicts of interest between owners and managers of firms are managed by the key intermediary institution of the board of directors. There has been increasing controversy over whether directors are playing the role they are meant to in governance or whether they have become excessively beholden to chief executive officers. Regulation and the use of the legal system have been the predominant means of disciplining directors, but each has its drawbacks, particularly in terms of the disincentives they create for qualified individuals to serve as directors in the first place. What is missing is any role for market forces in governance, with their promise to achieve better cost effectiveness and innovation in governance practice. The authors argue that governancelinked D&O insurance is a means toward that end of market-based governance, with process-based coverage bringing together the tools for better governance risk management with the motivation for directors to exercise their fiduciary responsibilities.