Governance and D&O insurance

I was part of a panel discussion on 17 Nov, on the benefits of Directors & Officers (D&O) insurance cover for organizations and why it would contribute to better governance. Some of my key points were from the discussion were;

1. Directors and Officers are held to a higher standard and have legal responsibilities to shareholders, investors, creditors, regulators, employees and any other stakeholders. Therefore in today’s litigious environment D&O Liability Insurance coverage becomes an essential part of managing a private or publicly traded company.

Boards have a “duty of care”, but if there is a personal financial consequence for violating that duty of care, the boards may not perform their task or make courageous decisions with the right risk appetite. NEDs do not manage the day-to-day operations of the organization and therefore cannot ensure that the organization will be successful. Thus the assessment of “reasonable care” in making decisions is important to shield directors from legal actions.

2. With the growing importance of Independent directors and Non executive directors, the director’s roles have evolved since Sarbanes Oxley, into much more than a prestigious title and rubber stamp approval of management decisions. There was a time where NEDs march into a board meeting without any concern, did not express any concern during the meeting and then march out of the meeting without any concern. However, now the public is increasingly holding them responsible for the day to day operations of companies, at least where the legal systems are developed and in advanced countries. Therefore, the number of boards a person can effectively serve is also reducing at an increasing pace!

3. D&O liability insurance is useful to attract and retain qualified board members (specially for the role of audit committees or risk committees). Their personal assets are at risk every day in making decisions to further the growth and success of an organization. Non executive directors, in particular, tend to feel more secure when there is an insurance policy in place to indemnify their actions, and therefore need not worry about their actions going wrong in hindsight.

However, not supporting the view for D&O Insurance, Warren Buffett, Chairman & CEO of Berkshire Hathaway is quoted to have said;
“[Our directors and officers] receive token compensation; no options, no restricted stock and, for that matter, virtually no cash. We do not provide them directors and officers insurance, a given at almost every other large public company. If they mess with your money, they will lose their money as well. Leaving my holdings aside, directors and their families own Berkshire shares worth more than $3 billion. Our directors, therefore, monitor Berkshire’s actions and results with a keen interest and an owner’s eye.” This would be a tough act to follow, because boards are now looking for directors to enhance their corporate image and for better governance. Therefore, boards need reputed and knowledgeable people, who don’t have to risk their personal assets when they exercise a proper standard of care.

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About surenraj

“Views expressed are my own”
This entry was posted in Governance and tagged . Bookmark the permalink.

One Response to Governance and D&O insurance

  1. Richard Ebell says:

    Great post, Suren. Thanks.

    From a personal perspective:

    1. I cannot relate to the Buffett view: INED’s have no significant shareholdings and therefore nothing significant to gain other than the satisfaction of serving as an INED (related to the challenge the position brings), the status / prestige of serving on a “good” Board and probably lastly, the fees they earn. 2. So protection is good to have, and – again a personal viewpoint, not because it increases risk appetite (as you suggest) but because it provides welcome and necessary comfort in an environment in which judgments “after the event” may tend to see actions and events more harshly than is warranted.

    Richard

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