wen-yen hsu feng chia university, taiwan yenyu huang st. john’s university, taiwan gene lai

Corporate Governance and Cash Holdings: Evidence from the U. S. Property-Liability

Insurance Industry

Wen-Yen Hsu Feng Chia University, Taiwan

Yenyu HuangSt. John’s University, Taiwan

Gene Lai Safeco Distinguished Professor of Insurance

Washington State UniversityPresented at China International Conference on Insurance and

Risk Management

Outline

• Introduction• Hypotheses Development• Data and Methodology• Results• Conclusion &Policy Implication

2

Introduction• Recent regulatory and listing requirements (NYSE, NASDAQ,

SEC and SOX) emphasize the role of board of directors and committee members in mitigating the conflict of interests between shareholders and managers

• Cash holdings - Inspired from Jensen’s (1986) work on agency theory of free cash flow

3

Why Property – Liability Insurance Industry?

• An exceptionally good setting to analyze the efficacy of corporate governance because– Virtually all business transactions have to be

completed in cash they usually generate and tempt to hold a substantial level of cash (Cash to NPW is 50%)

– Huge losses such as Sandy and earth quake and tsunami in Japan may result in illiquidity or insolvency

4

Why Property – Liability Insurance Industry?

• An exceptionally good setting to analyze the efficacy of corporate governance because– The impact of insolvency has more impact on

stakeholders of P-L insurance industry – P-L insurance industry is a highly regulated

industry. The regulations are external governance. Do we need to have other external governance such as independence of board or finance committee?

5

Introduction - Purpose

• To examine the relation between board and finance committee characteristics and cash holdings for property-liability insurers to provide the evidence about the monitoring and advising roles of board of directors and finance committee

• We focus on the independence of board and finance committee

6

Literature Review

• Monitoring role: the effectiveness of board of directors is negatively related to the level of cash holding (Costs of holding cash).

• Reasons:–Cash generates lower returns in

comparison with other assets–A high level of cash holdings will

decrease managers’ pressure to minimize costs or increase managers’ discretionary expense overspending

7

Literature Review

• Monitoring role: the effectiveness of board of directors is negatively related to the level of cash holding (Costs of holding cash).

• Reasons:–A high level of cash holdings is generally

preferred to lower the likelihood of having financial distress or becoming a takeover target–Self-interested managers tend to retain

cash to facilitate their perquisite consumption

8

Literature Review (cont.)• Advising role: the effectiveness of board of

directors is positively related to the level of cash holding (benefits).

• Main reasons:– Insolvency avoidance–Meeting future growth, underinvestment

prevention–Relatively higher cost of raising external

funds–Liquidity

Main Hypothesis

• We propose the independent director responsibility hypothesis that suggests responsible directors of boards and finance committees will not only monitor the agency costs related to excess cash holdings but also aim to avoid underinvestment problems. In other words, independent directors would maximize stakeholders’ wealth.

10

Reasons for less cash for Independent Directiors

• Without economic, social or psychological tie (Berton, 1995)

• Reputation capital (Fama and Jensen, 1983)

11

Reasons for more cash

• Shareholder power hypothesis (Harford et al., 2008) – prevent underinvestment problem– They did not find empirical support for the

hypothesis, but we do.

12

Hypotheses

• H1a: There is a positive association between the insurers’ cash holdings and the independence of board of directors.

• H1b: There is a positive association between of insurers’ cash holdings and the independence of finance committees.

13

Hypotheses (cont.)

• H2: There is a positive association between the growth of insurers and the independence of board of directors (finance committee) when insurers have excess cash holdings in the previous period.– Independent directors allow for more cash holding

to prevent underinvestment problem

14

Hypotheses (cont.)

• H3: There is a non-positive association between the expenses of insurers and the independence of board of directors (finance committee) when insurers have excess cash holdings in the previous period.– Independent directors allow for more cash holding

to prevent underinvestment problem, but do not allow for more expenses

15

Corporate Governance Control Variables: Board Size

• There is a positive association between the board size of insurers and the level of insurers’ cash holdings – Reasons for less cash: more monitoring with a

large board (Jensen, 1993)– Reasons for more cash: slow decision and not

effective of a large board (Jensen, 1993); More expertise and avoidance of underinvestment problem

16

Corporate Governance Control Variables (Duality)

• There is a positive association between the level of insurers’ cash holdings and CEO/Chairman Duality.– CEO/Chairman duality can control the information

made available to other board members because more power (Hambrick and Finelstein (1987)

– less monitoring more cash holdings– CEO/Chairman can consolidate the management

decisions and control struggle, thus, accelerate decision process (Harrison et al.). To avoid underinvestment by holding more cash.

17

Corporate Governance Control Variables (Other Directorship)

• There is an association between the level of insurers’ cash holdings and additional directorships by directors.–More cash: busy board less monitoring– Less cash: accumulating governance expertise

better monitoring

18

Corporate Governance Control Variables (Director Ownership)

• There is an association between the level of insurers’ cash holdings and stock ownership by directors.–Morck, Shleifer and Vishny (1998)– Alignment of interests (convergence-of-interest)

vs. self-interests– Ownership is small: Agency costs dominate

convergence-of-interest more cash– Ownership is large: Convergence-of-interest

dominate agency costs less cash– Non-linear relation

19

Corporate Governance Control Variables (Diligence)

• There is a negative association between the level of insurers’ cash holdings and board of director diligence.–More meetings Better monitoring less cash

holdings

20

Corporate Governance Control Variables (Finance Expertise)

• There is an association between the level of insurers’ cash holdings and percentage of directors with financial expertise

• When the % is small, cash holdings increase to prevent underinvestment problem as % of financial experts increase

• When the % is large, cash holdings decrease as % of financial experts increase. Directors have free rider problem do not wish to deal with underinvestment problem or easy way out

21

Corporate Governance Control Variables (F. Committee Blockholders)• There is a non-linear association between the

level of insurers’ cash holdings and financial blockholders holdings.

22

Data and Methodology (1)

• Sample: 1,939 stock property-casualty insurers U.S. firm-years

• Period : 1997-2001 (2006)• Database : NAIC, A.M. Best and U.S. SEC

EDGAR

23

Variable definitions• Independence, Governance Expertise, Incentive, and

Diligence are related to the effectiveness of board of directors and finance committee

25

Variable Predicted

Sign

H # Definitions/Descriptions

Cash Holdings

Ratio of insurer’s cash plus short-term investments to its total

invested assets

BD_Outside Director% +/+/- 1/2/3 % of outside directors (excluding affiliate directors) on the board

FC_Outside Director% +/+/- 1/2/3 % of outside directors on finance committee

Board Size + Number of the board directors

BD_Avg. # of Directorships ? Average number of directorship positions that board directors

hold in other firms’ boards

BD_CEO/Chair Duality ? One if the CEO is also the chair of the board, 0 otherwise

Board Director Ownership ? % of shares held by directors

Log(BD_# of Meetings) - Natural log of number of board meetings

FC_ % Expert ? % of directors with investment and financial matters oversight

responsibility on the finance committee, including chief

executive officer, chief financial officer, vice president of finance,

executives in the investment, investment banking, or

commercial banking industry, or financial consultants, all

categorized as having corporate financial management

experience

Table 1 Variable Definitions

Table 1 Variable Definitions

26

FC_5% Blockholder ? One if the firm has at least one outside blockholder on the finance

committee, where block is defined at the 5% ownership level, 0

otherwise

Institutional Ownership ? % of shares held by institutions

G-Index ? An index of shareholder rights developed by Gompers, Ishii, and

Metrick (2003)

Size - Natural log of total assets

Financial Strength - Best’s rating (0 = below B-; 1 = B, B-, 2 = B++, B+; 3 =A, A-; 4 = A++, A+)

Volatility of Cash Flows + The standard deviation of net cash flow from operation over the

previous five years

Duration of Liabilities - Estimated average duration of liabilities for the insurer

Leverage ? Ratio of the insurer’s total liabilities to total assets

M/B ratio + Ratio of the market value to book value of insurers’ assets

Non-Invested Assets + Ratio of the insurer’s total non-invested assets to its total assets

Common Stock - Ratio of the insurer’s common stock holdings to its total invested

assets

Firm Age + Natural log of the difference between firms’ ages and 5

Dividend - One if the insurer pays a cash dividend to stockholders in the year, 0

otherwise

Summary StatisticsVariable Mean Median Std Dev Minimum MaximumCash Holdings 0.089 0.047 0.118 0.000 0.907BD_Outside Director% 0.604 0.625 0.218 0.000 0.938FC_Outside Director% 0.569 0.632 0.249 0.000 1.000Board Size 10.861 9.000 3.632 5.000 19.000BD_Avg. # of Directorships 1.893 2.188 1.037 0.000 3.750BD_CEO/Chair Duality 0.693 1.000 0.462 0.000 1.000Board Director Ownership 0.150 0.088 0.158 0.000 0.673Log(BD_# of Meetings) 1.554 1.609 0.436 0.000 2.773FC_ % Expert 0.630 0.600 0.199 0.000 1.000FC_5% Blockholder 0.132 0.000 0.339 0.000 1.000Institutional Ownership 0.337 0.250 0.271 0.000 0.926G-Index 2.868 3.000 1.470 0.000 8.000Size 18.984 18.912 1.681 15.361 24.389Financial Strength 3.400 3.000 0.640 0.000 4.000Volatility of Cash Flows 0.106 0.052 0.188 0.003 2.124Duration of Liabilities 2.281 2.294 0.618 0.665 4.957Leverage 0.574 0.641 0.202 0.005 0.972M/B Ratio 1.789 1.501 1.128 0.346 6.241Non-Invested Assets 0.159 0.118 0.138 0.000 0.926Common Stock 0.124 0.037 0.178 0.000 0.940Firm Age 3.105 3.135 1.035 0.000 5.333Dividend 0.455 0.000 0.498 0.000 1.000

Results – Major

28

Table 4: Regression analysis of the level of cash holdings and board and finance committee structureVariable Predicted

Sign

Model 1w/o Board & FC

outsider

Model 2w/o FC outsider

Model 3w/o Board outsider

Colquitt, et al. (1999)

Intercept0.351(0.90)

0.386(0.99)

0.369(0.95)

Cash Holdingst-1

0.030(0.67)

0.031(0.68)

0.027(0.61)

BD_Outside Director% + 0.134(2.60)

*** 0.167(3.63)

***

FC_Outside Director% + 0.053(1.56)

0.098(3.15)

***

Board Size + 0.006(1.79)

* 0.007(2.19)

** 0.006(2.02)

**

BD_Avg. # of Directorships ? -0.015(-2.52)

** -0.012(-2.11)

** -0.015(-2.44)

**

Board Director Ownership + 0.596(3.43)

*** 0.570(3.28)

*** 0.530(3.04)

***

Board Director Ownership2 - -0.733(-2.76)

*** -0.680(-2.57)

*** -0.626(-2.34)

**

Log(BD_# of Meeting) - -0.023(-1.92)

* -0.023(-1.91)

* -0.020(-1.75)

*

FC_ % Expert + 0.259(1.89)

* 0.201(1.61)

* 0.284(2.08)

**

FC_ % Expert2 - -0.235(-1.89)

* -0.195(-1.67)

* -0.252(-2.04)

**

FC_5% Blockholder ? -0.021(-1.56)

-0.025(-1.93)

* -0.021(-1.55)

Variable PredictedSign

Model 1w/o Board & FC

outsider



Colquitt, et al. (1999)

BD_CEO/Chair Duality + 0.015(2.08)

** 0.015(2.10)

** 0.011(1.62)

*

Institutional Ownership ? -0.013(-0.41)

-0.025(-0.76)

-0.003(-0.10)

G-Index ? -0.006(-0.73)

-0.005(-0.69)

-0.005(-0.63)

Size - 0.016(1.28)

0.015(1.25)

0.016(1.33)

-0.0189(.0001)

***

Financial Strength - -0.030(-2.08)

** -0.030(-2.10)

** -0.030(-2.11)

** -0.0180(.0001)

***

Volatility of Cash Flows + -0.003(-0.15)

-0.004(-0.16)

0.002(0.11)

0.1333(.0351)

***

Duration of Liabilities - -0.107(-3.35)

*** -0.108(-3.39)

*** -0.109(-3.36)

*** -0.0213(.0001)

***

Leverage ? -0.015(-0..28)

-0.018(-0.35)

-0.009(-0.16)

-0.0356(.0888)

*

M/B Ratio + 0.004(1.10)

0.004(1.16)

0.002(0.76)

0.0054(.5126)

Non-Invested Assets + -0.042(-0.71)

-0.042(-0.71)

-0.046(-0.79)

0.0229(.4459)

Common Stock - -0.263(-4.59)

*** -0.259(-4.58)

*** -0.265(-4.56)

*** -0.1753(.0001)

***

Firm Age + 0.054(2.80)

*** 0.054(2.82)

*** 0.055(2.79)

***

Dividend - -0.009(-1.22)

-0.009(-1.32)

-0.009(-1.23)

Regression analysis of the level of cash holdings and board and finance committee structure (cont~)

Regression analysis of the level of cash holdings and board and finance committee structure

Variable PredictedSign

Model 1with Board

& FC outsider



Colquitt, et al.

(1999)

Intercept

0.351(0.90)

0.386(0.99)

0.369(0.95)

Cash Holdingst-1

0.030(0.67)

0.031(0.68)

0.027(0.61)

BD_Outside Director%+ 0.134

(2.60)*** 0.167

(3.63)***

FC_Outside Director%+ 0.053

(1.56)0.098

(3.15) ***

Other Results• Board size– Positively associated with the level of cash holdings.• Slow-decision process, or difficult to coordinate.• Or prevent underinvestment problem

• Duality– Positive• Self-interests• Prevent from underinvestment problem

• Avg. # of Directorship– Negative• More experience and accumulated expertise and better

monitoring

32

Other Results

• Board ownership– Non-linear associated with the level of cash holdings• Inverse U shape

• # of meetings– Negative– Good monitoring

33

Other Results• Percentage of directors with finance expertise – Non-linear associated with the level of cash holdings• Inverse U shape

• Financial strength– Negative

• Duration of liabilility– Negative

• Common stock– Negative

• Firm Age– Positive

34

Other Results• Finance committee blockholder– Negatively associated with the level of cash

holdings• Agency costs reduction

35

Table 5 Regression analysis of future growth and governance variables of interest (using Market-to-Book)

Variable Model 1 Model 2 Model 3

Intercept -3.758(-2.64)

*** -4.084(-2.86)

*** -3.777(-2.65)

***

Excess Casht-1 -0.321(-0.97)

-0.309(-0.91)

0.005(0.02)

BD_Outside Director%t-1 1.985(5.71)

*** 1.281(4.51)

***

BD_Outside Director%t-1 x Excess Casht-1(positive) 0.609(0.22)

1.710(1.97)

**

BD_Outside Director%t-1 x Excess Casht-1(negative) 5.906(1.62)

-0.512(-0.47)

FC_Outside Director%t-1 -1.081(-4.11)

*** -0.353(-1.67)

*

FC_Outside Director%t-1 x Excess Casht-1(positive) 1.244(0.52)

1.403(1.85)

*

FC_Outside Director%t-1 x Excess Casht-1(negative) -6.688(-1.79)

* -1.132(-1.06)

Board Sizet-1 0.006(0.22)

0.012(0.43)

0.019(0.67)

BD_Avg. # of Directorshipt-1 0.048(1.50)

0.010(0.32)

0.066(2.04)

**

Board Director Ownershipt-1 6.368(5.67)

*** 7.128(6.32)

*** 5.568(4.97)

***

Board Director Ownership2t-1 -10.991

(-6.09)*** -12.498

(-6.84)*** -9.725

(-5.30)***

Log(BD_# of Meeting) -0.123(-1.92)

* -0.111(-1.70)

* -0.051(-0.86)

FC_ % Expertt-1 0.449(1.66)

* 0.750(2.85)

*** 0.520(1.84)

*

FC_5% Blockholdert-1 -0.119(-1.65)

* -0.072(-1.02)

-0.131(-1.84)

*

BD_CEO/Chair Dualityt-1 -0.125(-2.18)

** -0.141(-2.56)

*** -0.179(-3.29)

***

Institutional Ownershipt-1 0.366(1.47)

0.577(2.18)

** 0.526(1.99)

**

G-Indext-1 0.195(4.54)

*** 0.187(4.31)

*** 0.197(4.16)

***

Independent System 0.197(1.36)

0.201(1.38)

0.234(1.56)

Line_HHI 0.216(1.41)

0.210(1.35)

0.268(1.71)

*

State_HHI -0.125(-1.07)

-0.120(-1.01)

-0.109(-0.92)

Size 0.158(2.22)

** 0.176(2.47)

** 0.177(2.49)

***

Firm Age 0.410(2.77)

*** 0.399(2.65)

*** 0.453(3.06)

***

Table 5 Regression analysis of future growth and governance variables of interest (using Market-to-Book)


Intercept -3.758(-2.64)

*** -4.084(-2.86)

*** -3.777(-2.65)

***

Excess Casht-1 -0.321(-0.97)

-0.309(-0.91)

0.005(0.02)


*** 1.281(4.51)

***

BD_Outside Director%t-1 x Excess Casht-1(positive) 0.609(0.22)

1.710(1.97)

**


-0.512(-0.47)


*** -0.353(-1.67)

*


1.403(1.85)

*


* -1.132(-1.06)

Table 5 Regression analysis of future growth and governance variables of interest (using two years direct premium growth rate)


Intercept 3.114(3.56)

*** 2.976(3.44)

*** 3.021(3.45)

***

Excess Casht-1 -0.186(-1.14)

-0.150(-0.94)

-0.147(-0.91)


-0.229(-1.59)

BD_Outside Director%t-1 x Excess Casht-1(positive) -0.819(-0.54)

0.978(1.66)

*


-0.691(-1.10)


** -0.281(-2.59)

***


1.055(1.89)

*


-0.874(-1.3)

Board Sizet-1 0.018(2.04)

** 0.013(1.44)

0.019(2.14)

**

BD_Avg. # of Directorshipt-1 0.047(2.25)

** 0.040(1.88)

* 0.048(2.31)

**

Board Director Ownershipt-1 -0.726(-1.20)

-0.564(-0.95)

-0.664(-1.09)

Board Director Ownership2t-1 0.676

(0.69)0.301(0.31)

0.563(0.57)

Log(BD_# of Meeting) -0.023(-0.74)

-0.018(-0.60)

-0.023(-0.75)

FC_ % Expertt-1 -0.276(-2.73)

*** -0.201(-2.15)

** -0.274(-2.73)

***

FC_5% Blockholdert-1 0.063(1.43)

0.075(1.71)

* 0.062(1.41)

BD_CEO/Chair Dualityt-1 -0.039(-1.52)

-0.044(-1.75)

* -0.037(-1.51)

Institutional Ownershipt-1 -0.251(-1.79)

** -0.201(-1.49)

-0.255(-1.85)

*

G-Indext-1 0.009(0.38)

0.009(0.36)

0.008(0.34)

Independent System 0.045(0.81)

0.051(0.94)

0.046(0.83)

Line_HHI 0.198(1.75)

* 0.195(1.72)

* 0.198(1.75)

*

State_HHI -0.104(-1.33)

-0.105(-1.31)

-0.105(-1.34)

Size -0.176(-3.94)

*** -0.168(-3.80)

*** -0.172(-3.85)

***

Firm Age -0.020(-0.19)

-0.023(-0.22)

-0.025(-0.25)

Table 5 Regression analysis of future growth and governance variables of interest (using two years direct premium growth rate)


Intercept 3.114(3.56)

*** 2.976(3.44)

*** 3.021(3.45)

***

Excess Casht-1 -0.186(-1.14)

-0.150(-0.94)

-0.147(-0.91)


-0.229(-1.59)

BD_Outside Director%t-1 x Excess Casht-1(positive) -0.819(-0.54)

0.978(1.66)

*


-0.691(-1.10)


** -0.281(-2.59)

***


1.055(1.89)

*


-0.874(-1.3)

Table 6 Regression analysis of the impact of main governance variables of interest on the association between the excess cash holdings and salary expense divided by net premium written


Intercept0.231

(1.89) * 0.267

(2.10) ** 0.267

(2.15)**

Excess Casht-1

0.077(1.70)

* 0.067(1.48)

0.62(1.45)

*

BD_Outside Director%t-1

0.036(1.00)

0.009(0.29)

BD_Outside Director%t-1 x Excess Casht-1(positive)

0.450(1.46)

-0.126(-1.12)

BD_Outside Director%t-1 x Excess Casht-1(negative)

-1.496(-1.68)

* -0.424(-2.17)

**

FC_Outside Director%t-1

-0.060(-2.95)

*** -0.074(-3.11)

***

FC_Outside Director%t-1 x Excess Casht-1(positive)

-0.597(-1.87)

* -0.133(-1.19)

FC_Outside Director%t-1 x Excess Casht-1(negative)

1.116(1.34)

-0.347(-2.09)

**

Board Sizet-1

0.004(2.02)

** 0.001(0.66)

0.003(1.86)

*

BD_Avg. # of Directorshipt-1

0.000(0.08)

0.005(-1.01 )

0.000(0.06)

Board Director Ownershipt-1

-0.055(-0.54)

-0.020(-0.18)

-0.126(-1.20)

Board Director Ownership2t-1

0.274(1.61)

0.206(1.14)

0.398(2.26)

**

Log(BD_# of Meeting)0.009

(1.28) 0.008

(1.18) 0.010(1.45)

FC_ % Expertt-1-0.011

(-0.56) 0.015

(0.81) -0.012(-0.57)

FC_5% Blockholdert-1

-0.011(-1.35)

-0.006(-0.76)

-0.011(-1.44)

BD_CEO/Chair Dualityt-1

-0.005(-1.04)

-0.006(-1.23)

-0.007(-1.43)

Institutional Ownershipt-1

-0.050(-2.18)

** -0.028(-1.23)

-0.044(-1.89)

*

G-Indext-1

-0.007(-1.75)

* -0.008(-2.00)

** -0.007(-1.74)

*

M/B Ratio 0.004(1.29)

0.005(1.64)

* 0.004(1.58)

Commercial Line % -0.000(-0.01)

0.000(0.00)

-0.005(-0.24)

Independent System-0.001

(-0.17) -0.003

(-0.05) -0.000(-0.06)

Line_HHI0.007

(0.32) 0.004

(0.17) 0.007(0.32)

State_HHI-0.031

(-2.21) ** -0.027

(-1.90) * -0.029

(-2.07)**

Size_DPW-0.010

(-1.86) * -0.010

(-1.94) ** -0.010

(-1.82)*

Firm Age0.012

(0.70) 0.011

(0.66) 0.015(0.91)

Table 6 Regression analysis of the impact of main governance variables of interest on the association between the excess cash holdings and salary expense divided by net premium written


Intercept0.231

(1.89) * 0.267

(2.10) ** 0.267

(2.15)**

Excess Casht-1

0.077(1.70)

* 0.067(1.48)

0.62(1.45)

*

BD_Outside Director%t-1

0.036(1.00)

0.009(0.29)

BD_Outside Director%t-1 x Excess Casht-1(positive)

0.450(1.46)

-0.126(-1.12)

BD_Outside Director%t-1 x Excess Casht-1(negative)

-1.496(-1.68)

* -0.424(-2.17)

**

FC_Outside Director%t-1

-0.060(-2.95)

*** -0.074(-3.11)

***

FC_Outside Director%t-1 x Excess Casht-1(positive)

-0.597(-1.87)

* -0.133(-1.19)

FC_Outside Director%t-1 x Excess Casht-1(negative)

1.116(1.34)

-0.347(-2.09)

**

Additional test (1)

• We also examine the relation between other corporate governance variables and growth opportunity and between other corporate governance and variables and expenses. Our analyses of this section are similar to those of Tables 5 and 6.

Conclusions

• The independence of boards of directors and the independence of finance committees are found to be positively associated with insurers’ level of cash holdings

• Independence of boards and finance committees is positively related to the actual growth of an insurer when it has excess cash

• Excess cash spent on advertising and salary expenses does not significantly increase with a higher proportion of outside directors on a board and outside members on a finance committee

43

Policy Implication

• Our analysis suggests board and finance committee independence provide significant benefits to the insurers, benefits are:– Allowing managers to hold the higher level of cash to meet

future growth, yet effectively control managers’ discretionary expense spending

• These results support regulatory and listing requirements (NYSE, NASDAQ, SEC and SOX): – board and committee independence

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Thank you!Questions?Comments?

wen-yen hsu feng chia university, taiwan yenyu huang st. john’s university, taiwan gene lai

Documents

substantial level of

managers cash holdings

excess cash holdings

role of board

effectiveness of board

independence of board

roles of board

independent directors