MANAGERIAL BEHAVIOR ON RISK TAKING AND RESERVE MANAGEMENT FOR INSURANCE COMPANIES

Sangyong Han

This dissertation consists of two essays on managerial behavior on risk taking and reserve management for insurance companies. In the first essay, we investigate the impact of CEOs who hold firm-specific risk on insurer’s risk-taking and firm performance by using two conventional measures of CEO overconfidence: option holdings-based and net stock purchase-based measures. We focus on the insurance industry because using reinsurance demand provides a precise measurement of CEO’s risk-taking. We find that the two CEO overconfidence measures are negatively associated with insurer’s risk-taking and positively related to firm performance. In addition, we present evidence that CEOs’ late option exercise and habitual stock purchases are consistent with the alternative explanation of CEO overconfidence measures, such as CEOs’ private information. Overall, our findings suggest that it may not be CEO overconfidence, but rather the private information and the intention to control the company’s risk that drive our results. Thus, we cast doubt on the validity of the two conventional measures of CEO overconfidence. The second essay examines the relationship between corporate transparency, reserve management, and earnings surprises at U.S. publicly traded property-liability insurance companies. The evidence shows that a higher level of corporate transparency is associated with more conservative loss reserve estimation, indicating that enhanced transparency enables outside stakeholders to better monitor the firm, and consequently, makes insurers take a more conservative approach to reserve management. We also find that several firm-specific characteristics have substantial impacts on the relationship between corporate transparency and insurer’s loss reserving behavior. Our findings suggest that additional regulatory mandates by the Sarbanes-Oxley Act (SOX) may be redundant given existing regulations, and that insurer’s reserve estimate conservatism was more pronounced during the recent financial crisis. Further, we provide evidence that firms with opaque information environments are more likely to report small positive earnings surprises through manipulating loss reserves in an effort to avoid negative earnings surprises. Our results suggest that high levels of corporate transparency may be an important mechanism for reducing the incentives of insurers to inappropriately manipulate loss reserves, even in a highly regulated environment like the insurance industry.

MANAGERIAL BEHAVIOR ON RISK TAKING AND RESERVE MANAGEMENT FOR INSURANCE COMPANIES

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