The strategic use of corporate insurance in China

Abstract

We use the agency theory to conduct a novel test of the strategic use of property insurance in China's corporate sector. With regard to our main test hypotheses, we find that the incidence of property insurance purchased is directly related to the degree of product-market competitiveness, and positively related to market liquidity and firms' growth opportunities. However, the homogeneity of market operations is not statistically significant. In our second-stage Cragg regression, market liquidity becomes insignificant while firms' growth opportunities are now inversely related to the amount of insurance purchased. Additionally, the homogeneity of market operations becomes significantly related to the corporate purchase of property insurance. Therefore, different factors (e.g. cost considerations) may influence the decisions to purchase property insurance and subsequently, the level of coverage provided. We argue that our results are relevant for companies in other emerging markets such as Eastern Europe and companies operating in more developed Western economies such as the European Union (EU).insurance, strategy, agency theory, emerging markets, China,

Does managerial entrenchment motivate the insurance decision?

“…Property insurance can help resolve this dilemma by ensuring that after a major asset loss event, managers can limit exposure to liquidity risks, reduce dependence on external capital markets, and so realize their strategic investment goals. This ex-post financing function of risk management (insurance) is likely to be particularly advantageous in maximizing value for shareholders when firms' capital expenditures are relatively large scale (Adam, 2002(Adam, , 2009Jia et al, 2011). The ability of insurance to mitigate the crowding out problem has also become particularly important in the Chinese corporate sector in recent years given the heightened investment opportunities associated with China's rapid economic growth and development (Cull & Xu, 2005).…”

“…Several studies (e.g., Froot, Scharfstein, & Stein, 1993;Jia et al, 2011Jia et al, , 2012MacMinn, 1987;Mayers & Smith, 1982, 1987 argue that insurance is an important financial contracting mechanism that hedges the risk of severe unanticipated losses, and commits managers to operating and investment decisions that maximize the traded value of the firm. One way in which property insurance can achieve this is by alleviating the 'crowding out' problem as described in Froot et al (1993) and Doherty (2000).…”

“…In turn, these measures help to increase the market value of the firm (Mayers & Smith, 1982;Zou & Adams, 2008a). This strategic capability is particularly beneficial to financially constrained firms as they can shift cash flows to future periods when asset losses occur at a time when the marginal value of cash resources will be high (Jia et al, 2011).…”

“…Moreover, our data set comprises a cross-section of listed and unlisted companies with a variety of ownership structures and includes firms with different systems of internal monitoring and corporate governance, which again helps us to conduct potential rich tests of our research hypotheses. We nevertheless acknowledge that the survey data may be subject to potential (e.g., response) bias in data collection, but as the same data set has been used in other academic research (e.g., Adams et al, 2011;Cull & Xu, 2005;Jia et al, 2011) such concerns should not unduly inhibit our analysis in the present study.…”

“…2 Property insurance is also a commonly used pure (indemnity) hedge for accidental asset-loss risks in China. 3 Consequently, the use of property insurance in the Chinese corporate sector provides a prospectively interesting context within which to examine whether insurance contracts are efficient and effective in mitigating agency problems (costs) between shareholders and managers (Jia, Adams, & Buckle, 2011;Zou, Adams, & Buckle, 2003;Zou, Wong, Shum, Xiong, & Yan, 2008). Mayers and Smith (1982) and Jia, Adams, and Buckle (2012), among others, further argue that insurance is an integral part of corporate strategy and that it helps to promote effective governance systems in firms.…”