Yi Xiwei: Rui Xing Coffee bought “Dong Li Insurance” before the market. Can Thunder be compensated?
On April 5th, Lu Zhengyao, chairman of Ruixing Coffee, issued an apology in the WeChat circle of friends regarding Ruixing Coffee’s alleged financial fraud of US $ 2.2 billion.The Ruixing incident is still fermenting, and the insurance circle is also involved.The Ping An Air Force of China responded to Ruixing’s policy of insuring the liability of the insurance directors, “the claim application has been received and is being further processed.”People can’t help but ask: Is the responsibility of financial fraud, insurance management compensation?Combining Ruixing’s case, Yi Xiwei, an assistant professor in the Department of Organization and Strategic Management of Peking University and a doctoral supervisor, wrote an article from an academic perspective to discuss the original intention of the establishment of “Director’s Liability” and its role in corporate governance.On the evening of April 2, Ruixing Coffee “exposed” the company to falsify financial data, involving 2.2 billion yuan in sales from the second quarter to the fourth quarter of 2019.As soon as this happened, Ruixing Coffee’s U.S. stocks fell 85% before the market.On the evening of April 3, a piece of news suddenly appeared in the public eye: “Ping An responded to Ruixing’s liability for insurance directors: the claim application has been received and is being further processed.”According to media reports, Ruixing had insured the directors’ liability insurance before going public in the United States. About a dozen domestic insurance companies participated in the underwriting in the form of co-insurance, and Ping An is also among them.”This can’t help making people who eat melons dumbfounded. Everyone in their lives will buy accident insurance for accidents and medical insurance and critical illness insurance for unpredictable disease risks. However, if the financial scandal is a “subjective active” bad behavior,If you can get insurance, can everyone buy insurance first, then do bad things, and finally let the insurance company settle the claim?Everyone ‘s uncertainty is not unreasonable.In fact, the change in the behavior of the purchaser of insurance after participating in the insurance (minor, deliberately engaged in high-risk activities) causes losses to the insurance company, which is the origin of the concept of “moral hazard” in economics.To give a simple example, in our lives, we often see some old smokers. After buying medical insurance, they breathe a sigh of relief and smoke more fiercely, because, anyway, someone is sick and someone manages to compensate!For insurance companies, since it is impossible to monitor people who buy insurance 24 hours a day, this loss caused by the information asymmetry between the two parties after the completion of the contract is regarded as “moral hazard”.Similarly, if there is a “director’s liability insurance” that can insure directors, executives, and supervisors of financial scandals, wouldn’t it be that after the insurance is purchased, the “directors and supervisors” will do the bad things without any worries, how could it be?Is there such insurance?This requires us to take a look at the “Dong Liability” story. What was the original intention of its establishment?What role does such an insurance play in corporate governance?Responsibility for financial fraud, does this insurance cover compensation?First of all, the full name of “director’s liability insurance” is directors’ executive liability insurance. It is a director. When supervisors and executives are held accountable for their negligence and misconduct in the course of their duties, the insurance company will compensate the legal costs and bear other expensesCorresponding civil liability insurance.When you see the word “misconduct”, you may be stunned, think this is not a real hammer, you see, misconduct also governs compensation. However, it needs to be clarified that the “misconduct” here refers to the “negligent behavior” of the honest management team, and does not include maliciousness, breach of loyalty obligations (fiduciary duty), intentional false or misleading statements in information disclosure, violationAct of law.Therefore, in the matter of Ruixing Coffee, the key to whether the claim can be settled lies in the final characterization of the securities regulatory department after the investigation.Generally speaking, if it is deliberate financial fraud and accounting violations, it is difficult for insurance companies to settle claims against directors.Then everyone may be curious, what is the original intention and significance of the establishment of such a director liability insurance?Director liability insurance originated in the United States. Through the passage of the Securities Law in 1993, the risks that directors and senior executives of American listed companies need to bear increased, and this type of insurance opened the precedent in this context.After China announced the “Listed Companies Governance Regulations” in 2002, which clearly stipulated the civil compensation liability of listed company executives, Chinese listed companies issued directors’ executive liability insurance for the first time.After its emergence, academia has formed three different views on its role.The first view is called “Leadership Incentive Hypothesis”.A classic problem in the study of corporate governance is that shareholders can reduce the risk of their portfolios by diversifying their investments, and the performance income of the management team can only be managed by the company they work in, so shareholders remain risk-neutral, obviouslyRisk aversion is more likely to reject some high-risk but unpredictable projects.The existence of directors’ liability insurance can reduce the risk aversion of the management team by transferring the “honest” fault risk of the management team and stimulate their enthusiasm to perform their duties, thereby increasing the company’s value.This is particularly important for the impact of company innovation, because managerial risk tolerance is an important factor influencing corporate innovation.A recent study using the data of A-share listed companies as a sample found that subscribing to directors ‘liability for managers has significantly promoted companies’ independent innovation behavior.The second view is the “external supervision hypothesis”.Insurance companies have a professional team to investigate and evaluate the underwriting enterprise governance level and risks.Therefore, insurance companies have both motives for paying attention to underwriting companies and the professional ability to supervise underwriting companies, which can effectively play the role of external supervision of corporate governance.Regardless of whether the company is insured or after it is insured, the insurance company will use a series of changes to monitor the business behavior of the enterprise, to ensure that the company’s decision-making decision from the perspective of protecting the interests of shareholders, reduce the risk of corporate litigation.The third view is the “moral hazard hypothesis” we mentioned at the beginning of the article.According to this view, directors’ liability insurance can help managers avoid litigation risks and reduce litigation costs, and deal with speculation by managers without worries.The study found that because the compensation of insurance institutions reduces the shock effect of investor litigation, managers will promote the company’s non-related mergers and acquisitions business and kill it for private gain.Executives may also make more short-term loans and long-term investments, thereby increasing the company’s operating risks.In addition, large shareholders may also help senior executives to transfer litigation risk by purchasing directors’ liability insurance for senior executives, and promote the “collusion” intentions of senior executives.Studies have found that large shareholders purchase directors’ liability insurance for senior executives, driving managers to accompany the company’s illegal manipulation of company mergers for private gain.So which of these three views is more reliable?The actual situation is often more complicated than the theoretical model.Many times, the effectiveness of the tool depends on how it is used.For example, in corporate governance, we are familiar with a tool that grants compensation or equity to the senior management team, so that the interests of the senior management team and shareholders are converged, thereby incentivizing executives to strategically maximize shareholder value. This is ourA “good tool” that everyone is familiar with.However, the recent plunge in U.S. stock market meltdown caused Boeing ‘s plunge, which just exposed the bad use of budget grant / allocation grant: Boeing ‘s executives maximize profits for stock repurchases to push upCompany leaders[Note: Boeing’s profit in 2017 was 84.600 million US dollars, repurchased shares of 9.2 billion US dollars; 2018 profit 104.$ 600 million, $ 9 billion in stock repurchase], and even borrowing money to repurchase stocks even in a crisis of operations[Note: Boeing ‘s net replacement in 2019 6.3.6 billion US dollars, repurchased shares 26.$ 500 million].The management team’s “for the sake of shareholders” is really a headache.The Tao is one foot tall, the magic is one foot tall, so how can the “Tao” go back?This may be the reason why the research field of corporate governance is fascinating.Article | Yi Xiwei Assistant Professor, Peking University Guanghua Department of Organization and Strategic Management