The purchase of property/liability insurance by a large, widely held corporation may be, from the view of a diversified equity holder, redundant at best, and considering the high transaction costs involved, potentially wasteful. Yet responses from a survey of the Fortune 500 reveal that corporations find insurance an attractive method of compensating for various market imperfections.
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References
1.
For a theoretical discussion of some of these considerations, see MainBrian G. M., “The Firm's Insurance Decision: Some Questions Raised by the Capital Asset Pricing Model,”Managerial and Decision Economics, vol. 3 (October 1981); idem, “Corporate Insurance Purchases and Taxes,” paper, Institute of Business and Economic Research, U. C. Berkeley (April 1981); and MayersDavidSmithClifford W.Jr., “On Corporate Demand for Insurance,” mimeo, University of Rochester, Graduate School of Management (1981).
2.
The response rate (232 out of 500) was the result of a postal survey with no warning given before nor reminder or second questionnaire sent after the dispatch of the questionnaire. Sixteen refused to participate and 252 did not reply. Among the replies, the response rate was reasonably even across the range of the Fortune 500 (its numbers responding from the largest one hundred to the smallest one hundred were 57, 40, 48, 49, and 38).
3.
Fortune, “How Major Corporations View Property/Liability Insurance” (New York: Fortune Market Research Department, 1973). Two-thirds of the top one hundred corporations made some use of captives.
4.
SmithC. W.WarnerJ. B., “On Financial Contracting: An Analysis of Bond Covenants,”Journal of Financial Economics, vol. 7 (June 1979), pp. 117–161.
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JensenM. C.MecklingW. H., “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,”Journal of Financial Economics, vol. 3 (October 1976).
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For a discussion of the costs of bankruptcy, see WarnerJ. B., “Bankruptcy Costs: Some Evidence,”Journal of Finance, vol. 32 (May 1977), pp. 337–348.
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GordonM. J., “Towards a Theory of Financial Distress,”Journal of Finance, vol. 26 (May 1971), pp. 347–356.
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The problems of undiversified human-capital portfolio are extensively discussed in MayersDavid, “Portfolio Theory, Job Choice and the Equilibrium Structure of Expected Wages,”Journal of Financial Economics, vol. 1 (May 1974), pp. 23–42.
9.
AzariadesC., “Implicit Contracts and Unemployment Equilibria,”Journal of Political Economy, vol. 83 (December 1975), pp. 1183–1202; BaileyM. N., “Wages and Unemployment under Uncertain Demand,”Review of Economic Studies, vol. 41 (January 1974), pp. 37–50; GordonD.F., “A Neoclassical Theory of Keynesian Unemployment,”Economic Inquiry, vol. 12 (December 1974), pp. 431–459.
10.
A few of the Fortune 500 respondents claimed that an important motivation in purchasing insurance was in being able to sleep easy at night. Of course, even a behavioral theory of the firm would admit limits to the extent to which the corporation can afford or tolerate such risk-shifting behavior.
11.
CyertRichardMarchJames G., A Behavioral Theory of the Firm (Englewood Cliffs, New Jersey: Prentice-Hall, 1963).
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SimonHerbert A., Administrative Behavior (New York: The Free Press, 1957).
13.
An important exception to this general case will be discussed below when considerations of taxation are introduced.
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AdamsWilliams JamesYellenJanet L., “Commodity Bundling and the Burden of Monopoly,”Quarterly Journal of Economics, vol. 90 (August 1976), pp. 475–498.
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AkerlofGeorge A., ‘The Market for “Lemons’: Qualitative Uncertainty and the Market Mechanism,”Quarterly Journal of Economics, vol. 89 (August 1970), pp. 488–500.
16.
CampbellTim S.KracawWilliam A., “Information Production, Market Signalling, and the Theory of Financial Intermediation,”Journal of Finance, vol. 35 (September 1980), pp. 863–882; LelandHayne E.PyleDavid H., “Informational Asymmetries, Financial Structure and Financial Intermediation,”Journal of Finance, vol. 32 (May 1977), pp. 371–387.
17.
ArrowKenneth J., “Insurance, Risk and Resource Allocation,” in Essays in the Theory of Risk Bearing (New York: Markham Publishing, 1971).
