Product Market Competition and Corporate Demand for Insurance 1
This article shows through a simple model that there is a monotonic relationship between the competitiveness of the product market and firms’ demand for insurance. The more competitive the product market is, the more likely firms competing in the market will acquire insurance or purchase full coverage. This holds true no matter whether firms exhibit risk aversion or not in their preferences. Investment in risk management prior to competition is used as a strategic commitment device in the product market competition. Firms optimize their risk management investment by balancing the strategic commitment benefit and the cost of insurance. Therefore, the “outside the box factors” such as the industry characteristics, the market environment and the competitive pressure are important ones shaping firms’ risk management strategies. This provides clear empirical implications for firm’s investment in risk management and its relationship with the product market environment. By focusing on primary insurers’ reinsurance purchases, we provide strong empirical support for the theoretical predictions.