Does Option Trading Affect Audit Pricing?

Abstract

We examine the impact of options trading on audit pricing for a sample of US firms over the period from 2001 to 2016. Using two option trading measures, the average daily natural logarithm of option contracts volume and the average daily natural logarithm of option contracts dollar volume, we find that option trading is significantly and negatively related to audit fees, indicating that firms with higher option trading incur lower audit fees. We conduct several additional tests to establish the robustness of the causal relation between option trading and audit fees. Using difference-in-difference analysis, we document that firms which had options listed for the first time experience a significant decrease in their audit fees after the options listing relative to a matched sample of firms without listed options. Further, we find that auditors spend a lower number of days to audit firms with higher option trading and firms with higher option trading experience lower probabilities of lawsuits and misstatements. The impact of option trading on audit fees is stronger when the auditor is located further away from the audited firm, for firms with non-specialized auditors and for firms with higher information asymmetry problems, poorer earnings and governance quality. Our findings underscore the significance of option trading in improving a firm’s information environment and reducing litigation risk, thereby enabling firms with higher option trading levels to negotiate lower audit fees than firms with lower option trading.