Abstract
Using a difference-in-differences approach that relies on the exogenous increase in options trading activity generated by the Securities and Exchange Commission's Penny Pilot Program, we find a negative causal effect of options trading on earnings management. With a reduced magnitude of discretionary accruals, the pilot firms are less likely to marginally beat earnings targets and less likely to have financial misstatements during the pilot period. Cross-sectional analysis shows that the effects are more pronounced among firms with a small or less independent board or a small audit committee. Furthermore, the pilot firms receive more market attention, and their stock price efficiency improves more than the nonpilot firms during the pilot period. The evidence is consistent with the argument that active options trading enhances market scrutiny of firms' reporting behavior, improving financial reporting quality and price efficiency.
Published Version
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