Abstract
This paper studies the effect of option trading on corporate investment and financing policies. Based on prior literature, I hypothesize that option market induces informed trading and thus reduces information asymmetry and the cost of capital. As a result, firms with high option trading have more investment and financing. Specifically, based on the United States public data, this paper finds that option trading volume increases corporate investment and financing, but reduces cash holdings and corporate payouts. These results are robust to the inclusion of industry or firm fixed effect, a control for endogenous options trading, and the use of alternative measures of option trading and corporate policies. The effect of option trading is stronger for firms with higher information asymmetry problems. Finally, this paper finds the results are inconsistent with the “quiet Life” hypothesis and the catering hypothesis.
Highlights
This paper studies one key section of financial market, namely, financial derivatives
This paper provides empirical evidence for the resulting of the hypothesis: an increase in option trading leads to an improvement in investment and financing through the reduction of information asymmetry and the cost of capital
This paper focuses on one measure of option volume (Option Volume), which is the average of the number of option trading in each day of each year across all trading days and all options listed on the stock
Summary
This paper studies one key section of financial market, namely, financial derivatives. This paper finds that the growth in total asset is significantly higher for firms with high option trading. If option trading increases equity price efficiency by incorporating private information and reducing information asymmetry, the effect of option trading on corporate investment and financing decisions should be stronger for firms with higher information asymmetry. If the cost of capital reduces when informed option trading is more active, the change in option activities should have stronger effect on corporate investment and financing decisions for firms that are financially constrained. The results indicate that market competition and corporate governance have no significant effect on the relation between option trading and corporate policies Another possible explanation is corporate managers cater to equity price deviations from fundamental value, especially when the expected duration of mispricing is long and shareholders have short investment horizons. The average change in cash holdings is − 0.6% of total asset
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