The disciplinary role of options trading: Evidence from earnings manipulation

Abstract

This paper delves into the disciplinary influence of options trading, contending that it enhances informational efficiency and augments the market's capacity to detect earnings manipulation, thereby diminishing managers' initial incentives to engage in such practices. Our empirical findings reveal a notably adverse effect of options trading on diverse measures of earnings manipulations. The causal relationship is corroborated through a battery of endogeneity tests. Furthermore, our additional analyses indicate a diminution in shareholder activism associated with options trading, with the impact being more pronounced in firms characterized by opacity in information disclosure or during the pre-Sarbanes-Oxley Act era. These results affirm that the disciplinary channel is the likely mechanism driving these outcomes.