Options Trading and Earnings Management

Abstract

This study examines how options trading plays a unique role in curbing firms’ earnings management. We find that options trading volume deters managers’ earnings manipulations, and the effect can be explained by unique characteristics of the options markets. Our results remain unchanged when using both an instrumental variable approach and difference-in-differences analyses to mitigate endogeneity concerns, and after controlling for investors’ short-selling activities. This study adds to the literature by documenting a real impact of options trading on financial reporting. Our results suggest that the options markets promote price efficiency not only by incorporating private information from informed traders, but also by incentivizing managers to disseminate less manipulated information.