Volume 51, Issue 9-10 pp. 2410-2451
ARTICLE

Options trading and firm investment efficiency

Charles Hsu

Charles Hsu

School of Business and Management, Hong Kong University of Science and Technology, Kowloon, Hong Kong

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Junqiang Ke

Junqiang Ke

School of Accountancy, Central University of Finance and Economics, Beijing, China

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Zhiming Ma

Zhiming Ma

Guanghua School of Management, Peking University, Beijing, China

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Lufei Ruan

Corresponding Author

Lufei Ruan

Lam Family College of Business, San Francisco State University, San Francisco, California, USA

Correspondence

Lufei Ruan, Lam Family College of Business, San Francisco State University, San Francisco, CA, USA.

Email: [email protected]

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First published: 28 January 2024
Citations: 1

Abstract

We examine the effect of options trading on an optioned firm's investment decisions. We find that active options trading improves an optioned firm's investment efficiency, and that this effect holds under several alternative empirical specifications and identification strategies, including fixed-effects models, different matching methods, an instrumental variable approach, a Granger causality test and a quasi-natural experiment based on the listing decisions of the options exchanges. This relation is mediated by two factors, namely, information asymmetry and uncertainty, consistent with the notion that options trading improves investment efficiency by providing information that facilitates external monitoring and managerial learning. The results of cross-sectional analyses indicate that the effect of options trading on investment efficiency increases with firms’ tendency to overinvest or underinvest, and with managers’ risk-taking and learning incentives. We also demonstrate that the effect of options markets on investment efficiency is distinct from the effect of stock markets. Overall, our findings suggest that options trading plays a nonnegligible role in improving an optioned firm's investment efficiency.

DATA AVAILABILITY STATEMENT

We obtain options trading data from OptionMetrics, stock price data from CRSP, company financial data from Compustat, analyst data from I/B/E/S and institutional ownership data from Thomson Reuters.

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