Does Options Trading Deter Real Activities Manipulation?

Abstract

We examine whether and how options trading activity curtails real activities manipulation. Using a large sample of US firms that are suspected of earnings manipulation, we document that an active options trading market significantly reduces real activities manipulation. We confirm our findings by using 2SLS analyses and alternative research designs. Our findings are also robust to using alternative proxies for options trading activity. Further, we find that the deterring impact of options trading on real activities manipulation is more pronounced among firms with low institutional ownership, firms in highly competitive industries, and small and young firms. Overall, our findings show that an active options market discourages managers from engaging in real activities manipulation as informed options trading helps stock prices better reflect adverse consequences of real activities manipulation. Our findings highlight the benefits of the options market development in reducing value-destroying activities and thus provide policy, practice, and research implications.

Keywords: Earnings management, Real activities manipulations, Options trading

JEL Classification: G14, G12, G30, M41