Abstract
By enhancing price efficiency of the underlying equity, options market activity may reduce adverse selection and agency costs faced by investors, in turn affecting firms’ optimal policies. Supporting this conjecture, we find that firms whose equity is linked to exchange-listed options carry larger cash holdings and lower financial leverage, while paying lower dividends. Meanwhile, those same firms invest more in physical assets as well as R&D, while achieving better innovation outcomes. We draw causal inferences from difference-in-difference tests that exploit option listings of stocks that meet regulatory requirements by a narrow margin vis-à-vis stocks that fail them by a similarly narrow margin. Overall, the availability of exchange-listed options appears to affect changes in corporate policies that suggest lower adverse selection and agency problems between firms and equity investors.