Options listings and loan contract terms: Information versus risk-shifting

The effect of option listing on financing decisions

“…Firms with option listing experience a decrease in information asymmetry (Hu, 2018) and lower costs of financing (Do et al., 2021; Naiker et al., 2013). We expect an increase in equity and debt issuances following the option listing.…”

“…Prior literature shows that option listing reduces information asymmetry by leading to more analysts following (Skinner, 1990), greater media coverage (Damodaran & Lim, 1991) and thus a lower cost of equity (Naiker et al., 2013). A related stream of papers indicates that more active option trading is associated with a decrease in the cost of debt (J. Cao et al., 2021; Do et al., 2021). These empirical studies lead to the important question of whether and how an option listing affects a firm's capital structure, which has not been explored in the literature.…”

“…Next, we examine whether the change in leverage is driven by new equity or new debt issues in the post‐listing period. Previous literature suggests that option listing leads to a lower cost of equity and debt due to reduced information asymmetry (J. Cao et al., 2021; Do et al., 2021; Naiker et al., 2013). As mentioned above, the pecking order theory suggests that firms issue stock during periods of low information asymmetry to build up cash reserves or financial slack, implying more equity issues than debt issues (Myers & Majluf, 1984).…”

“…The extant literature shows a significant impact of option listing on information asymmetry and the cost of financing. For example, listed firms on the option market have a larger number of analysts following (Skinner, 1990), greater media coverage (Damodaran & Lim, 1991), an increase in informational efficiency (Anthony, 1988; Mayhew et al., 1995; Pan & Poteshman, 2006), higher firm value (Roll et al., 2009), a lower cost of equity (Naiker et al., 2013) and a lower cost of debt (J. Cao et al., 2021; Do et al., 2021). However, the effect of option listing on capital structure has not yet been explored.…”

“…At the same time, firms might consider debt issuances after the option listing to secure a lower cost of debt. For example, Do et al (2021) show a reduction in both quantitative (e.g., bank loan spread) and qualitative costs (e.g., covenant strictness) as option trading volume increases, indicating that the assessment of borrowers' credit risk requires costly information collection and analysis. 3 Therefore, the impact of option listing on leverage is driven by firms' choice of financing sources.…”