Options Trading and the Cost of Debt

Abstract

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Equity option markets can have a dual effect on firms' cost of debt. On one hand, options attract more informed investors that increase price informativeness and reduce information asymmetries in the market, facilitating firm financing. On the other, by attracting more informed investors that provide reassurance regarding managerial career concerns, options can increase the potential for risk shifting in firms. We explore these two channels via different tests on corporate bond yields and use different econometric specifications including quasi-natural experiments to mitigate endogeneity concerns. We find evidence consistent with a preeminence of the risk-shifting channel when private managerial risk-taking incentives are sufficiently high and debtholders are more exposed to expropriation.