Option Trading, Information Asymmetry and Firm Innovativeness: Evidence from Stock Options Trading Firms from India

Present study examines the effect of option listing and subsequent trading on the innovation in the context of publicly listed Indian firms. Innovation is defined in terms of input and output as R & D expense to sales, and number of patents filed by firm, respectively. Multiple regression analysis is conducted to identify drivers of innovations. Measures of innovation are used as dependent variables, while dummy for option trading is taken as independent variable along with other firm level control variables. The study also examines the determinants of the option listing on individual stocks using binary-logistic regression. Firm age, financial leverage, dividend payout, and profitability affect internal R & D allocations for the sample firms. As far as firm’s research output is concerned, firm leverage, institutional holding, option trading, and ESOP are the major determinants. Firm leverage adversely affects R & D input and R & D output alike. Dividend paying, large firms having higher institutional holdings are likely to attract stock option listing, while firms with high firm specific return variations are likely to have very low probability of option listing.

short-sighted cutbacks in corporate investment. Therefore, capital markets on one hand limit agency costs through corporate raiders and activist investors, on the other side, they also mount enormous pressure on the firm management to meet quarterly or annual financial objectives, which gives rise to adverse externalities that may impair firm's incentives to innovate [1] [2]. The primary objective of the introduction of financial derivatives is to provide investors with an opportunity to hedge risk. Derivatives also increase liquidity of the underlying asset market, thereby making it more information efficient. Unlike futures, which is a contract to buy (or sell) the underlying asset at a certain  sequent trading may affect the underlying asset market behavior, including their prices, liquidity, and volatility. Ross [4] and Hakansson [5] show that options listing and trading complete the market by providing the investors with hedging opportunities. In the presence of information asymmetry under incomplete markets, increased hedging transactions can reduce the probability of trading against informed traders for uninformed traders. Black [3] argues that presence of option contracts can increase the informed trading in the underlying assets by providing higher leverage to financially constrained traders. Option trading also supports informed trading by relaxing the short-sale constrained on the individual stocks [6] and Johnson and So [7]. Also, Cao [8]  The remainder of the paper is organized as follows. Section 2 discusses the related literature. Section 3 describes the sample, and measurement of variables. In Section 4 presents the findings and analysis. Finally, Section 5 concludes the findings.

Literature Review
Black and Scholes [3] and Merton [11] argue that in frictionless competitive market, derivative contracts like options and futures are of no use, and their payoffs can be replicated using portfolio of underlying stock and a risk free bond. However, it is well documented in finance literature that capital markets are incomplete, and exhibit information asymmetry. Ross [4] was the first to argue that options trading can convey important information in a market with information asymmetry by expanding the contingencies that are covered by traded securities. Options trading complete the market and reduce information asymmetry in following three ways-by providing leverage to financially constrained  [4] and Hakansson [5]. In the presence of information asymmetry under the incomplete market conditions, increased hedging transactions can reduce the probability of informed trading by the investors. Black [3] argues that options trading can improve the volume of informed trading by providing higher leverage to informed traders who are financially constrained. Easley, O'Hara and Srinivas [12] argue that options can be more attractive for informed traders because the availability of multiple contracts confronts uninformed traders with substantial challenges. Cao [8] shows that option trading motivates uninformed investors to gather more private information about the underlying stock/firm, which in turn lead to improved price informativeness. Such private information is especially relevant for long term investments, and trading on such information make underlying stock market more information efficient. Additionally, option trading provides investors with information about stock price volatility [13]. These notions are further supported by Chakravarty, Gulen and Mayhew [9] and Pan and Poteshman [10], who also found that option trading volume contain information about the future direction of the underlying asset. Therefore, this branch of literature suggests that option trading completes the market for underlying stocks, and reduce information asymmetry.
Another branch of literature establishes links between price informativeness and investment decisions in the firm. The notion behind the linkage of price informativeness and investment decisions in the firm is that generation and aggregation of information as a consequence of trading between uninformed traders and informed investors can be useful for the provision of incentives in firms. Holmstrom and Tirole [2] and Faure-Grimaud and Gromb [14] examine the role of price informativeness in disciplining managers and providing incentives to insiders to engage in value-increasing activities. Gehrig [15] show that cross-listing enables firms to obtain more precise information on the value of their growth opportunities, which allows managers to make better investment decisions. Ferreira and Raposo [16] provide evidence that if prices are more efficient, the stock market is able to play a monitoring role that can reinforce internal and external monitoring mechanisms. Dow and Gorton (1997)

Model Specification
Linear multiple regression analysis is conducted using innovation input (R & D expense to sales ratio), and innovation output (number of patents filed by the firm) as dependent variables, and option trading dummy as independent varia- Firm specific stock return variation is measured by regressing stock returns with the market returns, and firm specific return variation is estimated by 1 − R 2 from the regression. Given the bounded nature of R 2 , a logistic transformation has been computed as follows: The variable Ψ measures firm-specific stock return variation relative to market-wide variation, or lack of synchronicity with the market.  Typically, research projects are financed through internal accruals. If internal accruals are not available, firms normally resort to external equity financing. However, debt is seldom used in such projects. Therefore level of firm leverage is an important determinant for firm innovativeness. According to dividend signaling hypothesis, dividend payments convey significant message to financial markets about the authenticity of firm's profitability. Therefore dividend payment reduces the informational asymmetry. Employee stock options work as proxy for lower agency conflicts. Institutional holding work as a double edged sword. On one hand, higher institutional holdings may provide the firm with    [23] and Roll [24] suggests that firm specific return variation measures the rate of private information incorporated in the stock prices via trading. Therefore, stock prices of the firms having higher firm specific return variations hold more private information. Such firms have low probability of option listing, however, option listing on these firm may result into information aggregation and dissemination through the option trading route and more market aligned and efficient stock prices.

Conclusion
The template is designed so that author affiliations are not repeated each time for study finds that higher institutional ownership along with higher propensity of issuing employee stock options and cross listing status exemplifies reduced information asymmetry for option trading firms.

Conflicts of Interest
The authors declare no conflicts of interest regarding the publication of this paper.