Financial Reporting Opacity and Implied Volatility Smirks: Firm-Level Evidence

We document a significant and positive relation between financial reporting opacity and the steepness of option-implied volatility smirks in individual equity options. Specifically, we show that the latter is positively associated with earnings management, the presence of financial restatements, and auditor-attested internal control weakness. These results are consistent with the notion that financial reporting opacity increases the expected probability and magnitude of future stock price crashes, which in turn increase the expensiveness of out-of-the-money put options relative to that of at-the-money call options.