The illiquidity risk premium hypothesis implies the existence of a positive relation between illiquidity in the option market and option returns. Based on numerous studies within the extant literature examining the roles of informed traders in the option markets, we explore how information asymmetry and short sales affect the illiquidity risk premium hypothesis. We find that the illiquidity risk premium is higher for both call and put options of those firms with higher information asymmetry, which is particularly driven by small firms. We also find that it is higher for put (call) options of those stocks with lower (higher) short-sale supply (demand).

ABSTRACT In this paper, we examine why Chinese reverse merger (RM) firms have lower financial reporting quality than U.S. IPO firms. We find that the financial reporting quality of U.S. RM firms is similar to that of matched U.S. IPO firms, but Chinese RM firms exhibit lower financial reporting quality than Chinese ADR firms. We also find that Chinese RM firms exhibit lower financial reporting quality than U.S. RM firms. These results indicate that the use of the RM process is associated with poor financial reporting quality only in firms from China, where legal enforcement and investor protection are weak. In addition, we find that compared with Chinese ADR firms, Chinese RM firms have weaker bonding incentives (as measured by CEO turnover-performance sensitivity) and poorer corporate governance. These factors, in turn, contribute to the lower financial reporting quality of Chinese RM firms. Overall, our results suggest that the less scrutinized RM process allows the Chinese firms with weak bonding incentives and poor governance to gain access to U.S. capital markets, resulting in poor financial reporting quality. JEL Classifications: G15; G24; G34; G38.