Corporate tax, financial leverage, and portfolio risk

Paul Moon Sub Choi, Chune Young Chung and Dongnyoung Kim

The North American Journal of Economics and Finance, 2020, vol. 54, issue C

Abstract: We examine the theoretical implications of corporate income tax for a risky portfolio in a aggregate-endowment economy. In this model, corporate income tax affects the portfolio risk associated with the rebalancing motive during market clearance. An asset is defined as a portfolio of stocks and bonds whose portfolio weights are similar to financial leverage. Corporate tax can decrease after-tax consumption from dividends (increase leverage) and increase the tax shield that increases dividends (decrease leverage). Changes in dividends are responsible for the correlation between expected dividend growth and consumption growth and, thus, affect stock pricing and returns. Overall, the model is characterized by tax-induced portfolio risk associated with financial leverage.

Keywords: Corporate tax; Financial leverage; Stock return; Portfolio risk (search for similar items in EconPapers)
JEL-codes: G12 G30 H25 (search for similar items in EconPapers)
Date: 2020
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:54:y:2020:i:c:s1062940820301613

DOI: 10.1016/j.najef.2020.101264

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