Corporate tax, financial leverage, and portfolio risk

Paul Moon Sub Choi; Chune Young Chung; Dongnyoung Kim

doi:10.1016/j.najef.2020.101264

Corporate tax, financial leverage, and portfolio risk

Paul Moon Sub Choi, Chune Young Chung, Dongnyoung Kim

Division of Business Administration

Research output: Contribution to journal › Article › peer-review

1 Scopus citations

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.

Original language	English
Article number	101264
Journal	North American Journal of Economics and Finance
Volume	54
DOIs	https://doi.org/10.1016/j.najef.2020.101264
State	Published - Nov 2020

Bibliographical note

Funding Information:
Special thanks are due to Hamid Beladi (the Editor) and an anonymous referee. Choi and Chung are grateful to the research support from Ewha Womans University and Chung-Ang University, respectively. The authors contributed equally to this work.

Publisher Copyright:
© 2020 Elsevier Inc.

Keywords

Corporate tax
Financial leverage
Portfolio risk
Stock return

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10.1016/j.najef.2020.101264

Cite this

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title = "Corporate tax, financial leverage, and portfolio risk",

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, Portfolio risk, Stock return",

author = "Choi, {Paul Moon Sub} and Chung, {Chune Young} and Dongnyoung Kim",

note = "Funding Information: Special thanks are due to Hamid Beladi (the Editor) and an anonymous referee. Choi and Chung are grateful to the research support from Ewha Womans University and Chung-Ang University, respectively. The authors contributed equally to this work. Publisher Copyright: {\textcopyright} 2020 Elsevier Inc.",

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AU - Choi, Paul Moon Sub

AU - Chung, Chune Young

AU - Kim, Dongnyoung

N1 - Funding Information: Special thanks are due to Hamid Beladi (the Editor) and an anonymous referee. Choi and Chung are grateful to the research support from Ewha Womans University and Chung-Ang University, respectively. The authors contributed equally to this work. Publisher Copyright: © 2020 Elsevier Inc.

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N2 - 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.

AB - 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.

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Corporate tax, financial leverage, and portfolio risk

Abstract

Bibliographical note

Keywords

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