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.
Bibliographical noteFunding 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.
© 2020 Elsevier Inc.
- Corporate tax
- Financial leverage
- Portfolio risk
- Stock return