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Corporate tax, financial leverage, and portfolio risk

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  • Choi, Paul Moon Sub
  • Chung, Chune Young
  • Kim, Dongnyoung

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.

Suggested Citation

  • Choi, Paul Moon Sub & Chung, Chune Young & Kim, Dongnyoung, 2020. "Corporate tax, financial leverage, and portfolio risk," The North American Journal of Economics and Finance, Elsevier, vol. 54(C).
    • Handle: RePEc:eee:ecofin:v:54:y:2020:i:c:s1062940820301613
    DOI: 10.1016/j.najef.2020.101264
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    More about this item

    Keywords

    Corporate tax; Financial leverage; Stock return; Portfolio risk;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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