Taxes: Fiscal policy changes and its effect on the stock market

Abstract

Fiscal policy changes are methods employed by the federal government to control the growth of the economy. An expansionary fiscal policy such as a tax cut would boost the economy during recessions and drive up corporate profits. As corporate stock valuation is not only reflective of the corporation’s income, but more importantly a reflection of investors’ opinion on the corporation, a perceived boost in profit would have an impact on share value as well. This honours thesis focuses on the effects that a major tax cut would have on the stock valuation of American, and Canadian firms. It aims at exploring the stock market related consequences of a fiscal policy change by examining abnormal returns and abnormal volatility using an event study. Preliminary results show that abnormal returns rose for US corporations but fell for Canadian corporations on the day prior to the announcement of the tax cut, whereas abnormal volatility rose for both markets, with Canadian firms exhibiting much higher volatility compared to the US corporations.