Working Paper: NBER ID: w8623
Authors: Ellen R. McGrattan; Edward C. Prescott
Abstract: U.S. stock prices have increased much faster than gross domestic product (GDP) in the postwar period. Between 1962 and 2000, corporate equity value relative to GDP nearly doubled. In this paper, we determine what standard growth theory says the equity value should be in 1962 and 2000, the two years for which our steady-state assumption is a reasonable one. We find that the actual valuations were close to the theoretical predictions in both years. The reason for the large run-up in equity value relative to GDP is that the average tax rate on dividends fell dramatically between 1962 and 2000. We also find that, given legal constraints that effectively prohibited the holding of stocks as reserves for pension plans, there is no equity premium puzzle in the postwar period. The average returns on debt and equity are as theory predicts.
Keywords: No keywords provided
JEL Codes: G12; H30; E13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| average tax rate on dividends (H29) | corporate equity valuations (G39) |
| reduction in average tax rate on dividends (G35) | doubling of corporate equity value relative to GDP (G39) |
| legal changes allowing pension funds and nontaxpaying entities to hold corporate equity (G23) | increase in corporate equity valuations (G39) |
| passage of ERISA in 1974 (G52) | substantial rise in equity holdings by nontaxpaying entities (H29) |
| changes in tax and regulatory frameworks (H29) | absence of equity premium puzzle (G19) |