Abstract:

Upon a reduction in corporate tax rates, theory tells us that the absolute increase in the value of a firm's equity is increasing in its productivity, while the excess return is related ambiguously to productivity. Using data on the U.S. stock market, I show that the excess returns due news on the latest U.S. tax reform are strongly related to traditional measures of firm profitability and market power. Compared to a firm in perfect competition, my model predicts that a monopolist would see its excess return increased by between 5 and 105 percentage points more upon news of the tax cut. I use this fact to construct a new measure of firm profitability based on its stock market reaction to the Tax Cuts and Jobs Act. My results show that profitability across U.S. firms is distributed with a long right tail, confirming results from a growing literature documenting an increase in mark-ups and a concentration of market power in the U.S. economy.