Reportgreen1981

Inflation and the Valuation of Corporate Equities

47 citations0/0 files storedNational Bureau of Economic Research

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Financial Markets and Investment Strategies Financial Analysis and Corporate Governance Financial Reporting and Valuation Research

Abstract

This paper examines the relationship between inflation and the return on individual corporate securities.This question is of substantial importance in light of the puzzling behavior of the stock market over the last decade.Conventional financial theory holds that equity should be a good inflation hedge since it represents a claim of real rather than nominal assets.Yet a negative relationship between both expected and unexpected inflation and stock market returns has been widely documented.This re- lationship, which appears to antedate the surge in inflation over the last 15 years.might provide an explanation for the market's surprising recent performance.This paper studies differences across firms in the response of stock market values to changes in expected inflation in an effort to explore the reasons for the aggregate negative relationship between inflation and stock market values.Two opposing hypotheses about the impact of inflation on market valuation are contrasted.The "inflation illusion" hypothesis holds that investors are not able to see through nominal accounting statements and respond to reported rather than real profits.The opposing "tax effects" hypothesis holds that firms which report spuriously high profits due to inflation are penalized because the extra tax burden incurred reduces real profits.The results from the l970's strongly bear out the predictions of the tax effects hypothesis.Aggregate calculations suggest that the interaction of inflation and taxation can account for a large part of the decline in the stock market which has been observed over the past decade.A significant part of the remainder appears to be due to increasing investor awareness of the need to adjust for historic cost depreciation.

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References

1980Macroeconomics and Reality 1980Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?1977Asset returns and inflation 2021Short- Term Interest Rates as Predictors of Inflation 1981Taxation and Corporate Investment: A q-Theory Approach 1976COMMON STOCKS AS A HEDGE AGAINST INFLATION 1976The "Fisher Effect" for Risky Assets: An Empirical Investigation 1982The Nonadjustment of Nominal Interest Rates: A Study of the Fisher Effect

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2016Hedging inflation with individual US stocks: A long-run portfolio analysis 1988Firm Characteristics, Unanticipated Inflation, and Stock Returns 1999Stock Prices, Expected Returns, and Inflation 2001Reexamining Stock Valuation and Inflation: The Implications of Analysts' Earnings Forecasts 1993RESPONSE OF STOCK PRICES TO MONEY SUPPLY ANNOUNCEMENTS: AUSTRALIAN EVIDENCE 1984Inflation and corporate financial management

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