The Impact of Climate Risk on Firm Performance and Financing Choices: An International Comparison

How does climate change impact firms' financing choices?

In The Impact of Climate Risk on Firm Performance and Financing Choices: An International Comparison, Henry He Huang, Joseph Kerstein, and Chong Wang examine the impact of climate risk on public firms' performance and financing choices.

They analyse 353,906 firm-years from 55 countries over 20 years (1993-2012) to conclude that:

• Firms in countries with higher climate risk have poorer economic performance.
• Moving from the first to third quartile of Germanwatch e.V.'s annual Climate Risk Index score, which captures country-level losses from extreme weather events, reduces a firm's return on assets by 1.8%.
• The effect of climate risk on firm performance varies across industries by inflicting various levels of physical damage and disrupting operational processes.
• Higher climate risk is associated with more volatile earnings and operating cash flows, consistent with extreme weather events disrupting business operations.
• Firms in high-climate-risk countries tend to hold more cash, have less short-term debt but more long-term debt, and are less likely to distribute cash dividends.

This study provides evidence of climate risk as a significant exogenous source of earnings and cash flow volatility.

It highlights the need to consider climate risk in financial policies and decisions, particularly in cash management and debt structuring.

A limitation of this study is its reliance on country-level climate risk measures, which may not fully capture firm-specific exposures or the potential benefits some industries may derive from climate change.