Lost in the Weather Forecast: The Effect of Climate Risk on Firm Performance and Managerial Choices – An International Comparison
Posted: 4 Sep 2014
Date Written: September 2, 2014
Abstract
This paper examines the implications of a country’s climate risk on firms’ performance, financial policies, and financial accounting and tax choices. We measure a country’s climate risk using the Global Climate Risk Index (Harmeling and Eckstein, 2013), which captures the extent of a country’s weather-related losses. Based on the sample period of 1993-2012, we show that firms in countries with greater climate risk have lower and more volatile accounting and cash earnings. Consistent with holding cash to hedge against the earnings volatility induced by the climate risk, these firms also hold more cash and are less likely to distribute cash dividends. Moreover, we contend that severe climate events and the corresponding lower and more volatile earnings provide managers with incentives and opportunities to engage in accounting and tax management. Consistent with this conjecture, our cross-country analysis indicates that climate risk is positively associated with the levels of discretionary accruals and tax avoidance. Finally, we provide evidence that banks price the climate risk into the borrowing cost by charging a higher cost of debt capital for firms in countries with greater climate risk. Overall, we provide initial evidence that climate risk influences a firm’s performance and managerial choices based on our international comparisons. This has potentially important implications given the advent of increasingly risky climate conditions in the future.
Keywords: climate risk, earnings volatility, earnings management, tax avoidance
JEL Classification: F01, M40
Suggested Citation: Suggested Citation