Climate Risk Materiality and Firm Risk

Abstract

Managers are required to disclose material climate risk (CR) in Form 10-K, but their decision whether or not to disclose is confounded by the lack of consensus on whether CR is material to the firms, as well as uncertainty about enforcement of disclosure regulations. Using the SASB Materiality Map™ to proxy for market expectations of CR materiality, we test whether the association between disclosing CR in 10-Ks and firm risk (proxied by cost of equity (COE)) varies with market expectations of CR materiality. Using S&P 500 firms’ decisions whether to disclose CR in Form 10-K for 2008 to 2016, we find that disclosing firms’ COE is 27 bps lower than nondisclosers. We also examine whether the association between disclosing CR and COE varies with the market expectations of CR materiality. In industries where the market expects CR to be material, disclosing firms’ COE is 50 bps lower than nondisclosers, while in industries where the market does not expect CR to be material, disclosing firms’ COE is 23 bps lower than nondisclosers. Our results indicate that markets use expectations of CR materiality to infer the credibility of managers’ CR disclosure decisions.

Keywords: Regulation S-K; Form 10-K; Mandatory disclosure; nonfinancial environmental risk; climate change risk; climate-related risk; SEC regulatory enforcement; cost of equity capital; self-selection; propensity score matching; doubly robust regression

JEL Classification: G18, G32, M14, M41