Climate Risk and Capital Structure

Abstract

We use new data that measure forward-looking physical climate risk at the firm level to examine the impact of climate risk on capital structure. We find that greater climate risk leads to lower leverage in the post-2015 period, i.e., after the Paris Agreement. Our results hold after controlling for firm characteristics known to determine leverage, including credit ratings. Our evidence shows that the reduction in leverage related to climate risk is shared between a demand effect (the firm’s optimal leverage decreases) and a supply effect (lenders increase the spreads when lending to firms with the greatest risk).

Keywords: Climate change, Paris Agreement, capital structure, leverage, natural disasters, credit rating, cost of debt, CSR

JEL Classification: G18, G2, G32, Q54