The Nonlinear Effects of Extreme Temperature Heat Spells on Financial Performance

Abstract

We examine a large sample of EU and UK firms to investigate the impact of extreme high temperature heat spells on three common financial performance measures, namely, the ratios of sales-to-assets, pretax profit margin, and return on assets. Using gridded data from Copernicus, we posit and find that extreme temperature heat spells impact financial performance nonlinearly. While extreme heat spells in normally hot conditions degrade financial performance, the opposite is true for extreme heat spells in normally cool conditions. These responses reveal that financial performance relates to extreme temperature heat spells as a hump shaped curve. For the sample as a whole, the inflection point of the sales-to-temperature hump shape occurs at 23˚C. As an indication of economic impact, for heat spells with a maximum temperature of five degrees above 23˚C, the ratios of sales-to assets, pretax profit margin, and return on assets fall by 2.9 percent, 13.5 percent, and 7.6 percent, respectively. We also find that heat spell duration affects financial performance only by intensifying the effects of temperature rather than having a direct effect itself. Our evidence responds to calls by accounting policymakers and other disclosure advocates for evidence on the effects and risks of acute weather events.

Keywords: Extreme temperature, sales performance, profit margin, nonlinear impact, excess stock return, unlisted firms, heat spell response function

JEL Classification: G14, Q51, Q54