The 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: the ratios of sales-to-assets, pretax profit margin, and return on assets. We posit and find that extreme temperature heat spells impact financial performance curvilinearly. While extreme heat spells in unusually hotter conditions degrade financial performance, the opposite is true for extreme heat spells in unusually cooler conditions. For the sample as a whole, the inflection point of the hump shape curve for the sales-to-asset ratio occurs at about 23˚C. As an indication of economic impact, heat spells with average maximum temperatures of five degrees above 23˚C result in a 2.0 percent decrease in the ratio of sales-to-assets, a 12.9 percent decrease in pretax profit margin, and a 7.7 percent decrease in return on assets. We also find that heat spells with maximum temperatures above 23˚C associate with lower ESG scores and higher emissions in the future, suggesting that managers’ actions to mitigate the risks of heat spells are limited at best. Our evidence of significant impacts supports calls by accounting policymakers for disclosure of the effects of acute weather events and the policies to manage them.

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

JEL Classification: G14, Q51, Q54