Climate change poses the best risk to the most defenseless peoplethe same applies to companies: highly leveraged companies – that is, those that have collected an excessive amount of debt – are extremely vulnerable to climate shocks. That’s what we present in one other study published in The Review of Corporate Finance, which analyzed data from: over 2,500 publicly traded US companies over 16 years old.
As professors who study climate financing AND corporate governancewe wanted to know how climate change affects businesses and the way stakeholders – individuals who share in the company’s success, e.g. consumers, employees and investors, reply to it.
So us and our colleagues Zadok El Ghoul at the University of Alberta and Omrane Guedhami at the University of South Carolina conducted a study to look at how climate risk affects indebted companies.
We find that climate change has a double impact on highly leveraged firms by increasing the costs that stakeholders impose on them.
Consider consumers. Scientists know that climate change can prompt people to change their purchasing patterns – for instance, by buying greener products or engaging in boycotts. And while changing consumer preferences pose challenges for all businesses, an organization that is deeply in debt has a harder time adapting.
Our study suggests as much. We found that two years after intense exposure to climate change, highly indebted companies saw sales growth decline by a mean of about 1.4%. In monetary terms, this translates into a mean lack of $59.7 million per company.
We found that climate change also worries investors. Companies exposed to climate risk face the threat of economic and operational disruption that could drain lenders’ resources, particularly for companies already burdened by high debt. Examining capital issuance in our sample of companies, we found that climate exposure reduced firms’ net debt issuance – that is, recent debt minus retired debt – by a mean of about $457 million per firm. This is an extra obstacle for indebted companies trying to lift money.
Why is it necessary?
Researchers have long known that indebted companies usually tend to experience product failures and losing market share when economic conditions go south. As some analysts say, an excessive amount of debt may even force companies to exit of business happened with Toys R Us.
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Our research shows that climate change, which the World Economic Forum predicts will pose a threat by 2100 about 2% of world financial assets, will push already fragile businesses over the edge. It highlights the enormous and asymmetric effects that global warming can have on businesses, in addition to the reality that the most vulnerable companies will endure the worst.
What’s next
Our research highlights the disproportionate impact of climate change on financially fragile businesses. In the future, we plan to research the impact of climate change on companies’ business behavior, especially in ethical terms.
When it involves climate solutions, one among us (Huan Kuang) showed how companies can use innovation to cut back their vulnerability to climate change. IN working document co-authored with Bing Liang from the University of Massachusetts Amherst found that every 1% increase in climate-related innovation – as measured by patent data – reduces the growth of company-level greenhouse gas emissions by roughly 100,000 metric tons.
However, indebted companies cannot rush to speculate in recent technologies without incentives. This means that policy incentives shall be key to success and further research is required to find out what these should appear to be.
Climate change might also have more complicated economic impacts than many individuals realize. For example, if it forces unprofitable companies to exit of business, that could be good for the economy – a minimum of in theory, as one among us (Ying Zheng) identified in a recent article on a related topic.
Many questions remain unanswered, but it surely is already clear that climate change can have a crucial and multi-faceted impact on the way forward for business. We encourage other researchers to conduct further research.