Abstract

• First systematic investigation of the effect of climate vulnerability on firms’ cost of capital and access to finance. • Theoretically, shows how climate vulnerability could affect firms’ cost of capital and access to finance. • Constructs new climate vulnerability index and uses panel instrumental variable regressions to address endogeneity problems. • Use of comprehensive firm-level data in panel data regressions and structural equation models. • Sheds light on a hitherto under-appreciated cost of climate change for climate vulnerable developing economies. This article presents the first systematic investigation of the effects of climate-related vulnerability on firms’ cost of capital and access to finance and sheds light on a hitherto under-appreciated cost of climate change for climate vulnerable developing economies. We first show theoretically how climate vulnerability could affect firms’ cost of capital and access to finance. Apart from a possible impact on cost of debt and equity, which drive cost of capital, firms in countries with high exposure to climate risk might be more financially constrained. The latter results in low levels of debt relative to total assets or equity due to restricted access to finance. We then examine this issue empirically, using panel data of 15,265 firms in 71 countries over the period 1999–2017. We invoke panel data regressions and structural equation models, with firm-level data from the Thomson Reuters Eikon database and different measures of climate vulnerability based on the ND-GAIN climate vulnerability index. We construct a new climate vulnerability index and use panel instrumental variable regressions to address endogeneity problems. Our empirical findings suggest that climate vulnerability increases cost of debt directly and indirectly through its impact on restricting access to finance. However, we find limited evidence that climate vulnerability affects cost of equity. Our estimations suggest that the direct effect of climate vulnerability on the average increase in cost of debt from 1991 to 2017 has been 0.63%. In addition, the indirect effect through climate vulnerability’s impact on financial leverage has contributed an additional 0.05%.

Highlights

  • Climate change is having real impact on economies already

  • Climate vulnerability is not independent from macroeconomic conditions, which can cause empirical concerns such as endogeneity. This alleged problem is likely to be more pronounced when using the ND-GAIN climate readiness index, which focuses on economic, governance and social measures. These tend to be highly correlated; an issue we address in our structural equation model

  • The first dependent variable is cost of debt (COD), which we estimate using interest expense in year t divided by total debt reported in period t

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Summary

Introduction

Climate change is having real impact on economies already. the frequency of natural disasters such as droughts, extreme temperatures, floods, landslides and storms, is on the rise (IPCC, 2018). The direct impact of catastrophic natural disasters on economies is empirically well established (e.g., Cavallo, Galiani, Noy, & Pantano, 2013; Felbermayr & Gröschl, 2014; Ferreira & Karali, 2015; Mendelsohn, Kerry, Chonabayashi, & Bakkensen, 2015; Alano & Lee, 2016; Botzen, Deschenes, & Sanders, 2019). Both gradual global warming and natural disasters are associated with. Impacts differ across countries, there is a consensus that the biggest impacts of climate change are being felt in developing countries

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