Weathering the policy storm: How climate strategy volatility shapes corporate total factor productivity

Abstract

Changes in climate policies have become a critical consideration for businesses, necessitating strategic adaptation and innovation in the face of evolving regulations to achieve long-term success. This study investigates the impact of climate policy uncertainty (CPU) on firm-level total factor productivity (TFP) using a dataset comprising 5954 North American listed companies from 2000 to 2019. Our findings demonstrate a significant negative relationship between CPU and firms' TFP. Particularly, firms operating in the secondary sector, with higher credit ratings, smaller Tobin's Q, and greater profitability, experience more significant negative effects from CPU. The mechanisms through which CPU operates include cost escalation, reduced turnover, and constrained investment. Employing the Local Projection Instrumental Variable (LP-IV) method, we observe that the relationship between CPU shocks and firm-level TFP is time-varying. The adverse effect of CPU on TFP is most severe in the third year following the occurrence of the shock. To mitigate the negative consequences, governments should enhance the continuity and foresight of climate policies, while firms need to effectively identify and manage climate risks to bolster their resilience in the face of uncertainty.