Is drought risk priced in private debt contracts?

Do, Viet; Nguyễn, Thu Hà; Truong, Cameron; Vu, Tram

doi:10.1111/irfi.12294

Cited by 23 publications

(14 citation statements)

References 29 publications

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“…Our main finding is consistent with several contemporary developments in the literature on the impact of climate risk. Because banks consider drought as a relevant type of credit risk (Cogan, 2008), banks can develop strategies to deal with drought threat, which in turn increases their lending rates (Do et al ., 2021). From the perspective of firms, they lower their debt to mitigate the overall risk and find other cheaper financing sources.…”

Section: Discussionmentioning

confidence: 99%

“…(2020) show that drought episodes can significantly increase a firm’s implied cost of equity capital and risk profile while Do et al . (2021) report that loan spreads are significantly higher when firms operate in drought‐affected areas. On the basis that auditors are concerned with climate risk, Truong et al .…”

Section: Literature Review and Hypothesis Developmentmentioning

confidence: 99%

“…First, due to the significant impacts of climate risk on economic and social activities, banks take into consideration climate risk in their risk management strategies (Cogan, 2008; Chen and Wang, 2012) and may reduce the amount of debt that they can lend to firms in drought‐affected areas. Moreover, they also charge higher costs for firms in drought areas than those in non‐drought areas (Do et al ., 2021). From the firm’s perspective, as drought is seen as the most disastrous out of all‐natural disasters resulting from climate change, firms should reduce leverage to mitigate their heightened overall risk levels.…”

Section: Literature Review and Hypothesis Developmentmentioning

confidence: 99%

“…In addition, Monnin (2018) also argues that due to the financial losses and inadequate credit quality of the deteriorated collateral assets, the central bank highlights the climate risk for the credit risk ranking. 5 Empirical evidence from Do et al (2021) shows that banks indeed charge firms operating in drought-affected areas higher borrowing costs. Because the cost of debt directly affects our variables of interest, drought can influence both capital structure and SOA through the channel of banking activities.…”

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confidence: 99%

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Drought risk and capital structure dynamics

Nguyen

Bai

Hou

et al. 2021

Accounting & Finance

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Using a fractional dependent estimator (DPF) approach and 130,511 US firm‐year observations over the period 1970–2015, this paper examines the impact of drought risk on firms’ capital structure and the adjustment speed of capital structure (SOA). We demonstrate that drought risk has negative effects on both leverage and the speed of leverage adjustment. We also find evidence of the spillover effect of drought on the adjustment speed of capital structure among firms operating in non‐water dependent industries. The effects are stronger for firms with no credit ratings. Interestingly, firms with strong cash flows can adjust their capital structure more quickly. Collectively, our findings suggest that climate risk in the form of drought not only affects firm risk but also the capital structure of firms, thereby highlighting that externality from climatic conditions are relevant to business operations and corporate polices.

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Section: Discussionmentioning

confidence: 99%

Section: Literature Review and Hypothesis Developmentmentioning

confidence: 99%

Section: Literature Review and Hypothesis Developmentmentioning

confidence: 99%

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confidence: 99%

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Drought risk and capital structure dynamics

Nguyen

Bai

Hou

et al. 2021

Accounting & Finance

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“…Physical risks also seem to impact the risk perceived by banks. Do et al (2020) investigated how the credit rating and risk premium of corporate borrowers correlated with drought risk. They studied private bank loans from the period 1984-2016 in the US and compared the loan spread to a drought index.…”

Section: Climate Related Credit Riskmentioning

confidence: 99%

Evaluating physical climate risk for equity funds with quantitative modelling – how exposed are sustainable funds?

Wiklund

2021

Journal of Sustainable Finance & Investment

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The climate system is undergoing rapid changes because of anthropogenic emissions of greenhouse gases. The effects from a warmer climate are already noticeable today with more frequent extreme weather events. These extreme weather events have financial consequences and pose risks to the financial system. This study evaluates such physical climate risks for the periods 2021-2025 and 2026-2030 by developing a quantitative model. Physical risks are here limited to heat waves, heavy precipitation events, drought and tropical cyclones. The model applies climate data from CMIP5 to evaluate hazard intensity at the location of a company. Vulnerability of the certain hazard is determined based on the sector. Physical risks from supply chain relations are also considered. The result is then aggregated on portfolio level. The model is applied to compare the exposure of physical climate risks on sustainable equity funds with the exposure on the general market and to determine what characteristics that contribute to low respectively high climate risks.Generally, the total climate risk proves to be lower for the period 2021-2025 compared to 2026-2030 because of the natural variability in the climate system. Europe has the lowest climate risk, and the GICS-sector with the highest risk is Real Estate. No clear conclusion can be drawn in the comparison of physical risk exposure between sustainable funds and the market; however, the result indicates that sustainable funds select securities of lower risk within a specific investment universe. The average sustainable funds select equities with lower risk within regions, sectors and market cap sizes in almost all studied cases. Regional allocation proves to be important for the exposure to physical climate risks. This is also related to market cap size since larger companies are likely to have their assets distributed in several countries which contributes to diversification. On fund level, the strategy of carbon minimising is shown to have no significant impact on physical climate risks, neither positively nor negatively.The awareness among investors on physical climate risks is currently low, and sustainability labels seem to offer no guarantee for minimising physical risk exposure. This study adds to the very small pool of studies on physical climate risks in investment management and provides a market wide overview. Hopefully, development of this research area can contribute to increase the awareness of investors and thereby drive capital towards a more resilient society.

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Climate change performance and financial distress

et al. 2022

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Given the crucial role that environmental accounting plays in sustainable development, this study investigates the relationship between climate change disclosure performance (CCDP) and financial distress as well as the moderating impact of litigation, the existence of a risk committee, the employment of Big4 auditing firms and the level of audit fees. Utilising a sample of the top 300 Australian Securities Exchange (ASX)‐listed non‐financial firms over the period 2008–2019 and ordinary least squares (OLS) regression analysis with fixed effects, it is found that higher levels of CCDP are related to lower levels of financial distress. Additionally, the significant association between CCDP and financial distress is manifested in firms with low litigation risk, firms with a risk committee, firms that employ Big4 auditing firms and firms that incur a higher level of audit fees. Additional tests that mitigate self‐selection and endogeneity, such as propensity score matching (PSM) and the system generalised method of moments (GMM), show that our findings are robust. Finally, our findings shed light on managers' strategic behaviour in relation to the consideration of, and transparency around, climate change risks.

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Is drought risk priced in private debt contracts?

Cited by 23 publications

References 29 publications

Drought risk and capital structure dynamics

Drought risk and capital structure dynamics

Evaluating physical climate risk for equity funds with quantitative modelling – how exposed are sustainable funds?

Climate change performance and financial distress

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