The University of Florida’s groundbreaking investigation, which meticulously quantified the exposure of corporations to climate change risks, is a significant contribution to the field. It encompasses threats such as hurricanes, wildfires, and climate-related regulations and delves into the profound impact of these risks on market valuations. The study’s key finding – companies that actively manage climate risks outperform those that disregard them-is a crucial insight for investors, corporate executives, financial analysts, and policymakers.

By analysing earnings call transcripts from nearly 5,000 publicly traded companies in the United States, researchers devised innovative metrics to gauge firms’ susceptibility to physical climate risks stemming from extreme weather events and the “transition risks” associated with the global transition towards a low-carbon economy. These transition risks encompass challenges such as adapting to renewable energy sources and reducing carbon emissions. The study uncovered that companies facing significant transition risks, such as regulatory changes impacting emissions, often face devaluation by investors.

Qing Li, Clinical Assistant Professor at the University of Florida Warrington College of Business, elaborated on the shifting landscape of investor attention towards climate change. Li stated, “In recent years, overall investor attention to climate change has increased,” noting that companies heavily exposed to transition risks tend to incur market penalties.

However, this valuation penalty does not extend to companies actively engaged in adapting their business models to mitigate climate impacts. Such proactive firms demonstrate a commitment to sustainability through increased investments in green technologies and sustainable practices. These proactive measures shield them from market devaluation even amidst intensifying transition risks.

Conversely, companies adopting a passive stance towards transition risks often resort to drastic measures such as slashing research and development (R&D) budgets and downsizing when confronted with heightened climate exposure. This reactive approach poses a potential threat to their long-term competitiveness.

Researcher Yuehua Tang, Emerson-Merrill Lynch Associate Professor, highlighted the stark disparity in outcomes between proactive and nonproactive firms. Tang observed, “The divide in strategies and outcomes between proactive and nonproactive firms is quite stark,” emphasising that companies that are transparent about their climate vulnerabilities and proactive in mitigating risks tend to garner favour with markets.

These findings emerge against a backdrop of mounting pressure from investors, regulators, and activists for companies to disclose climate risks publicly. The introduction of new regulations by the Securities and Exchange Commission (SEC) in 2024, mandating public corporations to report climate change impacts and, in some instances, their greenhouse gas emissions, underscores the increasing importance of climate risk management in the business landscape. This regulatory context is crucial for investors, corporate executives, financial analysts, and policymakers to be aware of and prepared for.

While adapting to physical and transitional climate risks incurs business costs, the study led by Li, Tang, Hongyu Shan from the China Europe International Business School, and Vincent Yao from Georgia State University indicates that proactive efforts could potentially enhance valuations and resilience. This finding offers a glimmer of hope, suggesting that companies cannot only survive but thrive in a rapidly evolving market environment by embracing proactive climate risk management. Investors are increasingly factoring climate threats into their investment decisions, amplifying the importance of these efforts.

More information: Qing Li et al, Corporate Climate Risk: Measurements and Responses, Review of Financial Studies. DOI: 10.1093/rfs/hhad094

Journal information: Review of Financial Studies Provided by University of Florida