The Impact of Climate Disasters on the Cost of Equity Capital: Evidence from China

Abstract

Climate change increases the probability and intensity of disaster and brings adverse impacts on social and economic activities. This paper presents the impact of climate risk on the cost of equity capital (COE) and sheds light on the influence mechanisms and moderating factors between climate disaster shocks and the COE in a developing country. We first explain how climate risk represented by drought impacts the COE theoretically. Using the sample data listed in A-share market from 2004 to 2019, we find that drought leads to the rise of the COE due to the deterioration of information environment and the rise of business risk. Specifically, the influence mechanism is tested, and the results show that 1) drought increases firms’ real earnings management 2) and drought has a negative impact on the firms’ return on asset (ROA). Namely, the influence mechanism of drought on the COE is that drought changes the firms’ information environment and business activities. Further analysis shows that the impact of drought on the COE is different in a heterogeneous firm. The drought has a significant impact on the COE in firms with low-ability managers, state-owned enterprises, and politically connected firms, but the impact is not significant in firms with high-ability managers, non-state-owned enterprises, and nonpolitically connected firms. Our research helps people to understand the consequences of climate change from the microeconomic-level firm’s perspective.