Drought risk and capital structure dynamics

Thao Nguyen, Min Bai (), Greg Hou and Cameron Truong

Accounting and Finance, 2022, vol. 62, issue 3, 3397-3439

Abstract: 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.

Date: 2022
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