A long-term shift in the typical weather patterns that have come to characterize local, regional, and global climates on Earth is referred to as climate change. The phrase is synonymous with a wide variety of observed outcomes resulting from these changes. Since the middle of the 20th century, human activity has been responsible for changes in Earth’s climate. Burning fossil fuels, in particular, has increased the amount of heat-trapping greenhouse gases in the atmosphere, which has raised the planet’s average surface temperature. Natural processes, overshadowed by human activity, can also cause climate change. These include external forces like volcanic activity, variations in Earth’s orbit, and changes in the Sun’s energy output, as well as internal variability like cyclical ocean patterns like El Niño, La Niña, and the Pacific Decadal Oscillation. Key indicators of climate change, such as increases in global land and ocean temperatures; rising sea levels; melting of ice in mountain glaciers and at Earth’s poles; variations in the frequency and intensity of extreme weather events like hurricanes, heat waves, wildfires, droughts, floods, and precipitation; and shifts in cloud and vegetation cover, are all demonstrated by climate data records. Despite their frequent interchangeability, the terms “global warming” and “climate change” have different meanings. Similar to this, although they describe occurrences with distinctly different spatial and temporal scopes, the terms “weather” and “climate” are occasionally used interchangeably.
The long-term warming of the Earth’s surface that has been seen since the pre-industrial era (between 1850 and 1900) is known as global warming. It is caused by human activity, mainly the burning of fossil fuels, which raises the atmospheric concentrations of heat-trapping greenhouse gases. There is a difference between “global warming” and “climate change.” The global average temperature of Earth has risen by around 1 degree Celsius (1.8 degrees Fahrenheit) from the pre-industrial era due to human activity; this value is currently rising by more than 0.2 degrees Celsius (0.36 degrees Fahrenheit) every decade. Since the 1950s, human activity has unquestionably contributed to the current warming trend, which is happening at a rate never seen in millennia.
Although there is a vast amount of literature showing the potential macroeconomic repercussions of climate change, business-level empirical research on how climate change affects corporate performance is limited. According to recent studies, nonfinancial firms operating in countries with greater vulnerability to climate change have more difficulty accessing debt financing, even at higher interest rates, and are less productive and profitable than firms in countries with lower vulnerability to climate change. It is widely recognized that uncertainty for 60 years decreases firms’ motivation to employ and invest, as well as consumers’ willingness to spend. However, it is a hazy idea since it expresses ambiguity in the thoughts of consumers, managers, and policymakers about future occurrences (which may or may not occur). It is also a broad concept because it encompasses both macroeconomic phenomena such as GDP growth and microeconomic phenomena such as business growth rates, as well as other events such as elections, wars, and climate change. With an aggregate of investment, production, and employment, new metrics of economic policy uncertainty are connected to firm-level stock price volatility, investment rates, and employment growth. According to theories that emphasize the detrimental impacts of uncertainty shocks on the economy, macroeconomic performance may have suffered as a result of the recent increase in policy uncertainty in the US and Europe. The cross-sectional structure of employment growth, investment rates, and equity volatility is significantly impacted by policy uncertainty.
While global warming started centuries ago, macroeconomic uncertainties have emerged, adversely affecting firms and markets in recent decades. A number of significant issues have surfaced in recent years, leading to political and economic unrest throughout the world, as reviewed in the literature. These started with the “Arab Spring,” which caused political unrest in the Middle East and among the superpowers of the world, and concluded with the US electing Donald Trump, who wants to drastically alter the status quo worldwide. Global uncertainty is increasing as a result of the world’s rapid evolution, which breeds political and economic instability. Relationships inside and between nations have been strained across Europe as a result of events like Russia’s annexation of Crimea and the refugee crisis, which have fueled the emergence of right-wing political ideologies and raised the threat of terrorism. Concerns over unclear policies, particularly those pertaining to economic and financial decisions, are emerging in the aftermath of the recent global financial crisis and the escalating political policy conflicts in the US. This is mostly predicated on the idea that the global financial and economic crisis of 2008, as well as the sluggish recovery that followed, were mostly caused by uncertainty regarding US and European taxation as well as fiscal, monetary, and other regulatory policies. Global economies have become increasingly complex due to factors like rising unemployment and income inequality, migration, and changes in oil prices.
Decisions made by regulators and politicians frequently change the business climate in which companies operate. Businesses frequently deal with a great deal of ambiguity about the timing, nature, and possible effects of policy decisions; thus, it’s critical to look into whether this uncertainty about policy has substantial economic ramifications. Scholars, politicians, and the media have all recently become more interested in this subject, with many analysts claiming that one of the primary causes of the slow recovery from the 2008–2009 financial crisis is the uncertainty created by the political system. Because globalization and technology have changed how we live, uncertainty is greater and more significant than it has ever been. Significant contributors to the recent surge in uncertainty include political polarization, division, and the growing importance of government spending in the economy as a whole. A range of indicators, including input and output pricing, total factor productivity, stock return volatility, dispersion in analyst projections, and firm fundamentals, have been used to quantify the overall uncertainty that businesses confront. Research demonstrates that there is a consistent, inverse link between investment and policy uncertainty. More importantly, climate change has been a long-lasting root of economic conditions and diverse kinds of uncertainty. Over the past decades, climate change has been among the dominant determinants of corporate default risk, where firms are exposed to global warming and climate transition risk in international equity markets.
The emerging field of climate finance is important in resolving the puzzles between firms’ probability to default (PD) and global A recent ground-breaking study shows that world uncertainty incentivizes firms to become greener (e.g., higher environmental innovation and R&D spendings) for the lower corporate cost of debt rewarded by financial institutions worldwide. In the era of global warming, corporate sustainable performance with a lower probability of default is for firms that seriously care about climate risks (e.g., carbon disclosure, higher environmental performance, and fewer ESG controversies).
Hai Hong Trinh is affiliated with the School of Economics and Finance at Massey University, New Zealand, toward a PhD in Finance. He is a research mentor, scientific committee, and executive board member of the British Accounting and Finance Association (BAFA) Annual Conference, Interdisciplinary Perspectives Special Interest Group (IPSIG-BAFA); Scientific Committee Member of the International Finance and Banking Society [IFABS]. Hai is a reviewing committee member of the Sydney Banking and Financial Stability Conference [SBFC] organized by the University of Sydney Business School, Sydney, Australia. He is a regular member of FMA International and the American Finance Association [AFA], United States.
This post was adapted from his paper, “Global Economic Policy Uncertainty, Firms’ Probability to Default, and ESG Ratings in the Era of Climate Change,” available on SSRN.
