Y. Chang et al.
Journal of Banking and Finance 166 (2024) 107233
cash outflows from firms.3 Kahle and Stulz (2021) report that from 2000
to 2017, firms in the United States (US) paid their shareholders over 10
trillion US dollars (USD), including 4.2 trillion USD in dividends and 6.6
trillion USD in share repurchases. While the main purpose of payouts is
to distribute cash back to shareholders, the level and form of payouts
influence the firm’s financial flexibility and risk. Bonaimé et al. (2014)
suggest that lower payouts or more repurchases relative to dividends
allow firms more financial flexibility in managing the risk of underin­
vestment and financial distress. The rationale is that a lower level of
payouts allows firms to conserve more cash, and a payout mix favoring
repurchases over dividends offers firms the flexibility to reduce or omit
payouts (repurchases) in the future without worrying about the rigidity
associated with dividends. Consistent with this view, prior studies have
shown that payout flexibility is related to financial hedging (Bonaimé
et al., 2014), litigation risk (Arena and Julio, 2023), future cash flow
volatility (Michaely et al., 2021), fixed cost structure (Kulchania, 2016),
the degree of coinsurance among the divisions of a conglomerate (Jor­
don et al., 2018), financial distress risk (Andriosopoulos et al., 2021),
and financial flexibility (Bonaimé and Kahle, 2024; Kumar and
Vergara-Alert, 2020).
We argue that climate change likely induces future financial risk and
motivates firms to adopt more flexible payout policies to cope with the
risk for two reasons. First, the physical risk of climate change, in the
form of storms, floods, heat waves, droughts, etc., is expected to inten­
sify (IPCC, 2014, 2018). As climate hazards become increasingly
frequent and damaging, firms’ future cash flows and performance are
expected to be impacted more frequently and substantially, increasing
firms’ financial risk. Second, climate change creates transition risk that
arises from constant changes in regulations, policies, technology, and
stakeholder demands. Transition risk will likely elevate firms’ financial
risk due to the corresponding negative regulatory shocks and extra ex­
penses required to implement adaptation strategies (Hsu et al., 2019;
Bolton and Kacperczyk, 2021, 2023). To manage the heightened
financial risk and maintain financial flexibility, firms will likely decrease
their payouts and use more repurchases to increase their payout flexi­
bility and mitigate the impact of future cash shortfalls in response to
climate risk.4
We collect data for 36,373 firms from 45 countries worldwide to
provide empirical evidence on changes in payout policies in response to
climate risk. Following Huang et al. (2018), we measure climate risk
using the global climate risk index compiled and published by Ger­
manwatch, a nonprofit, nongovernmental organization based in Bonn,
Germany. This index captures the extent to which countries and terri­
tories suffer from direct losses (fatalities and economic losses) caused by
extreme weather events, such as storms, floods, and heat waves. As
extreme weather events are likely to recur in the same location,5 the
index provides a country-level measure of potential climate risk in the
future (Kreft and Eckstein, 2014; Huang et al., 2018; Li et al., 2021). The
index starts in 2004; therefore, our sample period spans from 2004 to
2018.
Our initial results show that total payouts (the sum of dividends and
repurchases) are negatively associated with climate risk, consistent with
the expectation that firms make fewer payouts when climate risk is
higher. Furthermore, the likelihood of paying dividends and the
magnitude of dividends are negatively related to climate risk, suggesting
that firms pay fewer dividends in response to high-climate risk;
3
For surveys of the literature on corporate payouts, see Allen and Michaely
(2003), Bonaimé and Kahle (2022), DeAngelo et al. (2007), and Farre-Mensa
et al. (2014).
4
Climate change also allows some firms to develop new technologies or
businesses. Such growth opportunities could lead to further payout reductions,
as firms must invest cash in these new projects.
5
For example, hurricanes repeatedly hit the Philippines and some US states,
while heat waves are becoming increasingly common in Europe.
however, climate risk is positively related to the probability and
magnitude of share repurchases. This contrast between dividends and
repurchases implies that firms substitute dividends with repurchases
when climate risk is high. Consistent with this substitution, the ratio of
repurchases to total payouts is positively related to climate risk,
implying that firms increasingly use repurchases to make payouts to
increase payout flexibility when climate risk increases. These results are
obtained through multivariate regressions where we control for many
firm characteristics, such as cash flow volatility, cash holdings, and
operating performance, and country-level variables, such as the gross
domestic product (GDP) growth rate and the rule-of-law index.
Our results remain consistent after a battery of robustness tests,
including tests using various measures of dividends and repurchases and
different estimation methods (e.g., the Tobit model). Our results also
remain robust when we use a firm-level climate risk measure based on
corporate disclosures developed by Sautner et al. (2023a) and a pre­
dicted climate risk index capturing the extent to which a country will be
exposed to significant climate change in the future.6 Moreover, we
obtain similar results when we include additional control variables, such
as time-varying country characteristics, or use country-year aggregate
payout measures to align with the country-level climate risk index.
Regarding economic significance, the estimated coefficients show that a
one-standard-deviation increase in the climate risk index leads to a 4.4
% decrease in dividends, a 2.4 % increase in repurchases, and a 1.2 %
increase in the ratio of repurchases to total payouts.
To provide causal evidence on the impact of climate risk on payout
policies, we follow Li et al. (2021) and investigate several major
weather-related disasters worldwide. The World Meteorological Orga­
nization lists the top 20 climate disasters in terms of fatalities and eco­
nomic losses on each continent since 1970. From this list, we identify 15
disasters during our sample period and classify the firms in the
disaster-hit countries as treatment firms. We use a staggered
difference-in-differences (DiD) design, determining that treatment firms
pay fewer dividends, repurchase more shares, and increase their
repurchase-to-total payout ratios in the years after disasters than control
firms in countries unaffected by these disasters. The evidence supports
our prediction that firms increase payout flexibility by substituting
dividends with repurchases when their vulnerability and exposure to
climate risk increase. A dynamic test shows that the substitution does
not appear in the 3 years before the disasters but has a long-term effect
lasting for at least 3 years after the disasters.
We further conduct two additional DiD tests focusing on the 2005
Hurricane Katrina (one of the 15 most severe disasters in our sample)
and US firms. In the first test, we identify the states affected by Hurri­
cane Katina based on the numbers of deaths and injuries. We find that
compared to firms in unaffected areas, firms in affected states signifi­
cantly increase their payout flexibility during the 3 years after the storm.
In the second test, we measure the distance between a firm’s location
and the closest county that was most severely affected by Hurricane
Katrina. We divide firms into the NEAR and FAR groups based on the
sample median value of distance and find that payout flexibility in­
creases much more for firms that are close to the disaster location in the
postevent years.
We examine two possible channels—operating volatility and finan­
cial constraints—to better understand how the impact of climate risk
transfers to firms’ payout flexibility, measured as the ratio of
repurchases to total payouts. Our main argument is that in response to
climate risk, firms increase their payout flexibility to manage the
heightened future financial risk and maintain financial flexibility; thus,
we deem these two channels particularly relevant. Firms with higher
operating volatility (computed as the standard deviation of return on
6
While the two country-level climate risk measures focus on the physical risk
of climate change, the firm-level climate risk measure developed by Sautner
et al. (2023a) captures both the physical and transition risks of climate change.