Corporate Strategies for Managing Climate-Related Financial Risks: An Empirical Study Using Structural Equation Modeling

Abstract

Climate change has become a business risk for companies, impacting revenues, operating costs, asset values, financing conditions, availability of insurance, supply-chain continuity, and enterprise value. The physical risks from floods, heatwaves, droughts, storms and water stress are increasingly interacting with transition risks related to carbon pricing, regulatory change and transition, technological transition, shifting consumer preferences, and transition to low carbon business models. As such, climate-risk management has become an essential part of corporate financial management. This study tested the correlation between corporate climate-risk governance, risk identification and assessment, strategic investment related to climate, climate-risk disclosure, capabilities related to climate-resilience, and financial risk management effectiveness. A quantitative research design was used. The data was gathered using a structured questionnaire with 428 managers and senior professionals involved in roles across finance, risk management, sustainability, strategy, operations and corporate governance. For the assessment of the measurement and structural models, the partial least squares method of structural equation modeling was used. The findings confirmed that climate-risk governance, climate-risk identification and assessment, strategic climate investment, and climate-risk disclosure are significant factors that improve the effectiveness of climate-risk management within companies. Financial risk management effectiveness also had a positive and significant relationship with climate resilience capability. Moreover, the effectiveness of climate-risk management was found to be positively related to corporate financial resilience. The mediation analysis suggested that effectiveness in climate-risk management is the pathway through which the impacts of climate-risk governance, climate-risk assessment, strategic climate investment, and climate-risk disclosure reached financial resilience. The results indicate that companies that take climate into account in their governance, enterprise risk management processes, decisions around capital allocation, scenario analysis, disclosures and operational resilience are more likely to be able to safeguard their financial performance. The study adds to the literature on climate finance for the corporate environment by combining strategic management and financial risk perspectives in a structural equation modeling structure. Results have implications for corporate boards, chief financial officers, risk managers, investors, regulators and policy makers.