Extreme Weather Events and Discretionary Spending
48 Pages Posted: 12 Jul 2022 Last revised: 23 Dec 2023
Date Written: December 20, 2023
Abstract
This study examines the impact of extreme weather events on firms’ discretionary spending. Based on prior research, we expect weather events to impose unexpected costs on firms, which thus likely affects managers’ ability to meet short-term financial goals within the confines of normal operations. Additionally, extreme weather has been shown to induce significant long-run uncertainty for affected individuals, and extant theory suggests that individuals facing this type of uncertainty often make more short-term-focused decisions. Accordingly, we predict that firms exposed to more extreme weather will respond through reductions in discretionary spending. We focus on discretionary spending cuts because this is a plausible response to offset unexpected weather-related costs and is a well-established strategy for meeting short-term financial goals. We employ a difference-in-differences empirical design and document an association between extreme weather exposure and abnormal discretionary expenditure cuts. We also find that this relation varies predictably with several cross-sectional factors, including firms’ susceptibility to cost and uncertainty shocks, external monitoring, and managerial incentives. Further, we find evidence that extreme weather events impact both myopic spending cuts (i.e., cuts likely reflecting managerial short-termism) and prudent spending cuts (i.e., cuts likely reflecting strategic business decisions). Finally, we document that extreme weather exposure is associated with an increased incidence of “just meeting” earnings benchmarks and a reduction in innovative output. This study provides new evidence on how firms respond to the growing threat of weather events. More broadly, our findings add to the literature on the capital market consequences of climate-related risks.
Keywords: Extreme weather events, discretionary expenditures, innovation outputs, managerial myopia, climate risks.
JEL Classification: G32, M12, M40, M41, O32, Q54
Suggested Citation: Suggested Citation