By Xia Li, Boston University
Businesses around the world are facing increasing physical climate risks. Droughts and heat stress gripped the United States, Europe and China this summer, affecting labor productivity, resource availability and freight transportation. Floods in Pakistan and Australia have halted factory operations and wiped out crops.
How are companies responding to these issues and the growing risks of climate change?
In my recent study, I developed a dataset to measure corporate adaptation to climate change, merged it with climate science data, and examined if and how public companies around the world adapt to exposure to physical climate risk.
Are businesses adapting to physical climate risks?
Most companies do not adapt to the majority of climate risk factors. The average adaptation rate communicated for all companies and climate risks is 23%. Figure 1 shows the likelihood – on average – of SOEs adapting to different climate risk factors.
Several factors can prevent companies from adapting to physical exposures to climate risks:
- Not being able to accurately estimate the long-term impacts of climate change, which cannot be easily calculated based on historical data;
- Not being able to adapt to all climate risk factors because they are broad and adaptation is costly;
- Take a short-term view, leading to less investment at the expense of long-term adaptation benefits; and
- Try to shift adaptation costs to other parties, such as governments.
Figure 1 also suggests that companies are adapting more through operational rather than commercial strategies. This could be because operational measures are relatively quick to implement or less expensive than business strategies, and can be easily justified. On the other hand, changing business strategy is more difficult and time-consuming.
Figure 1: Adaptation to climate change disclosed by climate risk factor
What drives companies to adapt to physical climate risks?
Businesses are sensitive to the type of physical climate risks they face and their level of exposure to them. On average, they are more likely to adapt more often and more fully to higher climate risks affecting their own business.
However, the relationship between climate risk and adaptation varies across regions and industries, and changes over time:
- Companies headquartered outside Europe and North America are not sensitive to the climate risks that affect them the most;
- Companies in the real estate sector face the highest overall level of climate risk, and those in the energy and utilities sector have the highest rate of adaptation; and
- Businesses become more responsive to elevated climate risks over time, especially for adaptations categorized as business strategies.
Exposure to physical climate risk is not the only driver of companies’ adaptation strategies. Other factors, such as companies’ ESG performance, can influence their willingness and ability to adapt. Figure 2 illustrates this relationship. The organizational resources obtained by companies to improve their environmental and social impacts are linked to adaptation to climate change and prepare them to adapt further in the face of higher climate risk.
Figure 2: Physical climate risk, adaptation to climate change and ESG performance
What are the political and managerial implications?
My study offers insights for policy makers, business leaders and investors.
Environmental policies have traditionally focused on regulating the environmental impacts of businesses, such as reducing pollution. In recent years, governments have attempted to mitigate the effects of climate change by introducing carbon pricing or setting targets for reducing greenhouse gas emissions. Yet climate change adaptation policies are rare, as regulators generally expect companies to have the foresight to pursue adaptation strategies as an obvious preventative measure.
The results of this study suggest that although companies are sensitive to their own type and level of exposure to climate change, they do not always adapt automatically. How companies adapt is influenced by factors such as their adaptive capacity and how they perceive climate risks. Adaptation policies that guide and encourage businesses to cope with the impact of climate change are therefore needed.
The various adaptation strategies listed in the study can help business leaders identify best practices or benchmark their own risk management policies and adaptation measures against those of their peers and competitors.
The results can also inform investors about the climate risk exposures their portfolio companies face and the coping strategies they have adopted. This information can help them manage the overall risk exposure of their investment portfolio and allocate capital more effectively.
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