Climate Change Exposure and the Discipline of Capital Structure: Evidence From Managerial Leverage Distortion

ABSTRACT This study examines how climate change exposure affects corporate financing behaviour through the lens of managerial leverage distortion (MLD), defined as the absolute deviation of observed leverage from a benchmark implied by firm fundamentals. Using a large panel of the US firms and high‐dimensional fixed‐effects models with firm‐ and year‐fixed effects, the study finds that climate change exposure is associated with significantly lower MLD, indicating more disciplined, fundamentals‐aligned capital structure decisions. The effect is primarily driven by reductions in under‐leverage distortions, consistent with precautionary financial behaviour. The study documents that managerial incentives, business strategy and firm‐level risk conditions moderate this relationship, with weaker effects in high‐incentive and high‐risk environments. Further, the study reveals that higher MLD is associated with poorer firm performance, higher cost of debt and greater investment inefficiency. Overall, the findings suggest that climate risk improves financial discipline by constraining managerial discretion in capital structure decisions.