When Climate Meets Capital: How Climate Risk Constrains Corporate Finance

This research provides novel evidence on the role of climate risk in shaping corporate financial constraints, offering a fresh perspective on how exogenous environmental and regulatory pressures affect firm financing. Using a large sample of U.S. firms from 2002 to 2023, we leverage a text-based firm-level climate risk measure alongside traditional carbon intensity metrics, while financial constraints are captured through Altman’s Z score, Ohlson’s O score, and a textual measure. Our findings reveal that transition risks—stemming from policy, market, technological, and investor pressures—significantly tighten financing frictions, whereas acute physical risks have limited effects. We uncover three novel channels: constrained cash flow, limited customer support, and heightened institutional investor scrutiny. Using a 2SLS approach with state-level population density as an instrument, we provide robust evidence that climate risk causally exacerbates financial constraints. The results underscore the strategic importance of sustainable practices in enhancing financial resilience and offer actionable insights for managers, investors, and policy-makers navigating a rapidly evolving climate landscape.