Climate risks and corporate tax shields

ABSTRACT

This study investigates the influence of climate risks on the tax shields of US-based firms. The findings show a significant negative correlation between climate risks and debt-related tax shields (DTS), indicating reduced reliance on debt financing due to potential financial risks and regulatory uncertainties. Conversely, non-debt tax shields (NDTS) demonstrate a positive relationship with climate risks, highlighting firms’ proactive efforts to seek tax benefits from alternative sources. Additionally, the study uncovers distinct dynamics for high and low-leveraged firms in utilizing tax advantages. The research contributes valuable insights into the intricate interplay of climate risks, tax benefits, and corporate financing decisions.

KEYWORDS:

• Climate risks
• tax benefits
• leverage
• interest rates
• corporate tax rates

JEL CLASSIFICATION:

• G32
• G38
• H20
• Q54

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 The findings of the study are specific to the U.S. context and may not be directly applicable to other countries with different tax systems, regulatory environments, and levels of climate risk.

2 The analysis relies on secondary data sources. While these sources provide comprehensive financial and climate risk exposure data, they may have limitations in terms of coverage or granularity. For instance, certain types of firms or industries may be underrepresented, which could affect the generalizability of the findings.

3 The dataset, including the $\mathrm{CCexposure}$ variable, is publicly available at the provided DOI link https://doi.org/10.17605/OSF.IO/FD6JQ.

4 Higher ROA is typically associated with better financial health, which influences the utilization of tax shields. Firms with higher leverage are expected to use more DTS and less NDTS due to the tax benefits of debt. A wider term spread suggests favorable conditions for long-term borrowing, potentially increasing DTS. Larger firms often have more resources to engage in sophisticated tax planning. Firms with higher cash reserves may have less need to rely on debt for financing. Higher TBQ suggests that firms are investing in growth, which might correlate with higher NDTS. Higher ETR may incentivize firms to seek more tax shields. Firms with higher dividend yields might use different tax strategies to optimize shareholder returns.

5 The primary dependent variables, DTS and NDTS, exhibit temporal dynamics, where past values significantly influence current values. The potential endogeneity between climate risk measures and the dependent variables has been acknowledged. By including the lagged dependent variable, the model accounts for autocorrelation and reduces endogeneity concerns related to omitted variable bias and reverse causality. This approach is aligned with established econometric practices for handling endogeneity in panel data settings. This inherent characteristic necessitates the inclusion of lagged dependent variables, which is naturally and effectively handled by dynamic panel models.

6 The NOAA data on average quarterly temperature for each state can be obtained from https://www.ncei.noaa.gov/access/monitoring/climate-at-a-glance/statewide/time-series

7 The Florida Climate Center website offers extensive details on significant hurricanes that have affected Florida from 1926 to 2022. Access to all pertinent data is available through the following link: https://climatecenter.fsu.edu/topics/hurricanes