Extreme rainfall and corporate leverage dynamics: evidence and theory

Extreme precipitation events have become more frequent and severe in recent years, leading to devastating natural disasters around the world. This paper investigates the impacts of extreme rainfall on corporate leverage dynamics. We find that the increase of extreme precipitation brings about a significant drop in firm’s leverage. The channel tests show that extreme rainfall would generate the recession of firm’s balance sheet and thus tighten the financing constraints, inducing firm to cut down leverage. On the other hand, intense rainfall would depress the land price and heighten local government’s debt risk, which crowds out the credit resources allocated to private sector, contributing to the deleveraging of firms. Simulations from the new Keynesian DSGE model with extreme rainfall shock and local government land finance system, lend further support to our empirical findings. Furthermore, our model shows that the welfare cost of extreme rainfall risk can amount to 2.2% of the agent’s lifetime utility. Lower welfare cost can be achieved by accommodating monetary policy and active fiscal policy.