Weathering the past: Firms' risk responses to climate shocks

This paper investigates firms' risk reactions to lagged weather extremes, using corporate cash holdings as an indicator of perceived risk. Analyzing more than 700,000 firm-year observations of global listed firms over 34 years matched with high-resolution weather data, we document significant heterogeneity and asymmetry in these reactions. Firms tend to increase cash holdings following lagged extreme heat and excessive rainfall, while decreasing them after extreme cold and rainfall deficits. Mechanism tests reveal that these adjustments are fundamentally driven by attention-based behavioral biases rather than traditional corporate finance motives, with internal cash serving as the strictly preferred adjustment margin over alternative financial instruments. Furthermore, capital markets selectively discipline these behaviors by penalizing cash increases following extreme heat and excessive rainfall, as well as cash reductions after rainfall deficits. However, this investor penalization stems primarily from an initial market-wide misperception of climate risks rather than managerial agency conflicts. Finally, machine learning projections demonstrate that firms in developing countries maintain cash reserves significantly below advanced benchmarks, revealing a critical preparedness gap that exacerbates their vulnerability to climate-induced risks.