Firm characteristics, climate policy shocks, and climate risk exposures: Evidence of feedback loops from a quasi-experiment in GCC countries

We examine how external policy shocks and firm characteristics affect firms' environment-related transition risk exposure (TRE) and physical risk exposure (PRE) in Gulf Cooperation Council (GCC) countries, emphasizing feedback effects among these variables using a dataset of 775 firms from 2005 to 2024. First, we estimate transition and physical risk exposure using the Fama-French five-factor model augmented with global transition and physical risk indices. To disentangle climate-specific exposures from energy-price dynamics, we construct both standard (FF5) and oil-controlled measures, capturing two distinct sources of climate risk in GCC countries. Using seemingly unrelated regressions and system GMM, we document feedback loops between climate risk exposures and firm responses across investment, innovation, and sustainability channels. Firms expand investment under rising transition risk but contract it under physical risk, revealing distinct behavioral mechanisms. When both risks are present jointly, transition risk dominates investment and innovation responses. We also apply a quasi-natural experiment framework to assess the impact of the 2021 introduction of climate policies in the GCC on firms' climate-related risk exposure, using 3297 listed Chinese firms as the control group. We find that GCC firms face greater transition risks but lower physical risks following the 2021 climate initiatives in the GCC. Triple difference-in-differences analysis reveals that investor preference and regulatory pressure serve as the dominant transmission channels.